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:
March 31, 2003 0-10211
INTER-TEL, INCORPORATED
Incorporated in the State of Arizona I.R.S. No. 86-0220994
1615 S. 52nd STREET
TEMPE, ARIZONA 85281
(480) 449-8900
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Title of Class Outstanding as of March 31, 2003
-------------- --------------------------------
Common Stock, no par value 24,926,167
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No[ ]
INDEX
INTER-TEL, INCORPORATED AND SUBSIDIARIES
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Condensed consolidated balance sheets--March 31, 2003
and December 31, 2002 3
Condensed consolidated statements of income--three
months ended March 31, 2003 and March 31, 2002 4
Condensed consolidated statements of cash flows--three months
ended March 31, 2003 and March 31, 2002 5
Notes to condensed consolidated financial
statements--March 31, 2003 6
Item 2. Management's Discussion and Analysis of Financial 13
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 2. Changes in Securities and Use of Proceeds 32
Item 3. Defaults on Senior Securities 32
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 33
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 34
MANAGEMENT CERTIFICATIONS 35
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
(in thousands, except share amounts) 2003 2002
(Unaudited) (Note A)
--------- ---------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 76,226 $ 84,923
Short-term investments 55,372 40,916
--------- ---------
Total cash and short-term investments 131,598 125,839
Accounts receivable, net of allowances of $11,823 in 2003 and
$12,159 in 2002 37,681 42,566
Inventories, net of allowances of $9,273 in 2003 and
$10,558 in 2002 11,405 11,329
Net investment in sales-leases, net of allowances of $511 in 2003 and
$516 in 2002 13,884 13,344
Income taxes receivable 700 2,604
Deferred income taxes 3,184 2,377
Prepaid expenses and other assets 7,942 6,705
--------- ---------
TOTAL CURRENT ASSETS 206,394 204,764
PROPERTY, PLANT & EQUIPMENT 23,734 24,795
GOODWILL 17,646 17,646
PURCHASED INTANGIBLE ASSETS 6,933 7,416
NET INVESTMENT IN SALES-LEASES, net of allowances of
$1,486 in 2003 and $1,411 in 2002 25,585 24,692
OTHER ASSETS 165 2,749
--------- ---------
$ 280,457 $ 282,062
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 22,653 $ 23,089
Other current liabilities 42,963 50,051
--------- ---------
TOTAL CURRENT LIABILITIES 65,616 73,140
DEFERRED TAX LIABILITY 18,059 16,320
LEASE RECOURSE LIABILITY 11,219 11,125
RESTRUCTURING RESERVE 799 1,049
OTHER LIABILITIES 6,589 6,525
SHAREHOLDERS' EQUITY
Common stock, no par value-authorized 100,000,000 shares;
issued-27,161,823 shares; outstanding-24,926,167 at
March 31, 2003 and 24,908,983 shares at
December 31, 2002 111,679 111,639
Less: Shareholder loans (312) (338)
Retained earnings 93,574 89,643
Accumulated other comprehensive income 266 195
--------- ---------
205,207 201,139
Less: Treasury stock at cost - 2,235,656 shares in 2003
and 2,252,840 shares in 2002 (27,032) (27,236)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 178,175 173,903
--------- ---------
$ 280,457 $ 282,062
--------- ---------
See accompanying notes.
3
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended March 31,
(In thousands, except ----------------------------
per share amounts) 2003 2002
-------- --------
NET SALES $ 84,169 $ 90,070
Cost of sales 40,095 45,016
-------- --------
GROSS PROFIT 44,074 45,054
Research & development 5,234 4,317
Selling, general, and administrative 31,246 30,657
Amortization of purchased intangible assets 428 257
-------- --------
36,908 35,231
-------- --------
OPERATING INCOME 7,166 9,823
Litigation settlement (net of costs except for taxes) -- 15,302
Write-down of investment in Inter-Tel.NET/Vianet -- (600)
Interest and other income 443 439
Foreign currency transaction losses (40) (84)
Interest expense (32) (34)
-------- --------
INCOME BEFORE INCOME TAXES 7,537 24,846
Income tax provision 2,865 9,451
-------- --------
NET INCOME $ 4,672 $ 15,395
-------- --------
NET INCOME PER SHARE
Basic $ 0.19 $ 0.64
Diluted $ 0.18 $ 0.60
-------- --------
DIVIDENDS PER SHARE $ 0.03 $ 0.02
-------- --------
Weighted average basic common shares 24,920 24,179
Weighted average diluted common shares 26,039 25,550
-------- --------
See accompanying notes.
4
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31,
----------------------------
(In thousands) 2003 2002
-------- --------
OPERATING ACTIVITIES
Net income $ 4,672 $ 15,395
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation of fixed assets 1,798 1,879
Amortization of patents included in R&D expenses 55 55
Amortization of goodwill and purchased intangible assets 428 257
Provision for losses on receivables 933 856
Provision for losses on leases 1,120 1,606
Provision for inventory valuation 80 149
Decrease in other liabilities (1,031) (871)
Loss on sale of property and equipment 37 16
Deferred income taxes 932 148
Effect of exchange rate changes 70 280
Changes in operating assets and liabilities (2,033) 12,777
-------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 7,061 32,547
-------- --------
INVESTING ACTIVITIES
Purchases of short-term investments (33,153) (7,000)
Maturities and sales of short-term investments 18,698 1,000
Additions to property and equipment and equipment held
under lease (837) (1,250)
Proceeds from disposal of property and equipment 63 66
Cash used in acquisitions -- (8,000)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (15,229) (15,184)
-------- --------
FINANCING ACTIVITIES
Cash dividends paid (747) (449)
Treasury stock purchases (9) --
Payments on term debt (13) (268)
Proceeds from exercise of stock options, including
shareholder loan repayments 240 296
-------- --------
NET CASH USED IN FINANCING ACTIVITIES (529) (421)
-------- --------
INCREASE (DECREASE) IN CASH
AND EQUIVALENTS (8,697) 16,942
-------- --------
CASH AND EQUIVALENTS AT
BEGINNING OF PERIOD 84,923 58,795
-------- --------
CASH AND EQUIVALENTS AT END OF PERIOD $ 76,226 $ 75,737
-------- --------
See accompanying notes.
5
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2003
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 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 months ending March 31, 2003 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2003. The balance sheet at December 31, 2002 has been derived from
the audited financial statements at that date, but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States 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, 2002.
Certain prior year amounts have been reclassified to conform with the current
period presentation.
STOCK-BASED COMPENSATION
In 2002, the Financial Accounting Standards Board ("FASB") issued Statement
No. 148 "Accounting for Stock-Based Compensation--Transition and Disclosure, an
amendment of FASB Statement No. 123" ("SFAS No. 148"), which provides
alternative methods of transition for an entity that voluntarily changes to the
fair value based method of accounting for stock-based employee compensation. It
also amends the disclosure provisions of SFAS No. 123 to require prominent
disclosure about the effects on reported net income of an entity's accounting
policy decisions with respect to stock-based employee compensation. Finally,
this statement amends APB Opinion No. 28, "Interim Financial Reporting," to
require disclosure about those effects in interim financial information. We
adopted SFAS No. 148 in the fourth quarter of 2002. Since we have not changed to
a fair value method of stock-based compensation, the applicable portion of this
statement only affects our disclosures.
We do not recognize compensation expense relating to employee stock options
because we only grant options with an exercise price equal to the fair value of
the stock on the effective date of grant. At March 31, 2003, the Company has
four stock-based employee and director incentive plans and an employee stock
purchase plan. The Company accounts for these plans under the recognition and
measurement principles of APB No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Stock-based employee compensation costs
are not reflected in net income, as all options granted under the plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. If we had elected to recognize compensation expense using a fair
value approach, and therefore determined the compensation based on the value as
determined by the modified Black-Scholes option pricing model, the pro forma net
income and earnings per share would have been as follows:
Three Months Ended March 31,
----------------------------
(in thousands, except per share data) 2003 2002
------- -------
Net income, as reported $ 4,672 $15,395
Deduct: total stock-based compensation expense determined
under fair value based method for all awards, net of tax (711) (834)
------- -------
Pro forma net income $ 3,961 $14,561
------- -------
Earnings per share of common stock
Basic - as reported $ 0.19 $ 0.64
Basic - pro forma $ 0.16 $ 0.60
Diluted - as reported $ 0.18 $ 0.60
Diluted - pro forma $ 0.15 $ 0.57
6
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model using the low end of reasonable assumptions
for input variables rather than attempting to identify a best-point estimate.
The option pricing model utilized the following weighted average assumptions for
2003 and 2002, respectively: risk free interest rates of 2.73% for 2003 and
2002; dividend yields of 1.2% for 2003 and 0.75% for 2002; volatility factors of
the expected market price of our stock averaged .59 for 2003 and .576 for 2002.
Employee stock options vest over four to five year periods and director options
vest at the end of six months from the grant date.
NEW ACCOUNTING STANDARDS AND PRONOUNCEMENTS
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES: In 2002, the FASB issued
Statement of Financial Accounting Standards No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). This standard
requires companies to recognize costs associated with exit or disposal
activities when they are incurred, rather than at the date of a commitment to an
exit or disposal plan. Examples of costs covered by the standard include lease
termination costs and certain employee severance costs that are associated with
a restructuring, plant closing, or other exit or disposal activity. We adopted
SFAS No. 146 effective January 1, 2003, to be applied prospectively to exit or
disposal activities initiated after December 31, 2002, and its adoption did not
have any effect on our financial position or results of operations.
ASSET RETIREMENT OBLIGATIONS: In 2001, the FASB issued Statement of
Financial Accounting Standards No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS No. 143"). This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and associated asset retirement costs. We adopted SFAS No. 143 on January
1, 2003 and its adoption did not have any effect on our financial position or
results of operations.
VARIABLE INTEREST ENTITIES: In January 2003, the FASB issued Interpretation
No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB
51" ("FIN 46"). The primary objectives of FIN 46 are to provide guidance on the
identification of entities for which control is achieved through means other
than through voting rights ("VIEs") and how to determine when and which business
enterprise should consolidate the VIE. This new model for consolidation applies
to an entity which either (1) the equity investors (if any) do not have a
controlling financial interest or (2) the equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. We do not expect the adoption
of this standard to have any impact on our results of operations, financial
position or liquidity.
GUARANTEES: In November 2002, the FASB issued Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN 45"). This interpretation
expands the disclosure requirements of guarantee obligations and requires the
guarantor to recognize a liability for the fair value of the obligation assumed
under a guarantee. In general, FIN 45 applies to contracts or indemnification
agreements that contingently require the guarantor to make payments to the
guaranteed party based on changes in an underlying instrument that is related to
an asset, liability, or equity security of the guaranteed party. Other
guarantees are subject to the disclosure requirements of FIN 45 but not to the
recognition provisions and include, among others, a guarantee accounted for as a
derivative instrument under SFAS No. 133, "ACCOUNTING FOR DERIVATIVES AND
HEDGING" ("SFAS No. 133"), a parent's guarantee of debt owed to a third party by
its subsidiary or vice versa, and a guarantee which is based on performance. The
disclosure requirements of FIN 45 were effective as of December 31, 2002. The
recognition requirements of FIN 45 are to be applied prospectively to guarantees
issued or modified after December 31, 2002. Adoption of FIN 45 to has not had
any impact on our results of operations, financial position or liquidity.
CONTINGENCIES. We are a party to various claims and litigation in the
normal course of business. Management's current estimated range of liability
related to various claims and pending litigation is based on claims for which
our management can estimate the amount and range of loss. Because of the
uncertainties related to both the amount and range of loss on the remaining
pending claims and litigation, management is unable to make a reasonable
estimate of the liability that could result from an unfavorable outcome. As
additional information becomes available, we will assess the potential liability
related to our pending litigation and revise our estimates. Such revisions in
our estimates of the potential liability could materially impact our results of
operations and financial position.
7
Divisions of the United States Department of Justice are investigating other
companies' and Inter-Tel's participation in a federally-funded "E-Rate program"
to connect schools and libraries to the Internet. The Justice Department has not
provided Inter-Tel with a description of the evidence on which the
investigations are based. Inter-Tel is presently unable to predict or determine
the final outcome of, or to estimate the potential range of loss (if any) with
respect to, the investigations. Based upon the information known at this time,
we do not expect the investigations to result in a material adverse impact upon
the Company's business or financial condition. If Inter-Tel is convicted of any
crime or subjected to sanctions, or if penalties, damages or other monetary
remedies are assessed against Inter-Tel in connection with these and other
investigations, our business and operating results could be materially and
adversely affected. Nevertheless, the early nature of the investigations makes
it difficult to determine whether the likelihood of a material adverse outcome
is unlikely.
NOTE B--EARNINGS PER SHARE
Diluted earnings per share assume that outstanding common shares were increased
by shares issuable upon the exercise of all outstanding stock options for which
the 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 March 31,
----------------------------
(In thousands, except per share amounts) 2003 2002
------- -------
Numerator:
Net Income $ 4,672 $15,395
------- -------
Denominator:
Denominator for basic earnings per
share - weighted average shares 24,920 24,179
Effect of dilutive securities:
Employee and director stock options 1,119 1,371
------- -------
Denominator for diluted earnings per share - adjusted
weighted average shares and assumed conversions 26,039 25,550
Basic earnings per share $ 0.19 $ 0.64
------- -------
Diluted earnings per share $ 0.18 $ 0.60
------- -------
At March 31, 2003 and 2002, options to purchase 505,350 and 575,600 shares,
respectively, of Inter-Tel stock were excluded from the calculation of diluted
net earnings per share because the exercise price of these options was greater
than the average market price of the common shares for the respective fiscal
years, and therefore the effect would have been antidilutive.
8
NOTE C - ACQUISITIONS, DISPOSITIONS AND RESTRUCTURING 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.
In connection with the McLeod acquisition, we recorded goodwill of approximately
$4.0 million and other purchased intangible assets of $0.5 million, for a total
of $4.5 million. The goodwill balance is being accounted for in accordance with
SFAS 141 and 142. The balances included in other purchased intangible assets
will be amortized over periods ranging from two to five years from the date of
the acquisition. During the quarters ended March 31, 2003 and 2002, the
amortization of purchased intangible assets from McLeod was $38,000 and $25,000,
respectively.
SWAN. On December 3, 2002, Inter-Tel Integrated Systems, Inc., our wholly-owned
subsidiary, acquired 100% of the capital stock of Swan Solutions Limited
("Swan") in England and Wales, for $4.0 million in cash. Of this amount, $3.0
million was paid at closing, $250,000 is payable in six months from the closing
date and $250,000 is payable one year from closing date. The remaining $500,000
is subject to the achievement of five performance milestones triggering the
payment of $100,000 each. As of March 10, 2003, the first of the milestones was
achieved and $100,000 was paid to the Swan shareholders. Payments relating to
the achievement of performance milestones will be charged to expense, in the
period earned, if applicable. The Company recorded amortizable intangible
technology assets totaling $3.4 million in connection with this acquisition.
These technology assets are being amortized over 5 years. During the quarter
ended March 31, 2003, the amortization of purchased intangible assets from Swan
was $172,000.
INTER-TEL.NET/COMM-SERVICES/VIANET. On July 24, 2001, Inter-Tel sold 83% of the
stock of Inter-Tel.NET, Inc. to Comm-Services Corporation for a note of $4.95
million, collateralized by Comm-Services stock, other marketable securities of
the shareholders of Comm-Services and 100% of the net assets of Inter-Tel.NET.
In connection with the sale of 83% of Inter-Tel.NET, we assessed the fair value
of the remaining 17% investment in Inter-Tel.NET. Pursuant to SFAS 121, we
recorded a charge as of the close of the second quarter of 2001 of $5.4 million
($3.4 million after tax) associated with the impairment of our investment in
Inter-Tel.NET. After the impairment charge, the carrying value of our investment
(the note receivable from Comm-Services plus the 17% ownership interest in
Comm-Services) totaled $3.7 million as of December 31, 2001. The charge was
primarily non-cash.
Inter-Tel's management has not participated in the management of Inter-Tel.NET
since the sale in July 2001. As a result, since July 24, 2001, we have accounted
for the remaining Inter-Tel.NET/Comm-Services investment using the cost method
of accounting. On December 30, 2001, Comm-Services entered into a merger
agreement with Vianet. Inter-Tel's 17% investment in Comm-Services was converted
to approximately 10% of Vianet stock and as a result, Vianet assumed the loan
for the purchase and Inter-Tel continued to hold collateral from the former
shareholders of Comm-Services until March 2003. During the first six months of
2002, the net investment in the notes receivable and 10% interest in Vianet
(formerly Comm-Services) was written down by $1.2 million ($600,000 each in the
first and second quarters) and was recorded in other assets at a carrying value
of approximately $2.5 million as of December 31, 2002, which approximated
management's estimate of the related collateral value at that time.
During 1999, 2000 and 2001, Inter-Tel.NET entered into operating lease
agreements totaling approximately $6.5 million from an equipment vendor for
network equipment and software. The lease agreements required Inter-Tel.NET to
purchase vendor maintenance on their products. Inter-Tel originally guaranteed
the indebtedness. In February 2003, we executed an agreement with Vianet and
this vendor releasing Inter-Tel from its guarantee of all of these obligations,
and Inter-Tel and Vianet released the vendor from claims arising from the
failure of the network equipment and software previously leased. As part of this
agreement, Inter-Tel also received payment from the Vianet shareholders of $1.45
million plus certain collateral assets, in exchange for the release of the
remaining collateral and as payment of the loan. Inter-Tel also retained a
9
collateral interest in a Vianet shareholder's variable forward option contract
that matures in July 2003 for an amount up to $250,000. We have not recorded an
asset for this right as the amount is not guaranteed or reasonably estimable
based on the fluctuations of future stock prices. The value received in this
transaction was equivalent to our remaining investment value, less accruals for
potential obligations to the vendor discussed above.
Inter-Tel retains its ownership interest in Vianet and will account for the
remaining investment interest of approximately 10% in Vianet using the cost
method of accounting.
EXECUTONE 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 through March 31, 2003.
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 March 31, 2003.
ACTIVITY RESERVE
CASH/ RESTRUCTURING THROUGH 2003 BALANCE
DESCRIPTION NON-CASH CHARGE 2002 ACTIVITY AT 3/31/03
----------- -------- ------ ---- -------- ----------
PERSONNEL COSTS:
Severance and termination costs Cash $ (1,583) $ 1,580 $ -- $ (3)
Other Plant closure costs Cash (230) 230 -- --
LEASE TERMINATION AND OTHER CONTRACTUAL
OBLIGATIONS (NET OF ANTICIPATED
RECOVERY):
Building and equipment leases Cash (7,444) 5,431 223 (1,790)
Other contractual obligations Cash (1,700) 1,700 -- --
IMPAIRMENT OF ASSETS:
Inventories Non-Cash (3,454) 3,454 -- --
Prepaid inventory and other expenses Non-Cash (2,485) 2,485 -- --
Accounts receivable Non-Cash (1,685) 854 220 (611)
Fixed assets Non-Cash (3,151) 2,995 -- (156)
Net intangible assets Non-Cash (29,184) 29,184 -- --
-------- -------- -------- --------
TOTAL $(50,916) $ 47,913 $ 443 $ (2,560)
-------- -------- -------- --------
NOTE D - SEGMENT INFORMATION
Inter-Tel follows Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 131 established standards for reporting information regarding
10
operating segments in annual financial statements and requires selected
information for those segments to be presented in interim financial reports
issued to stockholders. SFAS 131 also established 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. The Company's chief decision maker,
as defined under SFAS 131, is the Chief Executive Officer.
We 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 services are provided through the Company's
direct sales offices and dealer network to business customers throughout the
United States, Europe, Asia, Mexico and Canada. As a result, financial
information disclosed represents substantially all of the financial information
related to the Company's 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 through June of 2002. 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.
For the quarters ended March 31, 2003 and 2002, we generated income from
business segments, including income from a litigation settlement and losses from
our investment in Inter-Tel.NET/Vianet for 2002, as follows:
THREE MONTHS ENDED MARCH 31, 2003
-----------------------------------------------------------------------
RESALE OF
LOCAL AND
SUBTOTAL LONG
(In thousands, except per share PRINCIPAL LITIGATION PRINCIPAL INTER-TEL.NET DISTANCE
amounts) SEGMENT SETTLEMENT SEGMENT /VIANET SERVICES TOTAL
--------- ---------- --------- --------- --------- ---------
Net sales $ 75,675 $ -- $ 75,675 $ -- $ 8,494 $ 84,169
Gross profit 41,560 -- 41,560 -- 2,514 44,074
Operating income 5,980 -- 5,980 -- 1,186 7,166
Interest and other income 409 -- 409 -- 34 443
Foreign currency transaction losses (40) -- (40) -- -- (40)
Interest expense (32) -- (32) -- -- (32)
Net income $ 3,916 $ -- $ 3,916 $ -- $ 756 $ 4,672
Net income per diluted share (1) $ 0.15 $ -- $ 0.15 $ -- $ 0.03 $ 0.18
Weighted average diluted shares (1) 26,039 26,039 26,039 26,039 26,039 26,039
Total assets $ 262,714 $ -- $ 262,714 $ -- $ 17,743 $ 280,457
Depreciation and amortization 2,269 -- 2,269 -- 12 2,281
11
THREE MONTHS ENDED MARCH 31, 2002
-----------------------------------------------------------------------
RESALE OF
LOCAL AND
SUBTOTAL LONG
(In thousands, except per share PRINCIPAL LITIGATION PRINCIPAL INTER-TEL.NET DISTANCE
amounts) SEGMENT SETTLEMENT SEGMENT /VIANET SERVICES TOTAL
--------- ---------- --------- --------- --------- ---------
Net sales $ 83,280 $ -- $ 83,280 $ -- $ 6,790 $ 90,070
Gross profit 43,597 -- 43,597 -- 1,457 45,054
Operating income 9,382 -- 9,382 -- 441 9,823
Interest and other income 410 15,302 15,712 (600) 29 15,141
Foreign currency transaction losses (84) -- (84) -- -- (84)
Interest expense (34) -- (34) -- -- (34)
Net income (loss) $ 6,112 $ 9,365 $ 15,477 $ (378) $ 296 $ 15,395
Net income (loss) per diluted
share (1) $ 0.24 $ 0.37 $ 0.61 $ (0.02) $ 0.01 $ 0.60
Weighted average diluted shares (1) 25,550 25,550 25,550 24,179 25,550 25,550
Total assets $ 239,666 $ -- $ 239,666 $ -- $ 12,003 $ 251,669
Depreciation and amortization 2,161 -- 2,161 -- 30 2,191
1) Options that are antidilutive because the exercise price was greater than the
average market price of the common shares are not included in the computation of
diluted earnings per share when a net loss is recorded.
Our revenues are generated predominantly in the United States. Total revenues
generated from U.S. customers totaled $81.7 million or 97.1% of total revenues,
and $87.4 million or 97.1% of total revenues for the quarters ended March 31,
2003 and 2002, respectively. The Company's revenues from international sources
were primarily generated from customers located in the United Kingdom, Europe
and Asia. In the first quarters of 2003 and 2002, revenues from customers
located internationally accounted for 2.9% and 2.9% of total revenues,
respectively.
NOTE E - NET INVESTMENT IN SALES-LEASES
Net investment in sales-leases represents the value of sales-leases presently
held under our Total Solution program. We currently sell the rental payments due
to us from some of the sales-leases. We maintain reserves against our estimate
of potential recourse for the balance of sales-leases and for the balance of
sold rental payments remaining unbilled. The following table provides detail on
the total net balances in sales-leases (in thousands):
March 31, December 31,
2003 2002
-------- --------
Lease balances included in consolidated accounts receivable, net of
allowances of $2,363 in 2003 and $2,562 in 2002 $ 6,793 $ 6,470
Net investment in Sales-Leases:
Current portion, net of allowances of $511 in 2003 and $516 in 2002 13,884 13,344
Long-term portion, includes residual amounts of $372 in 2003 and $518
in 2002, net of allowances of $1,486 in 2003 and $1,411 in 2002 25,585 24,692
-------- --------
Total investment in Sales-Leases, net of allowances of $4,360 in 2003 and
$4,489 in 2002 46,262 44,506
Sold rental payments remaining unbilled (subject to limited recourse
provisions), net of allowances of $11,219 in 2003 and $11,125 in 2002 193,170 194,684
-------- --------
Total balance of sales-leases and sold rental payments remaining unbilled,
net of allowances $239,432 $239,190
-------- --------
Total allowances for entire lease portfolio (including limited recourse
liabilities) $ 15,579 $ 15,614
-------- --------
12
Reserve levels are established based on portfolio size, loss experience, levels
of past due accounts and periodic, detailed reviews of the portfolio. Recourse
on the sold rental payments is contractually limited to a percentage of the net
credit losses in a given annual period as compared to the beginning portfolio
balance for a specific portfolio of sold leases. While our recourse is limited,
we maintain reserves at a level sufficient to cover all anticipated credit
losses. The aggregate reserve for uncollectible lease payments and recourse
liability represents the reserve for the entire lease portfolio. These reserves
are either netted from consolidated accounts receivable, netted against current
or long-term "investment in sales-leases" or included in long-term liabilities
for sold rental payments remaining unbilled. Sales of rental payments per
period:
Quarter Ended Year Ended
(In thousands) March 31, 2003 December 31, 2002
-------------- -----------------
Sales of rental payments $ 20,076 $ 83,141
Sold payments remaining unbilled at end of period $ 204,389 $ 205,809
Sales of rental payments represents the gross selling price or total present
value of the payment stream on the sale of the rental payments to third parties.
Sold payments remaining unbilled at the end of the period represents the total
balance of leases that are not included in our balance sheet. We do not expect
to incur any significant losses in excess of reserves from the recourse
provisions related to the sale of rental payments. Inter-Tel is compensated for
administration and servicing of rental payments sold.
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 OUR EXPECTATIONS, BELIEFS,
INTENTIONS OR STRATEGIES REGARDING THE FUTURE. ALL FORWARD-LOOKING STATEMENTS
INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATE
HEREOF, AND WE ASSUME 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. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING
THOSE SET FORTH UNDER "FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" BELOW
AND ELSEWHERE IN THIS DOCUMENT.
OVERVIEW
Inter-Tel, incorporated in 1969, is a single point of contact, full service
provider of converged voice and data business communications systems, voice mail
systems and networking applications. We market and sell voice processing and
unified messaging software, call accounting software, Internet Protocol ("IP")
telephony software, computer-telephone integration ("CTI") applications, local
and long distance calling services through NetSolutions (our wholly-owned
subsidiary), and other communications services. 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 voice processing and unified
messaging systems, IP telephony voice and data routers, and e-commerce software.
We also provide maintenance, leasing and support services for our products. Our
customers include business enterprises, government agencies and non-profit
organizations. Our common stock is quoted on the Nasdaq National Market System
under the symbol "INTL."
13
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 March 31, 2003, we had 51direct 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 United Kingdom and parts of Europe. In December 2002, we also acquired Swan
Solutions Limited, a research and development and software sales office in the
United Kingdom.
Sales of systems through our dealers and VARs typically generate lower gross
margins than sales through our direct sales organization, although direct sales
typically require higher levels of selling, general and administrative expenses.
In addition, our long distance services and Datanet products typically generate
lower gross margins than sales of software and system products. Accordingly, our
margins may vary from period to period depending upon distribution channel and
product mix. In the event that sales through dealers or sales of long distance
services increase as a percentage of net sales, our overall gross margin could
decline.
Our operating results depend upon a variety of factors, including the volume and
timing of orders received during a period, the mix of products sold and the mix
of distribution channels, general economic conditions, patterns of capital
spending by customers, the timing of new product announcements and releases by
us and our competitors, pricing pressures, the cost and effect of acquisitions
and the availability and cost of products and components from our suppliers.
Historically, a substantial portion of our net sales in a given quarter has been
recorded in the third month of the quarter, with a concentration of such net
sales in the last two weeks of the quarter. In addition, we are subject to
seasonal variations in our operating results, as net sales for the first and
third quarters are frequently less than those experienced during the fourth and
second quarters, respectively.
The markets we serve have been characterized by rapid technological changes and
increasing customer requirements. We have sought to address these requirements
through the development of software enhancements and improvements to existing
systems and the introduction of new systems, products, and applications.
Inter-Tel's research and development efforts over the last several years have
been focused primarily on the development of, and enhancements to, our AXXESS
and ECLIPSE(2) systems, including adding new applications, incorporating IP
convergence applications and IP telephones, developing Unified Messaging
Software applications, developing speech recognition and text-to-speech
applications, developing and enhancing call center applications, developing
Unified Communications Software applications, and expanding the
telecommunications networking package to include networking over IP and frame
relay networks. Inter-Tel's current efforts are focused on developing and
enhancing the convergence applications for our AXXESS and ECLIPSE(2) systems,
enhancing our server-PBX offering, enhancing our unified communications
applications, developing new IP endpoint technology, and enhancing our call
center applications.
We offer to our customers a package of lease financing and other services under
the name Total Solution (formerly, Totalease). Total Solution provides our
customers lease financing, maintenance and support services, fixed price
upgrades and other benefits. We finance this program through the periodic resale
of lease rental streams to financial institutions. Refer to Note E of Notes to
Consolidated Financial Statements for additional information regarding our
program.
14
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data
expressed as a percentage of net sales for the periods indicated:
Three months ended March 31,
----------------------------
2003 2002
------ ------
Net sales 100.0% 100.0%
Cost of sales 47.6 50.0
------ ------
Gross Profit 52.4 50.0
------ ------
Research and development 6.2 4.8
Selling, general and administrative 37.1 34.0
Amortization 0.5 0.3
------ ------
Operating income 8.5 10.9
Litigation settlement (net of costs except for taxes) -- 17.0
Interest and other income 0.5 0.5
Write-down of investment in Inter-Tel.NET/Vianet 0.0 (0.7)
Foreign currency transaction losses 0.0 (0.1)
Interest expense (0.0) (0.0)
------ ------
Income before income taxes 9.0 27.6
Income Taxes 3.4 10.5
------ ------
Net Income 5.6% 17.1%
====== ======
NET SALES. Net sales decreased 6.6% to $84.2 million in the first quarter
of 2003 from $90.1 million in the first quarter of 2002, representing a decrease
of $5.9 million. Sales from our direct sales offices decreased 13.4% in the
first quarter of 2003 compared to the first quarter of 2002. Sales to our dealer
network decreased by 3.4% in the first quarter of 2003 compared to the first
quarter of 2002. Sales from our government and national accounts division were
relatively flat, down $58,000 or 1.1%. Sales from our DataNet division decreased
33.0% and international revenues decreased by 13.5% in the first quarter of 2003
compared to the first quarter of 2002. These decreases were offset in part by
increases of $1.9 million in sales from our long distance resale and network
services divisions and $0.5 million in sales from lease financing in the first
quarter of 2003 compared to the first quarter of 2002.
The decrease in net sales for the first quarter of 2003 compared to the
first quarter of 2002 from our direct sales offices, dealer channel, government
and national accounts division and international operations was primarily
attributable to weak economic conditions, uncertainties associated with the war
in Iraq and threatened terrorist attacks, the impact of adverse weather
conditions, increased competitive pressures and delayed buying decisions by
customers. The decreases in net sales were primarily a result of lower volumes
of systems sold. In some instances, prices of various telecommunications systems
decreased, and discounts or other highly competitive promotions that were
offered to customers to generate sales resulted in lower revenues from both our
direct and indirect channels. Sales of communications systems were heavily
impacted by delayed buying decisions, in particular in our direct sales offices
resulting from weak economic conditions affecting our industry. Sales to new
customers declined during the first quarter of 2003; however, recurring revenues
to existing customers increased as a percentage of total sales.
Sales from long distance and network services represented our largest
percentage sales increases in the first quarter of 2003 as compared to the first
quarter of 2002. Sales increased in NetSolutions, our long distance division, by
25.1%, despite downward price pressure and significant competition. Increased
sales volume has allowed NetSolutions to offer more competitive pricing, which
improved sales to our existing customer base. Network services revenues
increased 14.1% in the first quarter of 2003 compared to the first quarter of
2002, on higher volume of sales and commissions on local and network services
such as T-1 access, frame relay and other voice and data circuit services. See
Note D of Notes to Condensed Consolidated Financial Statements for additional
segment reporting information.
GROSS PROFIT. Gross profit for the first quarter of 2003 decreased 2.2% to
$44.1 million, or 52.4% of net sales, from $45.1 million, or 50.0% of net sales,
in the first quarter of 2002. The decrease in gross profit dollars resulted from
lower consolidated sales. However, gross profit, as a percentage of sales (or
gross margin), increased as a result of several different factors. These factors
included having a higher proportion of recurring revenues from existing
customers (including increased maintenance and services revenues as a percentage
15
of total sales), higher software content in our products, cost containment
efforts, product design improvements, efficiencies achieved with our
manufacturing vendors and a more favorable sales channel mix. These increases
were offset in part by greater competitive pricing pressures and by pricing
discounts or special promotions on telephone system and software sales and
related equipment.
During the first quarter of 2003, recurring revenues from existing
customers in our direct sales and national and government accounts channels
increased as a percentage of total sales from these same channels relative to
the first quarter of 2002. Existing customers accounted for a significant
portion of our net sales from maintenance and other services, software additions
and/or upgrades, support, training and hardware products such as video
conferencing, headsets (wired and wireless), networking products and
speakerphones during the first quarter of 2003. Our business communications
platforms allow for system migration without the complete change-out of
hardware, which enables us to offer enhancements and new solutions through
software-only upgrades to our existing customers. Our gross margins are
generally higher with recurring revenues because we incur less materials costs
relative to new installations. Accordingly, our gross margins improved in the
first quarter of 2003 as a result of this recurring revenue percentage increase.
Sales from NetSolutions increased by 25.1%, or $1.7 million, in the first
quarter of 2003 as compared to the first quarter of 2002. Although gross margins
are generally lower in this division than our consolidated margins, the margins
improved in the first quarter of 2003 relative to the first quarter of 2002,
based in part on our ability to negotiate more favorable pricing with vendors on
higher resale volumes. In addition, sales from our network services division
increased 14.1% in the first quarter of 2003 compared to the first quarter of
2002. This division generally receives commissions on network services we sell
as an agent for Regional Bell Operating Companies. Sales from this division
carry little to no equipment costs and generated margins of over 90% during the
first quarter of 2003; therefore, the increase in sales from this division
improved our consolidated gross margins. We cannot accurately predict future
gross margins based on a number of factors, including among other factors,
competitive pricing pressures, sales of systems, software and services through
different distribution channels, and the mix of systems, software and services
we sell.
RESEARCH AND DEVELOPMENT. Research and development expenses for the first
quarter of 2003 increased 21.2% to $5.2 million, or 6.2% of net sales, from $4.3
million, or 4.8% of net sales, for the first quarter of 2002. Included in
research and development expenses in both the first quarter of 2003 and the
first quarter of 2002 is amortization of patents totaling $55,000 in each
period. The increase in research and development expenses was primarily
attributable to the increase in engineers hired in connection with our
acquisition of Swan in December 2002. The increase is also attributable, to a
lesser extent, to increased research and development spending related to our
development of convergence applications and new IP endpoint technology. In the
first quarter of 2003, research and development expenses were directed
principally toward the continued development of the AXXESS and Eclipse2 software
and systems (including versions 7.0 and 8.0), unified messaging and voice
processing software, speech recognition and text-to-speech applications, call
center applications, unified communications applications, IP endpoint
development, and certain CTI and IVR applications. We expect that research and
development expenses will increase in absolute dollars as we continue to develop
and enhance existing and new technologies and products. These expenses may vary,
however, as a percentage of net sales.
SELLING, GENERAL AND ADMINISTRATIVE. In the first quarter of 2003, selling,
general and administrative expenses, excluding amortization, increased 1.9% to
$31.2 million, or 37.1% of net sales, from $30.7 million, or 34.0% of net sales,
in the first quarter of 2002. The increase in absolute dollars was due in part
to higher costs associated with depreciation, insurance and professional fees.
Selling, general and administrative expenses increased, as a percentage of net
sales, primarily as a result of lower absorption of fixed costs. In addition,
higher relative sales through our long distance and network services agency
divisions led to high selling expenses and commission costs relative to total
sales, and we incurred higher relative overall compensation costs. We expect
that for the foreseeable future selling, general and administrative expenses may
vary in absolute dollars and as a percentage of net sales.
AMORTIZATION OF GOODWILL AND PURCHASED INTANGIBLE ASSETS. We adopted
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142") effective in the beginning of fiscal 2002. In
accordance with SFAS 142, we ceased amortizing goodwill. We are required to
16
perform goodwill impairment tests on an annual basis and between annual tests in
certain circumstances. As of March 31, 2003, 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.
Amortization of purchased intangible assets included in operating expenses
was $428,000 in the first quarter of 2003, compared to $257,000 in the first
quarter of 2002. An additional $55,000 of amortization was included in research
and development expenses for the first quarter of 2003 and the first quarter of
2002. The increase in the amortization of purchased intangible assets for the
first quarter 2003 compared to the same period last year was primarily related
to the additional amortization from recent acquisitions. For additional
information regarding purchased intangible assets, see Note C "Acquisitions,
Dispositions and Restructuring Charges " to the Condensed Consolidated Financial
Statements.
LITIGATION SETTLEMENT, NET OF COSTS EXCEPT TAXES. In May 2001, Inter-Tel
entered into an agreement to submit to binding arbitration a lawsuit we filed in
1996. The arbitration was completed in January 2002 and, as a result of the
arbitration, Inter-Tel received a one-time gross cash award of $20 million in
February 2002. Direct costs for attorney's fees, expert witness costs,
arbitration costs and estimated additional payments and expenses, totaled
approximately $4.7 million in the first quarter of 2002, excluding income taxes,
for a net award of approximately $15.3 million. The estimated net proceeds from
this arbitration settlement were approximately $9.5 million after taxes, or
$0.37 per diluted share for the quarter ended March 31, 2002.
INTEREST AND OTHER INCOME. Interest and other income in the first quarter
of 2003 and the first quarter of 2002 consisted primarily of interest income and
foreign currency transaction losses, with the exception of an expense of
$600,000 related to the write-down of Inter-Tel's investment in
Inter-Tel.NET/Vianet in the first quarter of 2002. Income from interest and
short-term investments in the first quarter of 2003 was flat compared to the
first quarter of 2002 despite higher level of invested funds, due to lower
yields on investments. Other changes in other income primarily reflected
slightly lower net foreign currency transaction losses. Interest expense in the
first quarter of 2003 was comparable to the first quarter of 2002.
INCOME TAXES. Inter-Tel's income tax rate for the first quarter of 2003
remained unchanged at 38% compared to the first quarter of 2002. Inter-Tel
expects the full-year 2003 tax rate to be comparable to the tax rate effective
for the first quarter of 2003.
NET INCOME. Net income for the first quarter of 2003 was $4.7 million
($0.18 per diluted share), compared to net income of $15.4 million ($.60 per
diluted share) in the first quarter of 2002. The decrease was primarily
attributable to the litigation settlement award received in 2002. Excluding the
2002 litigation settlement, we reported net income of $6.0 million, or $0.24 per
diluted share in the first quarter of 2002. The decrease in net income from the
first quarter of 2003 compared to the first quarter of 2002, excluding the
litigation settlement, is the result of lower operating profits primarily from
the lower volume of total sales achieved in the first quarter of 2003 compared
to the first quarter of 2002 and other items described in further detail above.
INFLATION/CURRENCY FLUCTUATION
Inflation and currency fluctuations have not previously had a material
impact on Inter-Tel's operations. International procurement agreements have
traditionally been denominated in U.S. currency. Moreover, a significant amount
of contract manufacturing has been or is expected to be moved to alternative
sources. The expansion of international operations in the United Kingdom and
Europe and increased sales, if any, in Japan and other parts of Asia could
result in higher international sales as a percentage of total revenues; however,
international revenues do not currently represent a significant portion of our
total revenues.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2003, we had $131.6 million in cash and short-term
investments, which represented an increase of approximately $5.8 million from
December 31, 2002. We maintain a $10 million unsecured, revolving line of credit
with Bank One, NA, that is available through June 1, 2003. Under the credit
facility, we have the option to borrow at a prime rate or adjusted LIBOR
interest rate. Historically, we have used the credit facility primarily to
17
support international letters of credit to suppliers. The remaining cash
balances may be used for acquisitions, strategic alliances, working capital,
dividends and general corporate purposes.
Net cash provided by operating activities totaled $7.1 million for the
three months ended March 31, 2003, compared to $32.5 million for the same period
in 2002. Cash provided by operating activities in the first quarter of 2003 was
primarily the result of cash generated from operations, including non-cash
depreciation and amortization charges. Cash used in the change in operating
assets and liabilities in the first quarter of 2003 was $2.0 million, compared
to cash generated by the change in operating assets and liabilities of $12.8
million in 2002. At March 31, 2003, accounts receivable totaled $37.7 million
compared to $42.6 million at December 31, 2002. The $4.9 million in cash
generated by the decrease in accounts receivable was substantially offset by
decreases in accounts payable and other accrued expenses, primarily reflecting
payments on accrued commissions, bonuses, 401(k) matching contributions and
profit sharing in the first quarter from year-end accruals. In the first quarter
of 2003, Inter-Tel received payment from the Vianet shareholders of $1.45
million, as payment of a loan in connection with the sale of 83% of our interest
in Inter-Tel.NET, and in exchange for the full release of our former guarantee
of vendor obligations. In February 2002, Inter-Tel received a gross cash award
of $20 million in settlement of a dispute submitted to binding arbitration.
Costs relating to attorney's fees, expert witnesses, and arbitration and
additional costs and expenses, including $1.3 million in bonus payments to
certain employees who assisted in the litigation and arbitration, totaled
approximately $4.7 million in the first quarter of 2002, resulting in a net
award of $15.3 million before income taxes. If we are able to expand sales
through our direct sales offices, dealer network and government and national
accounts divisions, this would likely require the expenditure of working capital
for increased accounts receivable and inventories.
Net cash used in investing activities totaled $15.2 million for each of the
quarters ended March 31, 2003 and March 31, 2002. During the first quarter of
2002, net cash used in acquisitions totaled approximately $8.0 million and
capital expenditures totaled approximately $1.3 million; however, we closed no
acquisitions during the first quarter of 2003. Net cash used in the purchase of
investments during the three months ending March 31, 2003 and March 31, 2002
were $14.5 million and $6.0 million, respectively. Approximately $837,000 was
used to acquire additional property and equipment during the first quarter 2003.
We anticipate incurring additional capital expenditures during 2003, principally
relating to expenditures for equipment and management information systems used
in our operations.
Net cash used in financing activities totaled $529,000 in the three months
ended March 31, 2003, compared to $421,000 for the same period in 2002. Net cash
used for dividends totaled approximately $747,000 and $449,000, respectively,
during the first quarters of 2003 and 2002, which was offset in each period by
cash provided by the exercise of stock options totaling $240,000 and $296,000.
During the first quarter of 2003 and the first quarter of 2002, we reissued
treasury shares through stock option exercises and issuances. In the three month
period ending March 31, 2003 the proceeds received from these reissued treasury
shares were approximately the same as the cost basis of the treasury stock
reissued, recording a minimal impact on retained earnings. However, during the
three month period ending March 31, 2002, the proceeds received totaled less
than the cost basis of the treasury stock reissued; accordingly, the difference
was recorded as a reduction to retained earnings.
We offer to our customers lease financing and other services, including our
Total Solution (formerly Totalease) program, through our Inter-Tel Leasing, Inc.
subsidiary. We fund our Total Solution program in part through the sale to
financial institutions of rental payment streams under the leases. Sold lease
rentals totaling $204.4 million and $205.8 million remained unbilled at March
31, 2003 and December 31, 2002, respectively. We are obligated to repurchase
such income streams in the event of defaults by lease customers and,
accordingly, maintain reserves based on loss experience and past due accounts.
Although we to date have been able to resell the rental streams from leases
under the Total Solution program profitably and on a substantially current
basis, the timing and profitability of lease resales could impact our business
and operating results, particularly in an environment of fluctuating interest
rates and economic uncertainty. If we are required to repurchase rental streams
and realize losses thereon in amounts exceeding our reserves, our operating
results will be adversely affected.
We believe that our working capital and credit facilities, together with
cash generated from operations, will be sufficient to develop and expand our
business operations, to finance acquisitions of additional resellers of
18
telephony products and other strategic acquisitions or corporate alliances, and
to provide adequate working capital for at least the next eighteen months.
However, to the extent that additional funds are required in the future to
address working capital needs and to provide funding for capital expenditures,
expansion of the business or additional acquisitions, we will seek additional
financing. There can be no assurance that additional financing will be available
when required or on acceptable terms.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The methods, estimates and judgments we use in applying our most critical
accounting policies have a significant impact on the results we report in our
consolidated financial statements. We evaluate our estimates and judgments on an
on-going basis. We base our estimates on historical experience and on
assumptions that we believe to be reasonable under the circumstances. Our
experience and assumptions form the basis for our judgments about the carrying
value of assets and liabilities that are not readily apparent from other
sources. Actual results may vary from what we anticipate and different
assumptions or estimates about the future could change our reported results. We
believe the following accounting policies are the most critical to us, in that
they 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 an arrangement exists; (ii) delivery of the products
and/or services has occurred; (iii) the selling price is both fixed and
determinable and; (iv) collectibility is reasonably probable. Revenue derived
from sales of systems and services to end-user customers is recognized upon
installation of the systems and performance of the services, respectively,
allowing for use by our customers of these systems. Pre-payments for
communications services are deferred and recognized as revenue as the
communications services are provided.
For shipments to dealers and other distributors, our revenues are recorded
as products are shipped and services are rendered, because the sales process is
complete. These shipments are primarily to third-party dealers and distributors,
and title passes when goods are shipped (free-on-board shipping point). Long
distance services revenues are recognized as service is provided.
SALES-LEASES. For our sales-type lease accounting, we follow the guidance
provided by FASB Statement No. 13, Accounting for Leases and FASB Statement No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities - A Replacement of FASB Statement No. 125. We
record the discounted present values of minimum rental payments under sales-type
leases as sales, net of provisions for continuing administration and other
expenses over the lease period. We record the lease sales at the time of system
sale and installation pursuant to Staff Accounting Bulletin No. 101, as
discussed above for sales to end user customers, and upon receipt of the
executed lease documents. The costs of systems installed under these
sales-leases, net of residual values at the end of the lease periods, are
recorded as costs of sales. The net rental streams are sold to funding sources
on a regular basis with the income streams discounted by prevailing like-term
rates at the time of sale. Gains or losses resulting from the sale of net rental
payments from such leases are recorded as net sales. We establish and maintain
reserves against potential recourse following the resales based upon historical
loss experience, past due accounts and specific account analysis. The allowance
for uncollectible minimum lease payments and recourse liability at the end of
the year represent reserves against the entire lease portfolio. Management
reviews the adequacy of the allowance on a regular basis and adjusts the
allowance as required. These reserves are either netted in the accounts
receivable, current and long-term components of "Net investments in
Sales-Leases" on the balance sheet, or included in long-term liabilities on our
balance sheet for off-balance sheet leases.
GOODWILL AND OTHER INTANGIBLE ASSETS. We assess the impairment of goodwill
and other identifiable intangibles whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Some factors we
consider important which could trigger an impairment review include the
following:
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* Significant under-performance relative to historical, expected or
projected future operating results;
* Significant changes in the manner of our use of the acquired assets or
the strategy for our overall business;
* Our market capitalization relative to net book value, and
* Significant negative industry or economic trends.
When we determine that the carrying value of goodwill and other identified
intangibles may not be recoverable, we measure any impairment based on a
projected discounted cash flow method using a discount rate determined by our
management to be commensurate with the risk inherent in our current business
model. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
on January 1, 2002, we ceased amortizing goodwill. Inter-Tel has tested goodwill
for impairment using the two-step process prescribed in SFAS 142. The first step
is a screen for potential impairment, while the second step measures the amount
of the impairment, if any. Inter-Tel has performed the first of the required
impairment tests for goodwill as of October 1, 2002 and has determined that the
carrying amount of goodwill is not impaired.
Inter-Tel adopted SFAS 142 effective January 1, 2002. Application of the
nonamortization provisions of SFAS 142 resulted in an increase in income from
continuing operations before income taxes of $439,000 for the quarter ended
March 31, 2003 and $439,000 for the quarter ended March 31, 2002.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. Additional reserves or allowances for doubtful accounts
are recorded for our sales-type leases, discussed above in "Sales-Leases." We
establish and maintain reserves against estimated losses based upon historical
loss experience, past due accounts and specific account analysis. Management
reviews the level of the allowances for doubtful accounts on a regular basis and
adjusts the level of the allowances as needed. At March 31, 2003, our allowance
for doubtful accounts for accounts receivable were $11.8 million of our $49.5
million in gross accounts receivable. If the financial condition of our
customers or channel partners were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be required.
INVENTORIES. We value our inventories at lower of cost or market. Cost is
determined by the first-in, first-out (FIFO) method, including material, labor
and factory overhead. Significant management judgment is required to determine
the reserve for obsolete or excess inventory. Inventory on hand may exceed
future demand either because the product is outdated, or obsolete, or because
the amount on hand is more than can be used to meet future need. We consider
criteria such as customer demand, product life-cycles, changing technologies,
slow moving inventory 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 March 31, 2003, our inventory reserves were $9.3
million of our $20.7 million gross inventories. If actual customer demand,
product life-cycles, changing technologies and market conditions are less
favorable than those projected by management, additional inventory write-downs
may be required.
CONTINGENCIES. We are a party to various claims and litigation in the
normal course of business. Management's current estimated range of liability
related to various claims and pending litigation is based on claims for which
our management can estimate the amount and range of loss. Because of the
uncertainties related to both the amount and range of loss on the remaining
pending claims and litigation, management is unable to make a reasonable
estimate of the liability that could result from an unfavorable outcome. As
additional information becomes available, we will assess the potential liability
related to our pending litigation and revise our estimates. Such revisions in
our estimates of the potential liability could materially impact our results of
operations and financial position.
Divisions of the United States Department of Justice are investigating
other companies' and Inter-Tel's participation in a federally-funded "E-Rate
program" to connect schools and libraries to the Internet. The Justice
Department has not provided Inter-Tel with a description of the evidence on
which the investigations are based. Inter-Tel is presently unable to predict or
determine the final outcome of, or to estimate the potential range of loss (if
any) with respect to, the investigations. Based upon the information known at
this time, we do not expect the investigations to result in a material adverse
impact upon the Company's business or financial condition. If Inter-Tel is
convicted of any crime or subjected to sanctions, or if penalties, damages or
other monetary remedies are assessed against Inter-Tel in connection with these
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and other investigations, our business and operating results could be materially
and adversely affected. Nevertheless, the early nature of the investigations
makes it difficult to determine whether the likelihood of a material adverse
outcome is unlikely.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
THIS REPORT ON FORM 10-Q CONTAINS 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. 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 INTER-TEL'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 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 and the condition of the markets our
business addresses;
* patterns of capital spending by customers;
* the timing of new product announcements and releases by us and our
competitors;
* pricing pressures, the cost and effect of acquisitions;
* the availability and cost of products and components from our
suppliers; and
* national and regional weather patterns.
In addition, we have historically operated with a relatively small backlog,
with sales and operating results in any quarter depending principally on orders
booked and shipped in that quarter. In the past, we have recorded a substantial
portion of our net sales for a given quarter in the third month of that quarter,
with a concentration of such net sales in the last two weeks of the quarter.
Market demand for investment in capital equipment such as business
communications systems and associated call processing and voice processing
software applications depends largely on general economic conditions, and can
vary significantly as a result of changing conditions in the economy as a whole.
We cannot assure you that we can continue to be successful operating with a
small backlog or whether historical backlog trends will continue in the future.
Our expense levels are based in part on expectations of future sales and,
if sales levels do not meet expectations, our operating results could be harmed.
In addition, because sales of business communications systems through our
dealers typically produce lower gross margins than sales through our direct
sales organization, operating results have varied, and will continue to vary
based upon the mix of sales through direct and indirect channels. In addition,
in the past we have derived a significant part of our revenue from recurring
revenue streams, which typically produce higher gross margins. If we do not
maintain recurring revenue streams at current or historic levels, our operating
results will suffer if we do not significantly increase sales to new customers.
Moreover, 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. We also
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.
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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. We believe that problems and delays
associated with new product development have in the past contributed to lost
sales. 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 applications, Internet
Protocol network products, or related products fail to develop or continue to
develop more slowly than we anticipate, or if we are unable for any reason to
capitalize on any of these emerging market opportunities, our business,
financial condition and operating results could be significantly harmed.
OUR FUTURE SUCCESS LARGELY DEPENDS ON INCREASED COMMERCIAL ACCEPTANCE OF OUR
AXXESS AND ECLIPSE2 SYSTEMS, ENCORE PRODUCT, SPEECH RECOGNITION AND INTERACTIVE
VOICE RESPONSE PRODUCTS, AND RELATED COMPUTER-TELEPHONY PRODUCTS.
During the past few years, we have introduced transparent networking and
unified messaging capabilities on our AXXESS and ECLIPSE2 systems and introduced
our Encore product and InterPrise family of voice and data convergence products.
In 2002, we introduced Unified Communicator, a web-based, speech-recognition and
WAP software application for controlling and managing your calls and contacts;
Inter-Tel Application Platform, a highly flexible speech-recognition,
text-to-speech and CTI application generation platform; enhanced convergence
features on the AXXESS and ECLIPSE2 systems; and several other telephony-related
products. During the past 12 months, sales of our AXXESS business communications
systems and related software have comprised a substantial portion of our net
sales. Our future success depends, in large part, upon increased commercial
acceptance and adoption of the Application Platform, the Unified Communicator
and related computer-telephony products, the AXXESS and ECLIPSE2 systems, Encore
products, MGCP and SIP standards-based functionality, new speech recognition and
Interactive Voice Response products, as well as future upgrades and enhancements
to these products and networking platforms. We cannot assure you that these
products or platforms will achieve commercial acceptance in the future.
OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN ERRORS OR DEFECTS THAT ARE DETECTED
ONLY AFTER THEIR RELEASE, WHICH MAY CAUSE US TO INCUR SIGNIFICANT UNEXPECTED
EXPENSES AND LOST SALES.
Our telecommunications products and software are highly complex. Although
our new products and upgrades are examined and tested prior to release, they can
only be fully tested when used by a large customer base. Consequently, our
customers may discover program errors, or "bugs," or other defects after new
products and upgrades have been released. Some of these bugs may result from
defects contained in component parts or software from our suppliers or other
third parties that are intended to be compatible with our products and over
which we have little or no control. Although we have test procedures and quality
control standards in place designed to minimize the number of errors and defects
in our products, we cannot assure you that our new products and upgrades will be
free of bugs when released. If we are unable to quickly or successfully correct
bugs identified after release, we could experience the following, any of which
would harm our business:
* costs associated with the remediation of any problems;
* costs associated with design modifications;
* loss of or delay in revenues;
* loss of customers;
* failure to achieve market acceptance or loss of market share;
* increased service and warranty costs;
* liabilities to our customers; and
* increased insurance costs.
22
THE COMPLEXITY OF OUR PRODUCTS COULD CAUSE DELAYS IN THE DEVELOPMENT AND RELEASE
OF NEW PRODUCTS AND SERVICES. AS A RESULT, CUSTOMER DEMAND FOR OUR PRODUCTS
COULD DECLINE, WHICH COULD HARM OUR BUSINESS.
Due to the complexity of our products and software, we have in the past
experienced and expect in the future to experience delays in the development and
release of new products or product enhancements. If we fail to introduce new
software, products or services in a timely manner, or fail to release upgrades
to our existing systems or products and software on a regular and timely basis,
customer demand for our products and software could decline, which would harm
our business.
BUSINESS ACQUISITIONS, DISPOSITIONS OR JOINT VENTURES ENTAIL NUMEROUS RISKS AND
MAY DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE OR DISTRACT MANAGEMENT
ATTENTION.
As part of our business strategy, we consider acquisitions of, or
significant investments in, businesses that offer products, services and
technologies complementary to ours. Such acquisitions could materially adversely
affect our operating results and/or the price of our common stock. Acquisitions
also entail numerous risks, some of which we have experienced and may continue
to experience, including:
* unanticipated costs and liabilities;
* difficulty of assimilating the operations, products and personnel of
the acquired business;
* difficulties in managing the financial and strategic position of
acquired or developed products, services and technologies;
* difficulties in maintaining customer relationships;
* difficulties in servicing and maintaining acquired products, in
particular where a substantial portion of the target's sales were
derived from our competitor's products and services;
* difficulty of assimilating the vendors and independent contractors of
the acquired business;
* the diversion of management's attention from the core business;
* inability to maintain uniform standards, controls, policies and
procedures; and
* impairment of relationships with acquired employees and customers
occurring as a result of integration of the acquired business.
In particular, in recent years our operating results were materially
adversely affected by several of the factors described above, including
substantial acquisition-related charges, operating losses or impairment losses
from the Executone acquisition, Cirilium Corporation joint venture and
Inter-Tel.NET operations. Refer to Management's Discussion and Analysis and
notes to the consolidated financial statements for additional information
regarding these transactions.
We completed four acquisitions during 2001 and 2002. During 2001, we
acquired certain assets and assumed certain liabilities of Convergent
Communication Services, Inc. ("Convergent") and Mastermind Technologies, Inc.
("Mastermind"). During 2002, we acquired certain assets and assumed certain
liabilities of McLeodUSA Integrated Business Systems, Inc. ("McLeod") and we
acquired 100% of the stock of Swan Solutions Limited ("Swan") in the United
Kingdom. These acquisitions are subject to risks and uncertainties including
those indicated above.
Finally, to the extent that shares of our stock or the rights to purchase
stock are issued in connection with any future acquisitions, dilution to our
existing shareholders will result and our earnings per share may suffer. Any
future acquisitions may not generate additional revenue or provide any benefit
to our business, and we may not achieve a satisfactory return on our investment
in any acquired businesses.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGY AND MAY BE
INFRINGING UPON THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS.
Our success depends upon our proprietary technology. We currently hold
patents for nineteen (19) telecommunication and unified messaging products and
have also applied to the U.S. Patent and Trademark Office for eleven (11)
additional patents. We also rely on copyright and trade secret law and
contractual provisions to protect our intellectual property. Despite these
precautions, third parties could copy or otherwise obtain and use our technology
without authorization, or develop similar technology independently.
23
We cannot assure you that any patent, trademark or copyright that we own or
have applied to own, will not be invalidated, circumvented or challenged by a
third party. Effective protection of intellectual property rights may be
unavailable or limited in foreign countries. We cannot assure that the
protection of our proprietary rights will be adequate or that competitors will
not independently develop similar technology, duplicate our services or design
around any patents or other intellectual property rights we hold. Litigation may
be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Litigation could be costly, absorb significant management time and
harm our business.
We are also subject to third party claims that our current or future
products or services infringe upon the rights of others. For example, we are
subject to proceedings alleging that certain of our key products infringe upon
third party intellectual property rights, including patents, trademarks,
copyrights or other intellectual property rights. We have viewed presentations
from Avaya, one of our primary competitors, alleging that our AXXESS business
communications system utilizes inventions covered by certain of their patents.
We are continuing the process of investigating this matter and we have made
claims against Avaya for infringement of our patents. While we do not believe
these matters, collectively, would have a material adverse impact on our
financial position and future results of operations, the ultimate outcomes by
their nature are uncertain.
When any such claims are asserted against us, among other means to resolve
the dispute, we may seek to license the third party's intellectual property
rights. Purchasing such licenses can be expensive, and we cannot assure you that
a license will be available on prices or other terms acceptable to us, if at
all. Alternatively, we could resort to litigation to challenge such a claim.
Litigation could require us to expend significant sums of cash and divert our
management's attention. In the event that a court renders an enforceable
decision with respect to our intellectual property, we may be required to pay
significant damages, develop non-infringing technology or acquire licenses to
the technology subject to the alleged infringement. Any of these actions or
outcomes could harm our business. If we are unable or choose not to license
technology, or decide not to challenge a third party's rights, we could
encounter substantial and costly delays in product introductions. These delays
could result from efforts to design around asserted third party rights or our
discovery that the development, manufacture or sale of products requiring these
licenses could be foreclosed.
OUR IP NETWORK PRODUCTS MAY BE VULNERABLE TO VIRUSES, OTHER SYSTEM FAILURE RISKS
AND SECURITY CONCERNS, WHICH MAY RESULT IN LOST CUSTOMERS OR SLOW COMMERCIAL
ACCEPTANCE OF OUR IP NETWORK PRODUCTS.
Inter-Tel's IP telephony and network products may be vulnerable to computer
viruses or similar disruptive problems. Computer viruses or problems caused by
third parties could lead to interruptions, delays or cessation of service that
could harm our operations and revenues. In addition, we may lose customers if
inappropriate use of the Internet or other IP networks by third parties
jeopardize the security of confidential information, such as credit card or bank
account information or the content of conversations over the IP network. In
addition, user concerns about privacy and security may cause IP networks in
general to grow more slowly, and impair market acceptance of our IP network
products in particular, until more comprehensive security technologies are
developed.
WE HAVE MANY COMPETITORS AND EXPECT NEW COMPETITORS TO ENTER OUR MARKET, WHICH
COULD INCREASE PRICE COMPETITION AND SPENDING ON RESEARCH AND DEVELOPMENT AND
WHICH MAY IMPAIR OUR ABILITY TO COMPETE SUCCESSFULLY.
The markets for our products and services are extremely competitive and we
expect competition to increase in the future. Our current and potential
competitors in our primary business segments include:
* PABX and converged systems providers such as Avaya, Cisco Systems,
Comdial, 3Com, Iwatsu, Mitel, NEC, NextiraOne, Nortel, Panasonic,
Siemens, Toshiba, Vertical Networks and Vodavi;
* large data routing and convergence companies such as 3Com and Cisco
Systems;
* voice processing applications providers such as ADC, InterVoice-Brite,
Active Voice (a subsidiary of NEC America), Avaya, and Captaris
(formerly AVT);
* long distance services providers such as AT&T, MCI, Qwest and Sprint;
24
* large computer and software corporations such as IBM, Intel and
Microsoft; and
* regional Bell operating companies, or RBOCs, cable television
companies and satellite and other wireless broadband service
providers.
These and other companies may form strategic relationships with each other
to compete with us. These relationships may take the form of strategic
investments, joint-marketing agreements, licenses or other contractual
arrangements, which could increase our competitors' ability to address customer
needs with their product and service offerings.
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;
* offer greater price discounts or make substantial product promotions;
* adapt to new or emerging technologies and changing customer needs
faster;
* take advantage of acquisitions and other opportunities more readily;
* negotiate more favorable licensing agreements with vendors;
* devote greater resources to the marketing and sale of their products;
and
* address customers' service-related issues more adequately.
Some of our competitors may also be able to provide customers with
additional benefits at lower overall costs or to reduce their gross margins
aggressively in an effort to increase market share. We cannot be sure that we
will be able to match cost reductions by our competitors. In addition, we
believe that there is likely to be consolidation in our markets, which could
lead to having even larger and more formidable competition and other forms of
competition that could cause our business to suffer.
OUR RELIANCE ON A LIMITED NUMBER OF SUPPLIERS FOR KEY COMPONENTS AND OUR
DEPENDENCE ON CONTRACT MANUFACTURERS COULD IMPAIR OUR ABILITY TO MANUFACTURE AND
DELIVER OUR PRODUCTS AND SERVICES IN A TIMELY AND COST-EFFECTIVE MANNER.
We currently obtain certain key components for our digital communication
platforms, including certain microprocessors, integrated circuits, power
supplies, voice processing interface cards and IP telephony cards, from a
limited number of suppliers and manufacturers. Our reliance on these limited
suppliers and contract manufacturers involves risks and uncertainties, including
the possibility of a shortage or delivery delay for some key components. We
currently manufacture our products through third-party subcontractors located in
the United States, the People's Republic of China, the United Kingdom and
Mexico. Foreign manufacturing facilities are subject to changes in governmental
policies, imposition of tariffs and import restrictions and other factors beyond
our control. Varian, Inc. currently manufactures a significant portion of our
products at Varian's Tempe, Arizona facility, including substantially all of the
printed circuit boards used in the AXXESS and ECLIPSE2 systems. We have
experienced occasional delays in the supply of components and finished goods
that have harmed our business. If inventory levels are not adequately maintained
and managed we are at risk of not having the appropriate inventory quantities on
hand to meet sales demand. We cannot assure that we will not experience similar
delays in the future.
Our reliance on third party manufacturers and OEM partners involves a
number of additional risks, including reduced control over delivery schedules,
quality assurance and costs. Our business may be harmed by any delay in delivery
or any shortage of supply of components or finished goods from a supplier. Our
business may also be harmed if we are unable to develop alternative or
additional supply sources as necessary. To date, we have been able to obtain
supplies of components and products in a timely manner even though we do not
have long-term supply contracts with any of our contract manufacturers. However,
we cannot assure you that we will be able to continue to obtain components or
finished goods in sufficient quantities or quality or on favorable pricing or
delivery terms in the future.
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WE DERIVE A SUBSTANTIAL PORTION OF OUR NET SALES FROM OUR DEALER NETWORK AND IF
THESE DEALERS DO NOT EFFECTIVELY PROMOTE AND SELL OUR PRODUCTS, OUR BUSINESS AND
OPERATING RESULTS COULD BE HARMED.
We derive a substantial portion of our net sales through our network of
independent dealers. We face intense competition from other telephone, voice
processing, and voice and data router system manufacturers for these dealers'
business, as most of our dealers carry other products that compete with our
products. Our dealers may choose to promote the products of our competitors to
our detriment. We have developed programs and expended capital to incentivize
our dealers to promote our products, and we cannot assure you that these
techniques will be successful. The loss of any significant dealer or group of
dealers, or any event or condition harming our dealer network, could harm our
business, financial condition and operating results.
MANAGING 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 maintain and expand our
international dealer network both in the countries in which we already have a
presence and in new countries and regions. International sales are subject to a
number of risks, including changes in foreign government regulations and
telecommunication standards, export license requirements, tariffs and taxes,
other trade barriers, difficulties in protecting our intellectual property,
fluctuations in currency exchange rates, difficulty in collecting receivables,
difficulty in staffing and managing foreign operations, and political and
economic instability. In particular, the terrorist acts of September 11, 2001,
the war in Iraq and continued turmoil in the Middle East and North Korea, have
created an uncertain international economic environment and we cannot predict
the impact of these acts, any future terrorist acts or any related military
action on our efforts to expand our international sales. Fluctuations in
currency exchange rates could cause our products to become relatively more
expensive to customers in a particular country, leading to a reduction in sales
or profitability in that country. In addition, the costs associated with
developing international sales may not be offset by increased sales in the short
term, or at all. Any of these risks could cause our products to become
relatively more expensive to customers in a particular country, leading to
reduced sales or profitability in that country. In addition, the costs
associated with developing an international dealer network may not be offset by
increased sales in the short term, if at all.
IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL AS
NECESSARY, WE MAY NOT BE ABLE TO ACHIEVE OUR OBJECTIVES.
We depend on the continued service of, and our ability to attract and
retain, qualified technical, marketing, sales and managerial personnel, many of
whom would be difficult to replace. Competition for qualified personnel is
intense, and we have historically had difficulty hiring employees in the
timeframe that we desire, particularly skilled engineers. The loss of any of our
key personnel or our failure to effectively recruit additional key personnel
could make it difficult for us to manage our business, complete timely product
introductions or meet other critical business objectives. For example, our
inability to retain key executives of Executone following our Executone
acquisition impaired our ability to benefit from the Executone business and to
grow revenues from the Executone assets. Moreover, our operating results could
be impaired if we lose a substantial number of key employees from recent
acquisitions, including personnel from McLeod, Swan, Mastermind and Convergent.
We cannot assure you that we will be able to continue to attract and retain the
qualified personnel necessary for the development of our business.
WE MAY BE UNABLE TO ACHIEVE OR MANAGE OUR GROWTH EFFECTIVELY, WHICH MAY HARM OUR
BUSINESS.
The ability to operate our business in an evolving market requires an
effective planning and management process. Our efforts to achieve growth in our
business has placed, and is expected to continue to place, a significant strain
on our personnel, management systems, infrastructure and other resources. In
addition, our ability to manage any potential future growth effectively will
require us to successfully attract, train, motivate and manage new employees, to
integrate new employees into our overall operations and to continue to improve
our operational, financial and management controls and procedures. Furthermore,
we expect that we will be required to manage an increasing number of
relationships with suppliers, manufacturers, customers and other third parties.
If we are unable to implement adequate controls or integrate new employees into
our business in an efficient and timely manner, our operations could be
adversely affected and our growth could be impaired which could harm our
business.
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THE INTRODUCTION OF NEW PRODUCTS AND SERVICES HAS LENGTHENED OUR SALES CYCLES,
WHICH MAY RESULT IN SIGNIFICANT SALES AND MARKETING EXPENSES.
In the past few years, we introduced the AXXESS and ECLIPSE2 ATM business
communications system and our version 7.0 IP networking software, which are
typically sold to larger customers at a higher average selling price and often
represent a significant communications infrastructure capital expenditure by the
prospective enterprise customer. Accordingly, the purchase of our products
typically involves numerous internal approvals relating to the evaluation,
testing, implementation and acceptance of new technologies. This evaluation
process frequently results in a lengthy sales process, which can range from a
few months to more than 12 months, thereby subjecting our sales cycle to a
number of significant uncertainties concerning budgetary constraints and
internal acceptance reviews. The length of our sales cycle also may vary
substantially from customer to customer. While our customers are evaluating our
products and before placing an order with us, we may incur substantial sales and
marketing expenses and expend significant management effort. Consequently, if
sales forecasted from a specific customer for a particular quarter are not
realized in that quarter, our operating results could be materially adversely
affected.
WE RELY HEAVILY UPON THIRD-PARTY PACKAGED SOFTWARE SYSTEMS TO MANAGE AND RUN OUR
BUSINESS PROCESSES AND TO PRODUCE OUR FINANCIAL STATEMENTS. FROM TIME TO TIME WE
UPGRADE THESE SYSTEMS TO ENSURE CONTINUATION OF SUPPORT AND TO EXPAND THE
FUNCTIONALITY OF THE SYSTEMS TO MEET OUR BUSINESS NEEDS. THE RISKS ASSOCIATED
WITH THE UPGRADE PROCESS INCLUDE DISRUPTION OF OUR BUSINESS PROCESSES, WHICH
COULD HARM OUR BUSINESS.
We currently run third-party applications for data processing in our
distribution center operations, shipping, materials movement, customer service,
invoicing, financial record keeping and reporting, and other operations and
administration. The nature of the software industry is to upgrade software
systems to make architectural changes, increase functionality and address
software bugs. Over time, older versions of the software become less supported
by our vendors for financial and other reasons and eventually become obsolete.
Oracle, the primary supplier of our third-party applications, provides notice of
the dates that Oracle will de-support the software and companies are expected to
either make plans to upgrade to newer versions or operate without Oracle
support. While Oracle and other third-party vendors may provide advanced notice
of product upgrade schedules and take other steps to make the upgrade process as
straight-forward as possible, we are subject to risks associated with the
process. Our software systems could become unstable following an upgrade process
and impact our ability to process data properly in these systems, including
timely and accurate shipment of products, invoicing our customers properly and
the production of accurate and timely financial statements. We also cannot
assure you that these software upgrades or enhancements will operate as intended
or be free from bugs. We upgraded our Oracle applications during the fourth
quarter of 2002 and expect to affect similar software upgrades in the future. If
we are unable to successfully integrate the new software into our information
systems, our operations, customer service and financial reporting could be
adversely affected and could harm our business.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, IMPAIRING YOUR ABILITY
TO SELL YOUR SHARES AT OR ABOVE PURCHASE PRICE.
The market price for our common stock has been highly volatile. The
volatility of our stock could be subject to continued wide fluctuations in
response to many risk factors listed in this section, and others beyond our
control, including:
* announcements of developments relating to our business;
* fluctuations in our operating results;
* shortfalls in revenue or earnings relative to securities analysts'
expectations;
* announcements of technological innovations or new products or
enhancements by us or our competitors;
* announcements of acquisitions or planned acquisitions of other
companies or businesses;
* investors' reactions to acquisition announcements or our forecasts of
future results;
* general conditions in the telecommunications industry;
* the market for Internet-related products and services;
* changes in the national or worldwide economy;
* changes in legislation or regulation affecting the telecommunications
industry;
* threats of or outbreaks of war, hostilities or terrorist acts;
27
* developments relating to our intellectual property rights and the
intellectual property rights or third parties;
* changes in our relationships with our customers and suppliers; and
* national and regional weather patterns.
In addition, stock prices of technology companies in general, and for voice
and data communications companies in particular, have experienced extreme price
fluctuations in recent years which have often been unrelated to the operating
performance of affected companies. We cannot assure you that the market price of
our common stock will not experience significant fluctuations in the future,
including fluctuations that are unrelated to our performance.
WE ARE CURRENTLY SUBJECT TO GOVERNMENT INVESTIGATIONS AND IN THE FUTURE WE MAY
BE SUBJECT TO LITIGATION, WHICH IF THEY RESULT IN ANY CONVICTIONS, SANCTIONS OR
PENALTIES AGAINST US, COULD HARM OUR BUSINESS.
Divisions of the United States Department of Justice are investigating
other companies' and Inter-Tel's participation in a federally-funded "E-Rate
program" to connect schools and libraries to the Internet. The Justice
Department has not provided Inter-Tel with a description of the evidence on
which the investigations are based.
Inter-Tel is presently unable to predict or determine the final outcome of,
or to estimate the potential range of loss (if any) with respect to, the
investigations. If Inter-Tel is convicted of any crime or subjected to
sanctions, or if penalties, damages or other monetary remedies are assessed
against Inter-Tel in connection with these and other investigations, our
business and operating results could be materially and adversely affected.
Inter-Tel is also subject to litigation in the ordinary course of business.
We cannot assure you that any adverse outcome in connection with such litigation
would not impair our business or financial condition.
OUR CHAIRMAN OF THE BOARD OF DIRECTORS, CEO AND PRESIDENT CONTROLS 21.9% OF OUR
COMMON STOCK AND IS ABLE TO SIGNIFICANTLY INFLUENCE MATTERS REQUIRING
SHAREHOLDER APPROVAL.
As of March 31, 2003, Steven G. Mihaylo, Inter-Tel's Chairman of the Board
of Directors, Chief Executive Officer and President, beneficially owned
approximately 21.9% of the existing outstanding shares of the common stock. As a
result, he has the ability to exercise significant influence over all matters
requiring shareholder approval. In addition, the concentration of ownership
could have the effect of delaying or preventing a change in control of
Inter-Tel.
RISKS RELATED TO OUR INDUSTRY
REDUCTIONS IN SPENDING ON ENTERPRISE COMMUNICATIONS EQUIPMENT MAY MATERIALLY AND
ADVERSELY AFFECT OUR BUSINESS.
The overall economic slowdown has had a harmful effect on the market for
enterprise communications equipment. Our customers have reduced significantly
their capital spending on communications equipment in an effort to reduce their
own costs and bolster their revenues. The market for enterprise communications
equipment may only grow at a modest rate or possibly not grow at all, and our
financial performance has been and may continue to be materially and adversely
affected by the reductions in spending on enterprise communications equipment.
THE EMERGING MARKET FOR IP NETWORK TELEPHONY IS SUBJECT TO MARKET RISKS AND
UNCERTAINTIES THAT COULD CAUSE SIGNIFICANT DELAYS AND EXPENSES.
The market for IP network voice communications products has begun to
develop only recently, is evolving rapidly and is characterized by an increasing
number of market entrants who have introduced or developed products and services
for Internet or other IP network voice communications. As is typical of a new
and rapidly evolving industry, the demand for and market acceptance of, recently
introduced IP network products and services are highly uncertain. We cannot
28
assure you that packet-switched voice networks will become widespread. Even if
packet-switched voice networks become more widespread in the future, we cannot
assure that our products, including the IP telephony features of the AXXESS and
ECLIPSE2 systems, our IP endpoints and IP applications will successfully compete
against other market players and attain broad market acceptance.
Moreover, the adoption of packet-switched voice networks and importance of
development of products using industry standards such as MGCP and SIP, generally
require the acceptance of a new way of exchanging information. In particular,
enterprises that have already invested substantial resources in other means of
communicating information may be reluctant or slow to adopt a new approach to
communications. If the market for IP network voice communications fails to
develop or develops more slowly than we anticipate, our IP network telephony
products could fail to achieve market acceptance, which in turn could
significantly harm our business, financial condition and operating results. This
growth may be inhibited by a number of factors, such as quality of
infrastructure; security concerns; equipment, software or other technology
failures; regulatory encroachments; inconsistent quality of service; poor voice
quality over IP networks as compared to circuit-switched networks; and lack of
availability of cost-effective, high-speed network capacity. Moreover, as
IP-based data communications and telephony usage grow, the infrastructure used
to support these IP networks, whether public or private, may not be able to
support the demands placed on them and their performance or reliability may
decline. The technology that allows voice and facsimile communications over the
Internet and other data networks, and the delivery of other value-added
services, is still in the early stages of development.
GOVERNMENT REGULATION OF THIRD PARTY LONG DISTANCE AND NETWORK SERVICE ENTITIES
ON WHICH WE RELY MAY HARM OUR BUSINESS.
Our supply of telecommunications services and information depends on
several long distance carriers, RBOCs, local exchange carriers, or LECs, and
competitive local exchange carriers, or CLECs. We rely on these carriers to
provide network services to our customers and to provide us with billing
information. Long distance services are subject to extensive and uncertain
governmental regulation on both the federal and state level. We cannot assure
that the increase in regulations will not harm our business. Our current
contracts for the resale of services through long distance carriers include
multi-year periods during which we have minimum use requirements and/or costs.
The market for long distance services is experiencing, and is expected to
continue to experience significant price competition, and this may cause a
decrease in end-user rates. We cannot assure you that we will meet minimum use
commitments, that we will be able to negotiate lower rates with carriers if
end-user rates decrease or that we will be able to extend our contracts with
carriers at favorable prices. If we are unable to secure reliable long distance
and network services from certain long distance carriers, RBOCs, LECs and CLECs,
or if these entities are unwilling or unable to provide telecommunications
services and billing information to us on favorable terms, our ability to expand
our own long distance and network services will be harmed. Carriers that provide
telecommunications services to us may also experience financial difficulties, up
to and including bankruptcies, which could harm our ability to offer
telecommunications services.
CONSOLIDATION WITHIN THE TELECOMMUNICATIONS INDUSTRY COULD INCREASE COMPETITION
AND REDUCE OUR CUSTOMER BASE.
There has been a trend in the telecommunications industry towards
consolidation and we expect this trend to continue as the industry evolves. As a
result of this consolidation trend, new stronger companies may emerge that have
improved financial resources, enhanced research and development capabilities and
a larger and more diverse customer base. The changes within the
telecommunications industry may adversely affect our business, operating results
and financial condition.
TERRORIST ACTIVITIES AND RESULTING MILITARY AND OTHER ACTIONS COULD HARM OUR
BUSINESS.
Terrorist attacks in New York and Washington, D.C. in September of 2001
disrupted commerce throughout the world. The continued threat of terrorism, the
war in Iraq and the potential for additional military action and heightened
security measures in response to these threats may continue to cause significant
disruption to commerce throughout the world. To the extent that disruptions
result in a general decrease in corporate spending on information technology or
advertising, our business and results of operations could be harmed. We are
unable to predict whether the war in Iraq, the threat of terrorism or the
responses thereto will result in any long-term commercial disruptions or if such
activities or responses will have a long-term adverse effect on our business,
results of operations or financial condition. Additionally, if any future
terrorist attacks were to affect the operation of the Internet or key data
centers, our business could be harmed. These and other developments arising out
of the potential attacks may make the occurrence of one or more of the factors
discussed herein more likely to occur.
29
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.
The Company also maintains short-term investments, which are all classified
as available for sale, and have been recorded at fair value, which approximates
cost. Short-term investments include certificates of deposit, auction rate
certificates, auction rate preferred securities, municipal preferred securities
and mutual funds. The auction rate securities are adjustable-rate securities
with dividend rates that are reset periodically by bidders through periodic
"Dutch auctions" generally conducted every 7 to 49 days by a trust company or
broker/dealer on behalf of the issuer. The Company believes these securities are
highly liquid investments through the related auctions; however, the
collateralizing securities have stated terms of up to thirty (30) years. These
instruments are rated A or higher by Standard & Poor's Ratings Group, or
equivalent. The Company's short-term investments are intended to establish a
high-quality portfolio that preserves principal, meets liquidity needs, avoids
inappropriate concentrations and delivers an appropriate yield in relationship
to the Company's investment guidelines and market conditions. Given the
short-term nature of these investments, and that we have no borrowings
outstanding other than short-term letters of credit, we are not subject to
significant interest rate risk.
LEASE PORTFOLIO. We offer to our customers lease financing and other services,
including our Total Solutions program, through our Inter-Tel Leasing subsidiary.
We fund these programs in part through the sale to financial institutions of
rental payment streams under the leases. Upon the sale of the rental payment
streams, we continue to service the leases and maintain limited recourse on the
leases. We maintain reserves for loan losses on all leases based on historical
loss experience, past due accounts and specific account analysis. Although to
date we have been able to resell the rental streams from leases under our lease
programs profitably and on a substantially current basis, the timing and
profitability of lease resales could impact our business and operating results,
particularly in an environment of fluctuating interest rates and economic
uncertainty. If we were required to repurchase rental streams and realize losses
thereon in amounts exceeding our reserves, our operating results could be
materially adversely affected. See "Liquidity and Capital Resources" and
"Critical Accounting Policies and Estimates" 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
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-14(c) and 15d-14(c) under the
Securities Exchange Act of 1934, as amended, within 90 days of the filing date
of this report (the "Evaluation Date"). Based on this evaluation, our principal
executive officer and principal financial officer concluded as of the Evaluation
Date that our disclosure controls and procedures were effective such that the
material information required to be included in our Securities and Exchange
Commission ("SEC") reports is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms relating to Inter-Tel,
Incorporated, including our consolidated subsidiaries, and was made known to
them by others within those entities, particularly during the period when this
report was being prepared.
30
In addition, there were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
Evaluation Date. We have not identified any significant deficiencies or material
weaknesses in our internal controls, and therefore there were no corrective
actions taken.
INTER-TEL, INCORPORATED AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved from time to time in litigation incidental to our business. We
believe that the outcome of current litigation will not have a material adverse
effect upon our business, financial condition or results of operations and will
not disrupt our normal operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS--NOT APPLICABLE
ITEM 3. DEFAULTS ON SENIOR SECURITIES--NOT APPLICABLE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Shareholders was held April 21, 2003 (the Annual Meeting).
On March 21, 2003 we mailed a Proxy Statement, pursuant to Regulation 14A under
the Securities Exchange Act of 1934, as amended, to our security holders to
solicit their votes regarding the following matters that were discussed at our
Annual Meeting:
1. Election of Directors: Steven G. Mihaylo, J. Robert Anderson, Jerry W.
Chapman, Gary D. Edens and C. Roland Haden were elected to serve as
directors until the 2004 Annual Meeting of Shareholders. The votes were as
follows:
Nominee For: Against: Abstain:
------- ---- -------- --------
Steven G. Mihaylo 17,043,186 6,034,605 --
J. Robert Anderson 21,795,009 1,282,782 --
Jerry W. Chapman 21,928,157 1,149,634 --
Gary D. Edens 22,685,532 392,259 --
C. Roland Haden 22,859,833 217,958 --
2. The shareholders also voted on and approved a proposal to ratify the
appointment of Ernst & Young LLP to act as the independent auditors to
audit our and our subsidiaries' financial statements for the year 2003. The
votes were as follows:
For: Against: Abstain:
---- -------- --------
22,733,160 336,710 7,921
3. Inter-Tel's shareholders voted on and approved an amendment (the
"Amendment") to the Inter-Tel, Incorporated 1997 Long-Term Incentive Plan
(the "1997 Plan") that was previously approved by the Board of Directors.
The Amendment would remove the 500,000 share lifetime individual grant
limitation and to create an annual individual grant limit per individual of
1% or less of the total outstanding shares for any one year period. The
votes were as follows:
For: Against: Abstain:
---- -------- --------
14,117,993 8,942,140 17,658
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ITEM 5. OTHER INFORMATION
Pursuant to Rule 14a-4(c)(1) under the Securities Exchange Act of 1934, as
amended, in connection with the Company's annual meeting of shareholders, if a
shareholder of the Company fails to notify the Company at least 45 days prior to
the month and day of mailing of the prior year's proxy statement, then the
proxies of management would be allowed to use their discretionary voting
authority when any such proposal is raised at the Company's annual meeting of
shareholders, without any discussion of the matter in the proxy statement. Since
the Company mailed its proxy statement for the 2003 annual meeting of
shareholders on March 21, 2002, the deadline for receipt of any such shareholder
proposal for the 2004 annual meeting of shareholders is February 5, 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
Exhibits:
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
Reports on Form 8-K:
On April 7, 2003, we filed a Current Report on Form 8-K under Item 7
(Financial Statements and Exhibits) and Item 9 (Regulation FD
Disclosure) to report our Press release dated April 7, 2003 announcing
anticipated net sales and earnings per share results for, and
anticipated cash and short-term investment levels as of, the fiscal
quarter ended March 31, 2003.
On April 21, 2003, we filed a Current Report on Form 8-K under Item 7
(Financial Statements and Exhibits) and Item 9 (Regulation FD
Disclosure) to report our Press release dated April 21, 2003
announcing non-GAAP results for the fiscal quarter ended March 31,
2003, and comparing such results with the results for the quarter
ended March 31, 2002.
32
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
May 12, 2003 /s/ Steven G. Mihaylo
- -------------- ----------------------------------------
Steven G. Mihaylo
Chairman of the Board, Chief Executive
Officer and President
May 12, 2003 /s/ Kurt R. Kneip
- -------------- ----------------------------------------
Kurt R. Kneip
Vice President and
Chief Financial Officer
33
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: May 12, 2003
By: /s/ Steven G. Mihaylo
------------------------------------
Name: Steven G. Mihaylo
----------------------------------
Title: Chief Executive Officer
---------------------------------
34
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: May 12, 2003
By: /s/ Kurt R. Kneip
------------------------------------
Name: Kurt R. Kneip
----------------------------------
Title: Chief Financial Officer
---------------------------------
35