UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission File Number:
December 31, 1997 0-10211
INTER-TEL, INCORPORATED
Incorporated in the State of Arizona I.R.S. No. 86-0220994
120 North 44th Street, Suite 200
Phoenix, Arizona 85034-1822
(602) 302-8900
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock
(26,796,272 shares outstanding as of March 13, 1998)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (S 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K - [ ].
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the last reported sales price in NASDAQ National
Market System on March 13, 1998, was approximately $543,688,355. Shares of
Common Stock held by each executive officer and director have been excluded in
that such persons may be deemed to be affiliates.
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Materials have been incorporated by reference into this Report from the
following documents: (1) materials from the registrant's Proxy Statement
relating to its 1998 Annual Meeting of Shareholders have been incorporated by
reference into Part III and Part IV and (2) documents from the registrant's Form
S-1 Registration Statements (Nos. 2-70437 and 33-70054), Form S-3 Registration
Statements (Nos. 33-58161, 33-61437, 333-01735, 333-12433 and 333-39221), Form
S-8 Registration Statements (Nos. 2-94805, 33-40353, 33-73620 and 333-41197),
Annual Reports on Form 10-K for the years December 31, 1984, 1988 and 1994, and
current reports on Form 8-K dated July 17, 1987, August 3, 1988 have been
incorporated by reference into Part IV, Item 14. Portions of the Annual Report
to Shareholders for the year ended December 31, 1996 are incorporated by
reference into Part II.
INTER-TEL, INCORPORATED
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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PART I
Page
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Item 1 Business 3
Item 2 Properties 25
Item 3 Legal Proceedings 26
Item 4 Submission of Matters to a Vote of Security Holders 26
PART II
Item 5 Market for the Registrant's Common Stock
and Related Stockholder Matters 26
Item 6 Selected Financial Data 26
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations 27
Item 7A Quantitative and Qualitative Disclosures About Market Risk 27
Item 8 Financial Statements and Supplementary Data 27
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 27
PART III
Item 10 Directors and Executive Officers of the Registrant 27
Item 11 Executive Compensation 27
Item 12 Security Ownership of Certain Beneficial Owners and Management 27
Item 13 Certain Relationships and Related Transactions 27
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 28
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PART I
ITEM 1. BUSINESS
The Company
This Annual Report to Shareholders on Form 10-K ("10-K") contains
forward-looking statements that involve risks and uncertainties. The statements
contained in this 10-K that are not purely historical are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including without limitation statements regarding the Company's expectations,
beliefs, intentions or strategies regarding the future. All forward-looking
statements included in this document are based on information available to the
Company on the date hereof, and the Company assumes no obligation to update any
such forward-looking statements. The cautionary statements made in this 10-K
should be read as being applicable to all related forward-looking statements
wherever they appear in this document. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth under "Factors That May
Affect Results of Future Operations" below and elsewhere in this document. In
evaluating the Company's business, shareholders and prospective investors should
consider carefully the following factors in addition to the other information
set forth in this document.
Inter-Tel, incorporated in Arizona in 1969, is a single point of
contact, full service provider of digital business telephone systems, call
processing software, voice processing software, call accounting software,
Internet Protocol (IP) telephony software, computer telephone integration
("CTI") applications and long distance calling services. Inter-Tel's products
and services include the AXXESS and Inter-Tel Axxent digital business
communication software platforms, the AXXESSORY Talk voice processing platform,
the Inter-Tel Vocal'Net IP telephony gateway, the Inter-Tel Vocal'Net Service
Provider Software and Centralized Accounting Software and Inter-Tel.net, an IP
telephony packet switched long distance service. The Company also provides
maintenance, leasing and support services for its products. The Company's Common
Stock is quoted on the Nasdaq National Market System under the symbol INTL.
The Company has developed a distribution network of direct sales
offices, dealers and value added resellers (VARs) which sell the Company's
products to small-to-medium-size organizations and to divisions or departments
of larger organizations, including Fortune 500 companies, large service
organizations and governmental agencies. The Company has 30 direct sales offices
in the United States, one in the United Kingdom, one in Japan and a network of
hundreds of dealers and VARs who purchase directly from the Company.
Industry Background
In recent years, advances in telecommunications technologies have
facilitated the development of increasingly sophisticated telephone systems and
applications. Users rely upon a variety of applications, including conference
calling, speaker phones, automated attendant, voice processing and unified
messaging (the integration of voice mail, facsimile and electronic mail), to
improve communications within their organizations and with customers and
vendors. Digital technology has facilitated the integration of computing and
telecommunications technologies, which has made possible a number of new
applications that further enhance productivity. Examples of these applications
include automatic call distribution (which provides for queuing and
prioritization of incoming calls), call accounting (which permits accounting for
telephone usage and toll calls), unified messaging, electronic data interchange
between customers and vendors and the use of automatic number identification
coupled with database look-up (where customer information is retrieved
automatically from a computerized database when the customer calls).
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The emergence of high-performance, low-cost computers and the growth of
the Internet and other digital IP networks have enabled real-time voice
communications to be transmitted on digital packet switched networks rather than
over traditional circuit switched telephone networks. This development of voice
applications for the Internet and other IP networks reflects a broader
convergence of standard voice communications and data networks. Because IP
network telephony converts all transmissions to the same type of packets, both
voice and data can use the same data circuits, thereby increasing efficiency and
maximizing the use of available bandwidth. The lowering of federal regulatory
barriers to competition across traditionally distinct sectors of the
telecommunications industry has opened new markets for and increased competitive
pressures on telecommunications companies. In response to these factors,
telecommunications companies have begun to establish a presence in Internet and
other IP network voice communications services.
Following the breakup of the Bell system in 1984, which removed
restrictions on the ability of the RBOCs to purchase telecommunications
equipment from independent suppliers and to resell such equipment to end users,
the market for telecommunications systems and applications became increasingly
fragmented. The number of independent suppliers and distributors of
telecommunications equipment initially increased, but increased levels of
competition subsequently led to consolidation among suppliers and distributors.
In addition, different telecommunications systems and applications were often
available from only one or a limited number of suppliers, which required
businesses seeking complete systems to work with a number of different
suppliers. A business seeking a telephone system, voice mail and long distance
services would most likely purchase the products and services from three
separate vendors. As business telecommunications requirements have become more
advanced, the integration of different systems has become increasingly
difficult.
Strategy
Inter-Tel's objective is to continue to strengthen its position as a
leading single-source provider of telecommunications equipment, software
applications and network services. The Company's strategy incorporates the
following key elements:
Offer Total Telephony Solution
The Company intends to continue to offer a broad range of products and
services that incorporates advanced technologies and provides customers with a
single source to fulfill their telecommunications needs on a cost-effective
basis. Inter-Tel couples this solution-oriented approach with a high level of
customer service and support and a commitment to quality throughout the
Company's operations. The Company's telephone systems are integrated with the
Company's long distance calling services, voice mail, automated attendant and
other telecommunications applications, support for interactive voice response.
Because of the modular design of the Company's systems and the high level of
software content in its products, customers can readily increase the size and
functionality of their systems as their needs change by adding software and
hardware applications or services or by upgrading to new systems or advanced
versions of existing systems. The Company believes that its customers prefer to
purchase telecommunications equipment and services from a single source because
of the convenience, consistency of service, ease of upgrade, availability of
financing alternatives and confidence in the performance of integrated systems
and services.
Accelerate Adoption of Inter-Tel Vocal'Net Gateway
In September 1997, Inter-Tel commercially released Inter-Tel Vocal'Net,
a gateway for bridging public circuit switched telephone networks and IP packet
switched networks such as the Internet. The Company intends to focus its initial
marketing efforts on existing customers as well
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as other multi-location companies and international enterprises. Inter-Tel
Vocal'Net can be used to reduce an enterprise's communications costs through
more effective use of its data network and reduced use of traditional long
distance services. In addition, the Company plans to pursue relationships with
ISPs, long distance resellers, cable television companies and other service
providers that choose to establish alternative networks to compete with
traditional long distance services and to provide additional applications to
their customers.
Expand Inter-Tel.net Network
The Company is currently developing and implementing its own private IP
telephony network, Inter-Tel.net, to carry telephone traffic at rates typically
lower than those of standard telephone networks. To date, the Inter-Tel.net
network has established points of presence in the San Francisco Bay Area,
Washington, D.C., Chicago, Reno, New York, Phoenix and Los Angeles. The Company
intends to expand the number of points of presence, both domestically and
internationally, as well as increase capacity in existing cities. Inter-Tel.net
is designed to carry long distance traffic originated from Inter-Tel's customer
base and provide other exchange carriers, individuals, and enterprises a
cost-effective alternative to current offerings of the conventional circuit
switched long distance carriers.
Continue to Develop Advanced Communications Products
The Company commits substantial research and development resources in
order to provide its customers with advanced telecommunications technologies on
a cost-effective basis. The Company has developed an extensive C++ library and
significant telecommunications expertise. In many cases, the Company develops
new technologies as software upgrades or add-ons to existing products. In this
regard, the AXXESS 5.0 platform, which is currently scheduled for release in the
first half of 1998, will provide an extensive enhancement of AXXESS, the
Company's primary product. Ongoing research and development efforts are directed
to the development of new products, applications and services for sale into the
Company's existing customer base and to new customers. Through CTI applications
and advanced network services, Inter-Tel provides technology that is designed to
enable its customers to improve their efficiency and enhance their
competitiveness.
Expand Distribution Channels
The Company continues to expand its distribution channels through a
growing network of direct dealers, expansion of the Company's direct sales
presence, hiring additional direct sales personnel and extension into
international markets. The Company has established sales relationships with
hundreds of direct dealers and continues to expand this network. The Company is
in the process of establishing dealer networks in Japan and other parts of Asia
and is expanding its dealer network in the United Kingdom and Europe. The
Company has expanded its direct sales activity in recent periods through
strategic acquisitions of resellers of telephony products and services in areas
where the Company has existing direct sales offices and other strategic markets,
and considers additional acquisition opportunities on an ongoing basis. The
Company also is expanding its distribution into other channels such as computer
equipment dealers, resellers of data communications equipment and software
resellers.
Products and Services
The Company offers a broad range of products and services designed to
support the needs of businesses and other organizations requiring voice and data
communications systems. The Company's principal products are digital telephone
systems which support installations up to 512 ports, IP telephony products and
services, CTI applications, unified messaging software and voice processing
software. The Company's principal system sales consist of systems supporting 10
to 300 telephones with suggested retail prices of up to $300,000 per system,
depending on
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configuration. The Company also offers long distance calling services, network
design and implementation services, maintenance, leasing and support services,
and resells other telecommunications products.
Digital Communication Platforms
Inter-Tel offers an extensive line of digital communication systems,
including hardware platforms and C++ software applications. Because these
platforms are based upon open architecture and conform to established computer
and telephone industry standard programming interfaces and protocols (such as
TAPI, TSAPI and TCP/IP), customers can choose from a variety of either server
level or desktop applications.
AXXESS. Inter-Tel's primary product, the AXXESS platform, incorporates
advanced technology for computer and telephone integration providing businesses
with the ability to customize applications to enhance their operations and
increase productivity. The current AXXESS system release supports up to 512
ports and includes such advanced capabilities as primary rate ISDN, integrated
call recording, voice prompts in different languages, and a Windows-based
attendant's console. The AXXESS 5.0 platform, which is currently scheduled for
release in the first half of 1998, is designed to allow, through fully
transparent digital networking, two or more systems to operate as one, and to
increase capacity to 5,000 ports. AXXESS 5.1, currently scheduled for release in
the second half of 1998, is designed to increase capacity to 20,000 ports.
The system incorporates fully-digital processing and transmission to
the desktop and open architecture interfaces which allow the system to be
integrated with and controlled by attached computers such as PCs and
workstations. The system incorporates object-oriented C++ software developed by
the Company, which facilitates upgrades and the incorporation of additional
features and functionality.
AXXESS system telephones incorporate user-friendly, 6-by-16 character
LCD displays with menu keys that permit the user to select from multiple menu
choices or access additional menu screens. AXXESSORY Talk, permits push-button
selection of voice processing commands to appear on the telephone's LCD display,
as well as voice-prompted selections through the telephone keypad. The AXXESS
system is multi-lingual, currently offering English or Japanese voice prompts
and LCD displays and allowing the user to switch from one language to the other.
Spanish is scheduled for controlled product introduction in the second quarter
of 1998. Additional languages can be added in the future.
The open architecture interface permits tight integration with a PC or
workstation system bus, using several industry-standard interfaces to provide
efficient access to voice processing and other applications on the PC or
workstation. Applications include database look-up (which utilizes Caller-ID
information to retrieve customer information automatically from a computerized
database), automated attendant, interactive voice response, automatic call
distribution (which queues and prioritizes incoming calls), and call accounting
(which permits the monitoring of telephone usage and toll cost). The AXXESS
system is managed through a Microsoft Windows-based graphical user interface on
a PC to facilitate installation, system configuration and programming.
The AXXESS system utilizes advanced software to configure and utilize
real-time digital signal processor semiconductor components ("DSPs")
incorporated into the system hardware. The use of DSPs and related software
lowers system costs, permits higher functionality and increases system
flexibility. For example, DSPs can be configured by the system manager for
different combinations of speakerphones, conference capabilities and other
DSP-based facilities. The system's speakerphones incorporate full-duplex
technology, which permits speakerphones to transmit in both directions at the
same time without the necessity to override one speaker's voice to prevent
feedback interference.
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The AXXESS software is written in a high-level, object-oriented
language which can operate on many commonly used processors. Accordingly, the
software can be readily ported to other hardware platforms. The Company intends
to port the AXXESS software to faster microprocessors which will permit the
AXXESS to grow to a much larger size, in order to enhance the functionality and
performance of these larger systems and to permit a migration path from the
smaller AXXESS system as a customer's system requirements increase.
Inter-Tel Axxent. Small businesses are demanding advanced telephony
applications formerly within reach of only large corporations. The Inter-Tel
Axxent is designed to bring many of the advanced features and functionality of
the AXXESS system to smaller installations on a cost-effective basis while
enabling users to migrate to an AXXESS system as their telecommunications needs
evolve. The Inter-Tel Axxent supports 24 lines and 12 trunks and provides
capabilities such as computer telephone integration, DSP technology, real-time
ACD reporting, and integrated voice processing. Housed in a compact, PC-type
mid-tower chassis, the Inter-Tel Axxent platform also offers the convenience of
a default database so the system is fully operational as soon as it is plugged
in. Basic database programming can also be performed through the digital
telephone terminals.
IP Network Gateway and Inter-Tel.net Network
Gateway products are designed as transition points between two
different network types, such as between the public circuit switched telephone
network and a packet switched IP network such as the Internet. Gateway products
convert regular voice transmissions to or from the compressed data packets that
travel over packetized networks.
In September 1997, the Company released Inter-Tel Vocal'Net, a
stand-alone IP network telephony solution available for use with the AXXESS
system or other traditional telephone systems equipped with T-1/E-1, ISDN or
analog capability. It provides a gateway for bridging the telephone network and
a company's intranet or the Internet. With the Inter-Tel Vocal'Net gateway,
users can conduct real-time, two-way voice communications over the Internet and
realize potential savings compared to standard long distance telephone service.
Designed to meet the needs of most businesses, the Inter-Tel Vocal'Net gateway
is available in multiple port sizes.
Inter-Tel Vocal'Net does not require customized telephone sets or
specialized software or cards in each desktop computer. Further, Inter-Tel
Vocal'Net does not rely on the central processing unit of the computer for the
compression or packetization of information, but instead uses high speed DSPs,
enabling the server to handle additional functions such as unified messaging.
A caller can dial from a standard telephone to the Inter-Tel Vocal'Net
gateway, which connects the call from the circuit switched telephone network,
converts it into the compressed, digitized data packets used by an IP network,
and routes the call via the IP network to another Inter-Tel Vocal'Net gateway.
The second gateway connects with the regular telephone system and dials the
final destination.
When used in a corporate environment, Inter-Tel Vocal'Net can be
attached to a T-1/E-1, ISDN or analog trunk interface on the PBX, and the PBX's
Automatic Route Selection or Least Cost Routing features will be programmed to
automatically route calls for other locations that have Inter-Tel Vocal'Net
Servers through that trunk interface. When phone users wish to place a call,
they simply dial the desired telephone number like any other call. The PBX will
route the call to Inter-Tel Vocal'Net, which converts it into the compressed,
digitized data packets used by an IP network, and routes the call via the IP
network to another Inter-Tel Vocal'Net gateway. The second gateway connects with
the far-end PBX and dials either the extension number of the desired party or
accesses a trunk on the PBX and makes a call into the switched network.
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Because IP network telephony converts all transmissions to the same
type of packets, both voice and data can use the same data circuits, thereby
increasing efficiency and maximizing the use of bandwidth. Bandwidth utilization
can be maximized to a point that some users may be able to reduce the overall
number of circuits needed.
In its initial commercial release, Inter-Tel Vocal'Net is designed to
work with business telephone systems that operate over T-1/E-1, ISDN and analog
lines, and to handle up to 24 simultaneous calls per server. Inter-Tel Vocal'Net
servers can also be networked to operate seamlessly in configurations consisting
of thousands of ports. The Company is currently developing additional
enhancements, including industry standard compatibility (H.323) for integration
with PC-based software applications and other types of gateways as well as a fax
gateway to provide fax and broadcast fax capabilities across the Internet. Other
planned enhancements to the Inter-Tel Vocal'Net include functionality designed
to allow businesses to create virtual offices, enabling traveling or off-site
employees to connect to the main office from remote locations. Another planned
application is "Touch-To-Talk" telephony-enabled web pages, which will allow
users to press a link on a web page and to automatically connect over an IP
network to talk to customer service agents.
In addition to the Vocal'Net Gateway Server, Inter-Tel has developed
the Inter-Tel Vocal'Net Service Provider and Centralized Accounting System which
provides a centralized pre-paid and post-paid billing system for IP Telephony
service providers. This system provides back-office support necessary to run an
IP Telephony service business. Future planned enhancements to the Service
Provider and Centralized Accounting System include the integration of an H.323
Gatekeeper to allow the system to provide pre-paid and post-paid billing
services for compatible H.323 gateways, routers, or software clients.
Utilizing Inter-Tel Vocal'Net technology, Inter-Tel continues to
develop and expand Inter-Tel.net, a private IP network designed to carry long
distance telephone traffic at rates typically lower than traditional long
distance providers. Inter-Tel.net is currently being used by the Company's
employees for calls between Inter-Tel.net's seven points of presence: the San
Francisco Bay Area, Washington D.C., Chicago, Reno, New York, Phoenix and Los
Angeles. In its initial commercial release, the Inter-Tel Vocal'Net gateway
supports calls placed from telephone to telephone. Later releases are planned to
support communications from telephone to computer, computer to telephone,
computer to computer and a facsimile machine to facsimile machine. See "Factors
That May Affect Future Operating Results--Developing Market for IP Network
Telephony; Uncertain Regulatory Environment," "--Risks Associated with Inter-Tel
Vocal'Net; Dependence upon IP Network Infrastructures; Risk of System Failure;
Security Risks" and "--Development and Maintenance of Inter-Tel.net Network."
Computer-Telephone Integration
Through CTI, the computer and the telephone are linked into one
environment. Inter-Tel's AXXESSORY Connect software for the AXXESS system
enables users to receive phone calls through their desktop PC. Using Caller
I.D., a caller's information can be retrieved from the company's database even
before the call is accepted. On an individual desktop or a company-wide network
basis, Inter-Tel offers a variety of products, such as AXXESSORY ACD, that can
manage automatic call distribution at peak efficiency or route incoming
telephone calls, based on various parameters, to a specific person. It can also
collect, analyze and report real-time call processing information for staff
forecasting and analysis.
Inter-Tel's software applications integrate, through the use of
Novell's TSAPI and Microsoft's TAPI standard interfaces, with other
"off-the-shelf" Windows applications such as personal information managers, call
routing or call management software that can further enhance customer service
while increasing call efficiency and employee productivity. Inter-Tel has formed
relationships
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with a number of third party software developers to integrate with their
existing applications to create a working environment for database, personal
organizer, or terminal emulation programs.
If these "off-the-shelf" applications do not adequately meet the needs
of a customer, the open design of Inter-Tel's software enables independent
software developers to write custom applications through Inter-Tel's Developer's
Program. Alternatively, Inter-Tel's CTI Solutions Group can provide professional
consulting services or development of individual customer applications, for
either desktop or local area network ("LAN")-based applications.
Unified Messaging and Voice Processing Software
Inter-Tel's unified messaging software, Visual Mail, works in
conjunction with a variety of messaging platforms, including the Microsoft
Exchange messaging application, Lotus Notes, Lotus cc:Mail, Novell's GroupWise
and Internet mail applications such as Qualcomm's Eudora. Visual Mail integrates
all types of messages into a single-user interface on a PC, supports both voice
mail and facsimile mail and provides another means for improving workplace
productivity and retrieving messages from a PC connected to a modem.
Inter-Tel's AXXESSORY Talk, Axxent Talk and IVX500 are voice processing
platforms that work with Inter-Tel's communication platforms. All three
applications use the Multi-Vendor Interface Protocol ("MVIP"), an industry
standard for connecting multi-vendor PC-based boards in voice processing, data
switching and video systems.
Other Services and Products
Networking Technologies Integration. To develop a solid foundation for
state-of-the-art data and telecommunications networking, customers require
strategic network expertise from their networking provider. Inter-Tel designs,
installs and supports the complete integration of a customer's complex data and
telecommunications network, from land-based LANs to geographically dispersed
wide area networks ("WANs").
By forming relationships with major manufacturers of hardware and
software technologies, Inter-Tel provides the routers, ATM, LAN and WAN
switches, file servers, intelligent hubs and any other device required for the
customer's intranet or for usage of the Internet. Pre-sale design support,
project coordination for implementation, and installation support are offered on
the full line of Inter-Tel server-based telephony products and services.
Network and Long Distance Services. The Company, through its Inter-Tel
NetSolutions, Inc. subsidiary, resells a variety of long distance calling
services, including domestic and international calling services, 800 calling
services, dedicated services, voice and video conferencing, customized billing
and a variety of other telecommunication services. The Company believes that
certain of its customers desire the convenience of acquiring long distance
calling services through the same vendor that the customer uses to purchase its
other telephony equipment and services. The Company currently resells long
distance services pursuant to contracts with four of the six largest U.S. long
distance carriers. There can be no assurance that the Company will meet its
minimum use commitments, will be able to negotiate lower rates with carriers in
the event of any decrease in end user rates or will be able to extend its
contracts with long distance carriers on prices favorable to the Company.
Call centers using T-1 access for incoming toll-free traffic, sales
offices using NetSolutions' switched long distance or companies linking multiple
offices throughout the country on a frame relay network are examples of the
applications currently supported by Inter-Tel NetSolutions.
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Leasing Services. The Company offers its Totalease program through its
Inter-Tel Leasing, Inc. subsidiary. Totalease enables an end user to acquire a
full range of telephony systems, applications, maintenance and support services,
as well as lease financing, from a single vendor. The Totalease contract
provides a total system solution to the customer at a set monthly cost, with
system expansion available at predictable additional fees. The typical Totalease
contract has a term of 60 months, with the customer entitled to renew the
contract at a specified price for up to an additional 36 months.
Inter-Tel also offers a line of low cost lease purchase financing.
Lease terms range from 24 to 84 months with $1.00, fixed and fair market value
purchase options. In addition, Inter-Tel will customize financing packages to
suit customers with special financial needs. By offering this type of financing
to acquire Inter-Tel products and services, the customer is able to lease
directly from the manufacturer and Inter-Tel, or the Inter-Tel dealer, is able
to maintain a close customer relationship.
Other Products. Inter-Tel also distributes other leading
telecommunications products from its Factored Products Division through its
direct sales offices, dealers and VARs. Factored Products represents products
that Inter-Tel has endorsed as leading communications peripherals utilized in
many day-to-day functions. Businesses require telecommunications products to
provide increased productivity, ease of operations and reliability. Many of
these products interface with Inter-Tel telephone systems. Inter-Tel's product
selection consists of videoconferencing, battery backup, headsets, surge
protection, paging equipment, wireless communications and data multiplexers.
Sales and Distribution
The Company has developed a distribution network of direct sales
offices, dealers and VARs which market the Company's products to small to medium
size organizations and divisions or departments of larger organizations. In the
United States, the Company has 30 direct sales offices and a network of hundreds
of dealers who purchase systems directly from the Company. Direct dealers are
typically located in geographic areas in which the Company does not maintain
direct sales offices. The Company also distributes its products through VARs.
These resellers have traditionally sold complex data solutions to customers, and
the Company is seeking to leverage this distribution network to capitalize on
the merging of the computer and telephony industries. The Company maintains a
dealer support office and direct sales office in the United Kingdom and has a
network of dealers in the United Kingdom and Europe. In addition, the Company
maintains a dealer support office and direct sales office in Japan.
The Company believes that its success depends in part upon the strength
of its distribution channels and the ability of the Company to maintain close
access to its end user customers. In recent periods, the Company has sought to
improve its access to end user customers by effecting strategic acquisitions of
resellers of telephony products and services in markets in which the Company has
existing direct sales offices and in other strategic markets. The Company has
expanded its direct sales office personnel from a total of 374 persons at
December 31, 1993 to a total of 822 at December 31, 1997.
The Company's sales through its direct sales offices as a percentage of
total sales have decreased from 66.4% of net sales in 1994 to 56.7% of net sales
in 1997. Sales to distributors, dealers, and VARs have increased from 24.5% of
net sales in 1994 to 28.0% of net sales in 1997. Sales through the Company's
long distance and network services operation have increased from 3.4% of net
sales in 1994 to 8.1% of net sales in 1997.
Direct dealers and VARs typically enter into non-exclusive reseller
contracts for a term of one or more years. The Company generally provides
support and other services to the reseller pursuant to the terms of the
agreement. The agreements often include requirements that the reseller meet or
use its best efforts to meet minimum annual purchase quotas. The Company faces
intense
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competition from other telephone system and voice processing system
manufacturers for its dealers' attention, as most of the Company's dealers carry
products which compete with the Company's products. There can be no assurance
that any such dealer will not promote the products of the Company's competitors
to the detriment of the Company's products. The loss of any significant dealer
or group of dealers, or any event or condition adversely affecting the Company's
dealer network, could have a material adverse effect on the Company's business,
financial condition and operating results. See "Factors That May Affect Future
Operating Results--Reliance on Dealer Network."
International sales, which to date have been made through the Company's
United Kingdom and Japan subsidiaries, accounted for approximately 2.3%, of net
sales in 1997. In order to sell its products to customers in other countries,
the Company must comply with local telecommunications standards. The Company's
AXXESS system can be readily altered through software modifications, which the
Company believes will facilitate compliance with these local regulations. In
addition, the AXXESS system has been designed to support multi-lingual
functionality, and currently supports English and Japanese. The Company is
presently establishing dealer networks in Japan and other parts of Asia and is
working to expand its dealer network in the United Kingdom and Europe.
International sales are subject to a number of risks, including changes in
foreign government regulations and telecommunications standards, export license
requirements, tariffs and taxes, other trade barriers, fluctuations in currency
exchange rates, difficulty in collecting accounts receivable, difficulty in
staffing and managing foreign operations and political and economic instability.
Fluctuations in currency exchange rates could cause the Company's 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.
Customer Service and Support
The Company believes that customer service and support are critical
components of customer satisfaction and the success of the Company's business.
The Company operates a technical support hotline to provide a range of telephone
support to its distributors, dealers and end user customers through a toll-free
number. The Company also provides on-site customer support and, through remote
diagnostic procedures, has the ability to detect and correct system problems
from its technical support facilities.
Information taken from customer call records allows feedback into
Inter-Tel's Quality First continuous improvement process, thus providing a road
map for continuous product and service enhancements. Each direct sales office is
given a periodic service activity report summarizing the reasons that
technicians are asking for assistance and common issues that give rise to
technical inquiries. This allows them to analyze trends in their service
operations and provide better customer service.
Research and Development
The Company believes that its ability to enhance its current products,
develop and introduce new products on a timely basis, maintain technological
competitiveness and meet customer requirements are essential to the Company's
success. The Company's research and development efforts over the last several
years have been focused primarily on development of and enhancements to the
existing AXXESS and AXXESSORY Talk systems with additional applications,
capacity and features, developing a unified messaging software application,
developing a telecommunications networking package, and developing new products
like the Inter-Tel Vocal'Net Server. Current efforts are related to support the
development and enhancement of IP telephony products like the Inter-Tel
Vocal'Net Gateway Server, the Vocal'Net Service Provider Package, the support of
H.323 on both the gateway and service provider products, development of
additional applications and features
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of the AXXESS and AXXESSORY Talk communications products. The software-based
architecture of the AXXESS system facilitates maintenance and support, upgrades,
and incorporation of additional features and functionality.
The Company had a total of 97 personnel engaged in research and
development as of December 31, 1997. Research and development expenses were
$7,998,000; $6,581,000 and $5,764,000 for 1997, 1996, and 1995, respectively.
Manufacturing
The Company manufactures substantially all of its systems through third
party subcontractors located in the United States, China and the Philippines.
These subcontractors use both standard and proprietary integrated circuits and
other electronic devices and components to produce telephone switches,
telephones and printed circuit boards to the Company's engineering
specifications and designs. The suppliers also inspect and test the equipment
before delivering them to the Company, which in some cases then performs systems
integration, software loading, final testing and shipment. Varian, a
multinational electronic company, currently manufacturers a significant portion
of the Company's products, including substantially all of the printed circuit
boards used in the AXXESS and Inter-Tel Axxent systems, at Varian's Tempe,
Arizona facility. If Varian or any of the Company's other manufacturers were
unable or unwilling to manufacture the Company's products in the future, the
Company could experience substantial delays in finding alternative sources,
which could have a material adverse effect on the Company's business and
operating results. The Company maintains written agreements with its principal
suppliers. The Company provides a forecast schedule to its suppliers and revises
the forecast on a periodic basis.
Foreign manufacturing facilities are subject to changes in governmental
policies, imposition of tariffs and import restrictions, and other factors
beyond the Company's control. Certain of the microprocessors, integrated
circuits and voice processing interface cards used in the Company's systems are
currently available from a single or limited sources of supply. From time to
time, the Company experiences delays in the supply of components and finished
goods. Delay or lack of supply from existing sources or the inability to develop
alternative sources if and when required in the future could materially and
adversely affect operating results. See "Risk Factors--Dependence on Contract
Manufacturers and Component Suppliers."
Quality
The Company believes that the quality of its systems, customer service
and support, and other aspects of its organization is a critical element of
meeting the needs of its customers. Through its Quality First continuous
improvement process initiated in 1991, Inter-Tel implements quality processes
throughout its business operations. The Company has established formal
procedures to ensure responsiveness to customer requests, to monitor response
times and to measure customer satisfaction. The Company has also established
means by which all end users, including customers of the Company's resellers,
can make product enhancement requests directly to the Company. The Company
supports its dealers and VARs through an extensive training program at the
Company's facility and at dealer sites, a toll-free telephone number for sales
and technical support, and the provision of end user marketing materials. The
Company typically provides a one year warranty on its systems to end users. In
manufacturing, the Company continuously monitors the quality of the products
produced on its behalf by the Company's manufacturing subcontractors, and is
extending the Company's Quality First continuous improvement process to its
suppliers.
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Competition
The market for the Company's products is highly competitive and in
recent periods has been characterized by pricing pressures and business
consolidations. The Company's competitors include Lucent Technologies, Inc.
("Lucent") and Northern Telecom Limited ("NorTel"), as well as Comdial
Corporation ("Comdial"), EXECUTONE Information Systems, Inc. ("Executone"),
Iwatsu America, Inc. ("Iwatsu"), Mitel Corporation ("Mitel"), NEC Corporation
("NEC"), Nitsuko Corporation ("Nitsuko"), Matsushita Electric Industrial Co.,
Ltd. ("Panasonic"), Siemens Rolm Communications, Inc. ("Siemens"), Toshiba
America, Inc. ("Toshiba") and others. Many of these competitors have
significantly greater financial, marketing and technical resources than the
Company. The Company also competes against the regional Bell operating companies
("RBOCs"), which offer systems produced by one or more of the aforementioned
competitors and also offer Centrex systems in which automatic calling facilities
are provided through equipment located in the telephone company's central
office.
The Telecommunications Act of 1996 (the "Telecommunications Act") and
AT&T Corporation's ("AT&T") announcement to divide itself into three enterprises
has had an impact on competition in the communications industry. The
Telecommunications Act opened the market for telephone and cable television
services, forcing telephone companies to open their networks to competitors and
giving consumers a choice of local phone carriers. Conversely, local phone
companies are now able to offer long distance services. In addition, cable
television companies can offer telephone services and Internet access. These
changes have increased competition in the communications industry and have
created additional competition and opportunities in customer premise equipment,
as these new services and interfaces have become available.
In the market for voice processing applications, including voice mail,
the Company competes against Applied Voice Technology, Inc. ("AVT"), Active
Voice Corporation ("Active Voice"), Centigram Communications Corporation
("Centigram"), Lucent and other competitors, certain of which have significantly
greater resources than the Company. In the market for long distance services,
the Company competes against AT&T, MCI Communication Corporation, Sprint
Corporation, Qwest Communications Corporation and other competitors, many of
which have significantly greater resources than the Company. The Company also
expects to compete with RBOCs, cable television companies, satellite and other
wireless broadband service providers and others for long distance business as
those companies gradually respond to the Telecommunications Act. Key competitive
factors in the sale of telephone systems and related applications include price,
performance, features, reliability, service and support, name recognition and
distribution capability. The Company believes that it competes favorably in its
markets with respect to the price, performance and features of its systems, as
well as the level of service and support that the Company provides to its
customers. Certain of the Company's competitors have significantly greater name
recognition and distribution capabilities than the Company. The Company expects
that competition will continue to be intense in the markets addressed by the
Company, and there can be no assurance that the Company will be able to continue
to compete successfully.
In the market for IP telephony products, the Company competes against
existing IP telephony gateway providers such as Lucent, NetSpeak Corporation,
VocalTec Communications Ltd., Vienna Systems Corporation and others. Several of
these competitors have been active in developing and marketing IP telephony
products for a greater period of time than the Company and have already
established relationships with customers within their market. In addition, the
Company could face significant competition from vendors such as Cisco Systems,
Inc., Bay Networks, Inc., 3Com Corporation, Motorola, Inc. and MICOM
Communications Corp., should such established data vendors choose to enter the
market for IP telephony products. Such companies currently produce products
that, if equipped with voice capabilities, could represent a considerable threat
to the Company within that market. Moreover, should the market for IP telephony
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products become fully developed or develop at a rapid rate, large companies such
as IBM Corporation ("IBM") and Microsoft Corporation ("Microsoft") could choose
to develop proprietary software designed to facilitate voice communication over
an IP network.
As the Company enters the markets for local telephone service and IP
network access, it will face additional competition from RBOCs and other
providers, which have larger marketing and sales organizations, significantly
greater financial and technical resources and a larger and more established
customer base than the Company. In addition, RBOCs and other providers have
greater name recognition, more established positions in the market and long
standing relationships with customers. Therefore, there can be no assurance that
the Company will compete successfully in these markets.
Intellectual Property Rights
The Company's future success will depend in part upon its proprietary
technology. Although the Company has applied to the U.S. Patent and Trademark
Office for a patent related to certain aspects of the Inter-Tel Vocal'Net
technology, the Company currently has no issued patents and relies principally
on copyright and trade secret law and contractual provisions to protect its
intellectual property. There can be no assurance that any patent, trademark or
copyright owned by the Company will not be invalidated, circumvented or
challenged or that the rights granted thereunder will provide meaningful
protection or any commercial competitive advantage to the Company. Further,
there can be no assurance that others will not develop technologies that are
similar or superior to the Company's technology or that duplicate the Company's
technology. As the Company expands its international operations, effective
intellectual property protection may be unavailable or limited in certain
foreign countries. There can be no assurance that the steps taken by the Company
will prevent misappropriation of its technology. Litigation may be necessary in
the future to enforce the Company's intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or invalidity.
Such litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's business and operating
results.
From time to time, the Company is subject to proceedings alleging
infringement by the Company of intellectual property rights of others. If any
such claim is asserted against the Company, the Company may seek to obtain a
license under the third party's intellectual property rights. There can be no
assurance that a license will be available on terms acceptable to the Company or
at all. In the alternative, the Company could resort to litigation to challenge
any such claim. Any such litigation could require the Company to expend
significant sums and could require the Company to pay significant damages,
develop non-infringing technology or acquire licenses to the technology which is
the subject of the asserted infringement, any of which could have a material
adverse effect on the Company's business and operating results. In the event
that the Company is unable or chooses not to license such technology or decides
not to challenge such third party's rights, the Company could encounter
substantial and costly delays in product introductions while attempting to
design around such third party rights, or could find that the development,
manufacture or sale of products requiring such licenses could be foreclosed.
Employees
As of December 31, 1997, the Company had a total of 1,248 employees, of
whom 1,029 were engaged in sales, marketing and customer support, 47 in quality,
manufacturing and related operations, 97 in research and development, and 75 in
finance and administration. The Company's future success will depend upon its
ability to attract, retain and motivate highly qualified employees, who are in
great demand. The Company believes that its employee relations are excellent.
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Factors That May Affect Results of Future Operations
Rapid Technological Change; Dependence On Recently Introduced Products
The market for the Company's software, products and services is
characterized by rapid technological change and continuing demand for new
products, features and applications. Current competitors or new market entrants
may develop new products or product features that could adversely affect the
competitive position of the Company's products. Accordingly, the timely
introduction of new products and product features, as well as new
telecommunications applications, will be key factors in the Company's future
success.
During the past eighteen months, the Company introduced unified
messaging on its AXXESSORY Talk platform, developed a number of enhancements to
its existing AXXESS and AXXESSORY Talk platforms and introduced Inter-Tel
Vocal'Net. The Company is also currently in the later stages of developing the
AXXESS 5.0 platform, which is a significant software upgrade and enhancement to
its AXXESS and AXXESSORY Talk platforms. The Company's future success will
depend, in large part, upon the timely and successful introduction of the AXXESS
5.0 platform. The Company's future success will also depend upon market
acceptance of the Company's other new products or enhancements, including
Inter-Tel Vocal'Net. There can be no assurance that these introduced products
and enhancements will be successful. In the event that the Company were to fail
to successfully introduce new software, products or services or upgrades to its
existing systems or products on a regular and timely basis, demand for the
Company's existing software, products and services could decline, which could
have a material adverse effect on the Company's business and operating results.
Further, if the markets for IP network products or CTI applications fail to
develop or grow more slowly than the Company anticipates, or if the Company is
unable for any reason to capitalize on either of these emerging market
opportunities, the Company's business, financial condition and results of
operations could be materially adversely affected.
Occasionally, new products contain undetected program errors or "bugs"
when released. Such bugs may result from defects contained in software products
offered by the Company's suppliers or other third parties that are intended to
be compatible with the Company's products, over which the Company has little or
no control. Although the Company seeks to minimize the number of bugs in its
products by its test procedures and quality control, there can be no assurance
that its new products will be error free when introduced. Any significant delay
in the commercial introduction of the Company's products due to bugs, any design
modifications required to correct bugs or any impairment of customer
satisfaction as a result of bugs could have a material adverse effect on the
Company's business and operating results. In addition, new products often take
several months before their manufacturing costs stabilize, which may adversely
affect operating results for a period of time following introduction.
Developing Market for IP Network Telephony; Uncertain Regulatory Environment
The market for IP network voice communications products has only
recently begun to develop, is rapidly evolving 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 in the case of a new and rapidly evolving industry, the demand for and
market acceptance of recently introduced IP network products and services are
subject to a high degree of uncertainty. There can be no assurance that voice
communications over IP networks will become widespread. Further, even if voice
communications over IP networks achieve broad market acceptance, there can be no
assurance that the Company's products, in particular Inter-Tel Vocal'Net, will
achieve market acceptance.
The adoption of voice communications over IP networks generally
requires the acceptance of a new way of exchanging information. In particular,
enterprises that have already invested
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substantial resources in other means of communicating information may be
reluctant or slow to adopt a new approach to communications. The lack of control
over IP network infrastructure and each user's system configuration may cause
users of IP network voice communications delays in the transmission of speech,
loss of voice packets and inferior sound quality relative to standard telephony
networks. If these factors cause the market for IP network voice communications
to fail to develop or to develop more slowly than the Company anticipates, the
Company's IP network telephony products could fail to achieve market acceptance,
which in turn could have a material adverse effect on the Company's business,
financial condition and results of operations.
The regulatory environment for IP network telephony is subject to
substantial uncertainty. There can be no assurance that the sale and use of IP
network telephony products such as Inter-Tel Vocal'Net will not violate
telecommunications or other regulations in any of the countries in which such
products are or will be marketed and used. In the United States, the Company
believes that there are currently few laws or regulations directly applicable to
voice communications over IP networks or to access to, or commerce on, IP
networks generally. However, changes in the regulatory environment, particularly
in regulations relating to the telecommunications industry, could have a
material adverse effect on the Company's business. The increased commercial
acceptance of voice communications over IP networks could result in intervention
by governmental regulatory agencies in the United States or elsewhere in the
world under existing or newly enacted legislation and in the imposition of fees,
charges or taxes on users and providers of products and services in this area.
There can be no assurance that such intervention or imposition of fees, charges
or taxes would not have a material adverse effect upon the acceptance and
attractiveness of IP network voice communications. Moreover, legislative
proposals from international, federal and state government bodies could impose
additional regulations and obligations upon on-line service providers. The
growing popularity and use of the Internet has increased public focus and could
lead to increased pressure on legislatures to impose such regulations. The
Company cannot predict the likelihood that any future legislation or regulation
will be enacted, nor the financial impact, if any, of such resulting legislation
or regulation. In the future, the Company may also develop and introduce other
products with new or additional telecommunications capabilities or services,
which could be subject to existing federal government regulations or result in
the imposition of new government regulations, either in the United States or
elsewhere.
Risks Associated with Inter-Tel Vocal'Net; Dependence Upon IP Network
Infrastructures; Risk of System Failure; Security Risks
In September 1997, the Company began commercial shipment of Inter-Tel
Vocal'Net, its stand-alone IP telephony gateway product and, to date, revenues
from the sale of this product have not been significant. To achieve market
acceptance, Inter-Tel Vocal'Net will be required to demonstrate its
functionality, scalability and reliability, of which there can be no assurance.
In addition, there can be no assurance that Inter-Tel Vocal'Net will comply with
industry standards or that industry standards will not change and render
Inter-Tel Vocal'Net obsolete. In the event that Inter-Tel Vocal'Net fails to
achieve market acceptance, the Company's business, financial condition and
results of operations could be materially and adversely affected.
The success of Inter-Tel Vocal'Net will also depend upon, among other
things, the continued expansion of the Internet and other IP networks and their
network infrastructures. There can be no assurance that the infrastructure or
complementary products necessary to make the Internet a viable commercial
network will continue to be developed. In addition, there can be no assurance
that IP networks will retain their current volume, distance and
time-of-day-independent pricing structure, or that the costs of access to IP
networks, lack of capacity or poor voice transmission quality of IP networks
will not adversely affect the market for IP network products and services.
Moreover, critical issues concerning the commercial use of the Internet
(including security, reliability, cost, ease of use and access and quality of
service) remain unresolved and may affect the growth of IP network use.
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There can be no assurance that the Internet will be able to meet additional
demand or its users' changing requirements on a timely basis, at a commercially
reasonable cost, or at all.
The Inter-Tel Vocal'Net gateway can 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. Further,
inappropriate use of the Internet or other IP networks by third parties could
potentially jeopardize the security of confidential information, such as credit
card or bank account information or the content of conversations over the IP
network, which may deter certain persons from ordering and using the Company's
products. Until more comprehensive security technologies are developed, the
security and privacy concerns of existing and potential users may inhibit the
growth of IP networks in general and the market for the Company's IP network
products in particular.
Development and Maintenance of Inter-Tel.net Network
The Company is currently utilizing its Inter-Tel Vocal'Net technology
to develop and expand its own IP network, Inter-Tel.net, to carry telephone
traffic. The Inter-Tel.net network is in its initial stages of deployment and,
accordingly, is subject to a high degree of risk. To date, the Inter-Tel.net
network has established points of presence in the San Francisco Bay Area,
Washington, D.C., Chicago, New York, Phoenix, Reno and Los Angeles. If the
market for IP network products fails to develop or develops more slowly than the
Company anticipates, the Company's Inter-Tel.net network could become
financially burdensome to maintain or obsolete, either of which could materially
and adversely affect the Company's business, financial condition and results of
operations.
The Company is dependent on third-party suppliers of telecommunications
and Internet network transmission services for implementation of Inter-Tel.net
and does not currently have long-term contracts with such suppliers. The
Company's ability to expand Inter-Tel.net is dependent upon its ability to
obtain services from such suppliers. Certain of these third party suppliers are
or may become competitors of the Company, and such suppliers generally are not
subject to restrictions upon their ability to compete with the Company. To the
extent that any of these suppliers raise their rates or change their pricing
structure, the Company may be materially adversely affected. Also, the Company
faces the risk that there will be a disruption in the service provided by these
suppliers, and can give no assurance that there will not be a significant
disruption in such service in the future, thereby causing a disruption in the
services provided by the Company to its customers.
Moreover, although the Company has devoted, and intends to continue to
devote, substantial resources to improve the quality of telephone conversations
using Inter-Tel Vocal'Net and the Inter-Tel.net network, there can be no
assurance that the problems of voice communications over the Inter-Tel.net
network that exist today, including delays in the transmission of speech, loss
of voice packets and sound quality inferior to that of standard telephony
networks, will be eliminated or reduced. In the event that the Company is unable
to improve upon the sound quality and other limitations of voice communications
over the Inter-Tel.net network and to offer such improvements to its customers
on a cost-effective basis, the Inter-Tel.net network could fail to achieve
market acceptance, and the Company's business, financial condition and results
of operations could be materially and adversely affected.
Highly Competitive Industry
The market for the Company's products is highly competitive and in
recent periods has been characterized by pricing pressures and business
consolidations. The Company's competitors include Lucent and NorTel, as well as
Comdial, Executone, Iwatsu, Mitel, NEC, Nitsuko, Panasonic, Siemens, Toshiba and
others. Many of these competitors have significantly greater financial,
marketing and technical resources than the Company. The Company also competes
against the RBOCs, which offer systems produced by one or more of the
aforementioned competitors and also
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offer Centrex systems in which automatic calling facilities are provided through
equipment located in the telephone company's central office.
The Telecommunications Act and AT&T's announcement to divide itself
into three enterprises has had an impact on competition in the communications
industry. The Telecommunications Act opened the market for telephone and cable
television services, forcing telephone companies to open their networks to
competitors and giving consumers a choice of local phone carriers. Conversely,
local phone companies are now able to offer long distance services. In addition,
cable companies can offer telephone services and Internet access. These changes
have increased competition in the communications industry and have created
additional competition and opportunities in customer premise equipment, as these
new services and interfaces have become available.
In the market for voice processing applications, including voice mail,
the Company competes against AVT, Active Voice, Centigram, Lucent and other
competitors, certain of which have significantly greater resources than the
Company. In the market for long distance services, the Company competes against
AT&T, MCI, Sprint Corporation, Qwest Communications Corporation and other
competitors, many of which have significantly greater resources than the
Company. The Company will also compete with RBOCs, cable television companies,
satellite and other wireless broadband service providers, and others for long
distance business as those companies gradually respond to the Telecommunications
Act. Key competitive factors in the sale of telephone systems and related
applications include price, performance, features, reliability, service and
support, name recognition and distribution capability. The Company believes that
it competes favorably in its markets with respect to the price, performance and
features of its systems, as well as the level of service and support that the
Company provides to its customers. Certain of the Company's competitors have
significantly greater name recognition and distribution capabilities than the
Company, although the Company believes that it has developed a competitive
distribution presence in certain markets, particularly those where the Company
has direct sales offices. The Company expects that competition will continue to
be intense in the markets addressed by the Company, and there can be no
assurance that the Company will be able to continue to compete successfully.
In the market for IP telephony products, the Company competes against
existing IP telephony gateway providers such as Lucent, NetSpeak Corporation,
VocalTec Communications Ltd., Vienna Systems Corporation and others. Several of
these competitors have been active in developing and marketing IP telephony
products for a greater period of time than the Company and have already
established relationships with customers within their market. In addition, the
Company could face significant competition from vendors such as Cisco Systems,
Inc., Bay Networks, Inc., 3Com Corporation, Motorola, Inc. and MICOM
Communications Corp., should such established data vendors choose to enter the
market for IP telephony products. Such companies currently produce products
that, if equipped with voice capabilities, could represent a considerable threat
to the Company within that market. Moreover, should the market for IP telephony
products become fully developed or develop at a rapid rate, large companies such
as IBM and Microsoft could choose to develop proprietary software designed to
facilitate voice communication over an IP network.
As the Company enters the markets for local telephone service and IP
network access, it will face additional competition from RBOCs and other
providers, which have larger marketing and sales organizations, significantly
greater financial and technical resources and a larger and more established
customer base than the Company. In addition, RBOCs and other providers have
greater name recognition, more established positions in the market and long
standing relationships with customers. Therefore, there can be no assurance that
the Company will compete successfully in these markets. Many of the Company's
current and potential competitors have longer operating histories, are
substantially larger, and have greater financial, manufacturing, marketing,
technical and other resources. A number also have greater name recognition and a
larger installed base of products than the Company. Competition in the Company's
markets may result in significant price
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reductions. As a result of their greater resources, many current and potential
competitors may be better able than the Company to initiate and withstand
significant price competition or downturns in the economy. There can be no
assurance that the Company will be able to continue to compete effectively, and
any failure to do so would have a material adverse effect on the Company's
business, financial condition and operating results.
Management of Growth; Implementation of New Management Information Systems
The growth in the Company's business has placed, and is expected to
continue to place, a significant strain on the Company's personnel, management
and other resources. The Company's ability to manage any future growth
effectively will require it to attract, train, motivate and manage new employees
successfully, to integrate new employees into its overall operations and to
continue to improve its operational, financial and management information
systems.
The Company implemented a new MIS system late in 1995. The MIS system
significantly affected many aspects of the Company's business, including its
accounting, operations, purchasing, sales and marketing functions. Following the
date of implementation, the Company experienced difficulty with the new MIS
software, which increased the Company's costs, had an adverse effect on the
Company's ability to provide products and services to its customers on a timely
basis and caused delays in coordinating accounting and financial results. During
the fourth quarter of 1996, the Company determined that the limitations of the
existing system software would prevent Inter-Tel from establishing an integrated
and centralized dispatch and telemarketing center. As a result, the Company
signed an agreement with a large, established software and database vendor to
replace its existing MIS software and implement, maintain and support alternate
MIS software to be utilized throughout the Company. Accordingly, during the
fourth quarter of 1996, the Company wrote off the software license and
implementation costs relating to the system software being replaced.
The actions to replace the MIS software could result in additional
costs and delays associated with obtaining a fully functional MIS system,
including but not limited to the costs of procuring additional or alternate
hardware and software required but not available in the current system
configuration, and additional personnel. Any such cost or delay could have a
material adverse effect on the Company's business, financial condition and
operating results. In addition, implementation of this system software and the
transition from the current system software to the new information system
software will require substantial financial resources, time and personnel.
The Company has made strategic acquisitions in the past and expects to
continue to do so in the future. Acquisitions require a significant amount of
the Company's management attention and financial and operational resources, all
of which are limited. The integration of acquired entities may also result in
unexpected costs and disruptions and significant fluctuations in, or reduced
predictability of, operating results from period to period. There can be no
assurance that an acquisition will not adversely affect the business
relationships of the Company or the acquired entity with its respective
suppliers or customers. Further, there can be no assurance that the Company will
be able to successfully integrate any acquired operations or achieve any of the
intended benefits of an acquisition. The Company's failure to manage its growth
effectively could have a material adverse effect on its business, financial
condition and operating results.
Dependence Upon Contract Manufacturers and Component Suppliers
The Company currently procures certain components used in its digital
communication platforms, including certain microprocessors, integrated circuits,
power supplies, voice processing interface cards and IP telephony cards from a
single source or limited sources of supply and, accordingly, product
availability could be limited. As the Company deploys its IP telephony products
and the Inter-Tel.net network, the Company expects that it will be required to
increasingly rely upon third party software and hardware suppliers. The Company
currently manufactures its
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products through a limited number of contract manufacturers located in the
United States, the Philippines and the People's Republic of China. Foreign
manufacturing facilities are subject to changes in governmental policies,
imposition of tariffs and import restrictions and other factors beyond the
Company's control. Varian Associates, Inc. ("Varian") currently manufactures a
significant portion of the Company's products at Varian's Tempe, Arizona
facility, including substantially all of the printed circuit boards used in the
AXXESS and Inter-Tel Axxent digital communication platforms. From time to time,
the Company has experienced delays in the supply of components and finished
goods, and there can be no assurance that the Company will not experience such
delays in the future. The Company's reliance on third party manufacturers
involves a number of additional risks, including reduced control over delivery
schedules, quality assurance and costs. Any delay in delivery or shortage of
supply of components or finished goods from Varian or any other supplier, or the
Company's inability to develop in a timely manner alternative or additional
sources if and when required, could damage the Company's relationships with
current and prospective customers and could materially and adversely affect the
Company's business, financial condition and operating results. The Company has
no long term agreements with its suppliers that require such suppliers to
provide fixed quantities of components or finished goods at set prices. There
can be no assurance that the Company will be able to continue to obtain
components or finished goods in sufficient quantities or quality or on favorable
pricing and delivery terms in the future.
Product Protection and Infringement
The Company's future success will depend in part upon its proprietary
technology. Although the Company has applied to the U.S. Patent and Trademark
Office for a patent related to certain aspects of the Inter-Tel Vocal'Net
technology, the Company currently has no issued patents and relies principally
on copyright and trade secret law and contractual provisions to protect its
intellectual property. There can be no assurance that any patent, trademark or
copyright owned by the Company will not be invalidated, circumvented or
challenged or that the rights granted thereunder will provide meaningful
protection or any commercial competitive advantage to the Company. Further,
there can be no assurance that others will not develop technologies that are
similar or superior to the Company's technology or that duplicate the Company's
technology. As the Company expands its international operations, effective
intellectual property protection may be unavailable or limited in certain
foreign countries. There can be no assurance that the steps taken by the Company
will prevent misappropriation of its technology. Litigation may be necessary in
the future to enforce the Company's intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or invalidity.
Such litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on the Company's business, financial
condition and operating results.
From time to time, the Company is subject to proceedings alleging
infringement by the Company of intellectual property rights of others. If any
such claim is asserted against the Company, the Company may seek to obtain a
license under the third party's intellectual property rights. There can be no
assurance that a license will be available on terms acceptable to the Company or
at all. In the alternative, the Company could resort to litigation to challenge
any such claim. Any such litigation could require the Company to expend
significant sums, divert management's attention and require the Company to pay
significant damages, develop non-infringing technology or acquire licenses to
the technology which is the subject of the asserted infringement, any of which
could have a material adverse effect on the Company's business, financial
condition and operating results. In the event that the Company is unable or
chooses not to license such technology or decides not to challenge such third
party's rights, the Company could encounter substantial and costly delays in
product introductions while attempting to design around such third party rights,
or could find that the development, manufacture or sale of products requiring
such licenses could be foreclosed.
20
<PAGE>
Reliance on Dealer Network
A substantial portion of the Company's net sales are made through its
network of independent dealers. The Company faces intense competition from other
telephone system and voice processing system manufacturers for such dealers'
business, as most of the Company's dealers carry products which compete with the
Company's products. The Company has no exclusive agreements with any of its
dealers. The loss of any significant dealer or group of dealers, or any event or
condition adversely affecting the Company's dealer network, could have a
material adverse effect on the Company's business, financial condition and
operating results.
Dependence on Key Personnel
The Company is dependent on the continued service of, and its ability
to attract and retain, qualified technical, marketing, sales and managerial
personnel. The competition for such personnel is intense, and the loss of any of
such persons, as well as the failure to recruit additional key technical and
sales personnel in a timely manner, would have a material adverse effect on the
Company's business and operating results. There can be no assurance that the
Company will be able to continue to attract and retain the qualified personnel
necessary for the development of its business.
Risks of Providing Long Distance and Network Services
Inter-Tel depends on its supply of telecommunications services and
information from several long distance carriers. Because it does not own
transmission facilities, the Company relies on long distance carriers to provide
network services to the Company's customers and for billing information. Long
distance services are subject to extensive and uncertain governmental regulation
on both the federal and state level. There can be no assurance that the
promulgation of certain regulations will not materially and adversely affect the
Company's business, financial condition and operating results. Contracts with
the long distance carriers from which the Company currently resells services
typically have a one year term in which the Company's prices are relatively
fixed and have minimum use requirements. The market for long distance services
is currently experiencing and is expected to experience in the future
significant price competition, resulting in decreasing end-user rates. There can
be no assurance that the Company will meet minimum use commitments, will be able
to negotiate lower rates with carriers in the event of any decrease in end user
rates or will be able to extend its contracts with long distance carriers at
prices favorable to the Company. The Company's ability to continue to expand its
long distance services depends upon its ability to continue to secure reliable
long distance services from a number of long distance carriers and the
willingness of such carriers to continue to provide telecommunications services
and billing information to the Company on favorable terms.
Potential Fluctuations In Quarterly Results; Limited Backlog
The Company's quarterly operating results depend upon a variety of
factors, including the volume and timing of orders received during the quarter,
the mix of products sold, mix of distribution channels, general economic
conditions, patterns of capital spending by customers, the timing of new product
announcements and releases by the Company and its competitors, pricing
pressures, the cost and effect of acquisitions, and the availability and cost of
products and components from the Company's suppliers. The Company's customers
typically require immediate shipment and installation of platforms and software.
As a result, the Company has historically operated with a relatively small
backlog, and sales and operating results in any quarter are principally
dependent on orders booked and shipped in that quarter. Historically, a
substantial portion of the Company's net sales in a given quarter have been
recorded in the third month of the quarter, with a concentration of such net
sales in the last two weeks of the quarter. Market demand for investment in
capital equipment such as digital communication platforms and associated call
processing and voice processing software applications is largely dependent on
general economic
21
<PAGE>
conditions, and can vary significantly as a result of changing conditions in the
economy as a whole. The Company's expense levels are based in part on
expectations of future sales and, if sales levels do not meet expectations,
operating results could be adversely affected. Because sales of digital
communication platforms through the Company's dealers produce lower gross
margins than sales through the Company's direct sales organization, operating
results have varied, and will continue to vary based upon the mix of sales
through direct and indirect channels. Although the Company to date has been able
to resell the rental streams from leases under its Totalease program profitably
and on a substantially current basis, 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 have
lower gross margins than the Company's core business, have grown in recent
periods at a faster rate than the Company's overall net sales. As a result,
gross margins could be adversely affected in the event that long distance
calling services continue to increase as a percentage of net sales. In addition,
the Company is subject to seasonality in its operating results, as net sales for
the first and third quarters are frequently less than those experienced, in the
fourth and second quarters, respectively. As a result of these and other
factors, the Company has in the past experienced, and could in the future
experience, fluctuations in sales and operating results on a quarterly basis.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Volatility of Stock Price
The market price for the Company's Common Stock has been highly
volatile. The Company believes that factors such as announcements of
developments relating to the Company's business, fluctuations in the Company's
operating results, shortfalls in revenue or earnings relative to securities
analysts' expectations, announcements of technological innovations or new
products or enhancements by the Company or its competitors, general conditions
in the telecommunications industry or the national or worldwide economy, changes
in legislation or regulation affecting the telecommunications industry, an
outbreak of hostilities, developments in intellectual property rights and
developments in the Company's relationships with its customers and suppliers
could cause the price of the Company's Common Stock to fluctuate, perhaps
substantially. Many of such factors are beyond the Company's control. In
addition, in recent years the stock market in general, and the market for shares
of technology stocks in particular, have experienced extreme price fluctuations,
which have often been unrelated to the operating performance of affected
companies. There can be no assurance that the market price of the Company's
Common Stock will not experience significant fluctuations in the future,
including fluctuations that are unrelated to the Company's performance.
Year 2000 Compliance
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. Beginning in the
year 2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, computer systems and/or software used by many companies may need
to be upgraded to comply with such "Year 2000" requirements. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance. The Company has established procedures for
evaluating and managing the risks and costs associated with Year 2000 problems
for its internal information systems, as well as its software, and, although the
Company currently offers software designed to be Year 2000 compliant, there can
be no assurance that the Company's software products contain all necessary date
code changes necessary to prevent processing errors potentially arising from
calculations using the Year 2000 date.
The Company has completed an assessment of its internal information
systems and believes the current software being implemented will function
properly with respect to dates in the Year 2000. The total costs of the new
software implementation are being capitalized as the Company has abandoned its
current MIS software in favor of a different system. The software is being
replaced with
22
<PAGE>
an integrated solution from a more established vendor and was not in response to
the Year 2000 issue. The Company believes that with conversions to new software,
the Year 2000 will not pose significant operational problems for its computer
systems, based in part on the vendor's assurance that the software is Year 2000
compliant. The software conversion is estimated to be completed in phases in
1998 and 1999, which is prior to any estimated impact on its operating systems.
However, if such conversions are not completed timely, the Year 2000 issue could
have a material impact on the operations of the Company.
The Company believes that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues in a variety of ways.
Many companies are expending significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase software products such as those offered
by the Company. Many potential customers may also choose to defer purchasing
Year 2000 compliant products until they believe it is absolutely necessary, thus
resulting in potentially stalled market sales within the industry. Conversely,
Year 2000 issues may cause other companies to accelerate purchases, thereby
causing an increase in short-term demand and a consequent decrease in long-term
demand for software products. Additionally, Year 2000 issues could cause a
significant number of companies, including existing customers of the Company, to
reevaluate their current communications platform, IP network telephony or voice
processing software needs, and as a result consider switching to other systems
or suppliers.
Concentration of Ownership
As of March 13, 1998, Steven G. Mihaylo, the Company's Chairman of the
Board of Directors and Chief Executive Officer beneficially owned approximately
20.0% of the outstanding shares of the Common Stock. As a result, he has the
ability to exercise significant influence over matters requiring shareholder
approval. In addition, the concentration of ownership could have the effect of
delaying or preventing a change in control of the Company.
Any of the foregoing could result in a material adverse effect on the
Company's business, financial condition and operating results.
23
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Position
- ---- --- --------
Steven G. Mihaylo 54 Chairman of the Board of
Directors and Chief
Executive Officer
Thomas C. Parise 43 President and Chief
Operating Officer
Craig W. Rauchle 42 Executive Vice President
Ross McAlpine 46 Sr. Vice President
Kurt R. Kneip 35 Chief Financial Officer,
Vice President and Secretary
J. Robert Anderson 61 Director
Gary Edens 56 Director
Maurice H. Esperseth 72 Director
C. Roland Haden 57 Director
Norman Stout 40 Director
MR. MIHAYLO, the founder of the Company, has served as Chairman of the
Board of Directors of the Company since September 1983 and as Chief Executive
Officer of the Company since its formation in July 1969. Mr. Mihaylo served as
President of the Company from 1969 to 1983 and from 1984 to December 1994, and
as Chairman of the Board of Directors from July 1969 to October 1982. Mr.
Mihaylo also is a director of MicroAge, Inc. and Microtest, Inc.
MR. PARISE was elected President and Chief Operating Officer of the
Company in December 1994. He served as Senior Vice President of the Company from
1986 to 1994. He is also President of Inter-Tel Integrated Services, Inc., a
wholly owned research and development, manufacturing and distribution subsidiary
of the Company. Mr. Parise joined the Company in 1981 and became Branch General
Manager of the Phoenix Direct Sales Office in 1982. In 1983, he became the
Mountain Regional Vice President, and in January 1985 he was appointed Vice
President of Operations and Sales Support. Mr. Parise also is a director of
Globe Business Resources, Inc.
MR. RAUCHLE was elected Executive Vice President in December 1994. He
had been Senior Vice President of the Company and continues as President of
Inter-Tel Technologies, Inc., a wholly owned sales subsidiary of the Company. In
addition, he currently serves the Company and all subsidiaries in corporate
strategic planning and mergers and acquisitions activities. Mr. Rauchle joined
the Company in 1979 as Branch General Manager of the Denver Direct Sales Office
and in 1983 was appointed the Central Region Vice President and subsequently the
Western Regional Vice President. From 1990 to 1992, Mr. Rauchle served as
President of Inter-Tel Communications, Inc. He is also a director of Prologic
Management Systems, Inc.
MR. MCALPINE was elected Senior Vice President in September 1997. He
also has served as President of Inter-Tel Leasing, Inc., a wholly-owned
subsidiary of the Company, since April 1993, and President of Inter-Tel.net,
Incorporated and Inter-Tel NetSolutions, Inc. since 1997. He also served as Vice
President of Inter-Tel Communications, Inc. from April 1991 to April 1992 and
Treasurer since April 1992. He joined the Company in July 1991 when Inter-Tel
acquired Telecommunications Specialists, Inc. Prior to joining Inter-Tel, Mr.
McAlpine worked 17 years in the leasing and financial services industry. Mr.
McAlpine holds an undergraduate degree in Accounting from Southwest Texas State
University.
MR. KNEIP has served as Vice President and Chief Financial Officer of
the Company since September 1993. He was elected Secretary and Treasurer in
October 1994. In May 1996 he was elected Assistant Treasurer, as John Abbott was
elected Treasurer. He joined the Company in May
24
<PAGE>
1992 as Director of Corporate Tax, after seven years with the accounting firm of
Ernst & Young. Mr. Kneip is a Certified Public Accountant, and holds an
undergraduate degree in Commercial Economics from South Dakota State University
and a Masters Degree in Professional Accountancy from the University of South
Dakota.
MR. ANDERSON has been a director of the Company since February 1997.
Mr. Anderson held various positions at Ford Motor Company from 1963 to 1983,
serving from 1978 to 1983 as President of the Ford Motor Land Development
Corporation. He served as Senior Vice President, Chief Financial Officer and a
member of the Board of Directors of The Firestone Tire and Rubber Company from
1983 to 1989, and as Vice Chairman of Bridgestone/Firestone, Inc. from 1989
through 1991. He most recently served as Vice Chairman, Chief Financial Officer
and a member of the Board of Directors of the Grumman Corporation from 1991 to
1994. Mr. Anderson is currently semi-retired, and he is an active leader in
various business, civic and philanthropic organizations.
MR. EDENS has been a director of the Company since October 1994. He was
a broadcasting media executive from 1970 to 1994, serving as Chairman and Chief
Executive Officer of Edens Broadcasting, Inc. from 1984 to 1994, when that
corporation's nine radio stations were sold. He is currently President of The
Hanover Companies, Inc., an investment firm. He is an active leader in various
business, civic and philanthropic organizations.
MR. ESPERSETH has been a director of the Company since October 1986.
Mr. Esperseth joined the Company in January 1983 as Senior Vice
President-Research and Development, after a 32-year career with GTE, and served
as Executive Vice President of Inter-Tel from 1986 to 1988. Mr. Esperseth
retired as an officer of the Company on December 31, 1989.
DR. HADEN has been a director of the Company since 1983. Dr. Haden has
been Vice Chancellor and Dean of Engineering of Texas A&M University since 1993.
Previously, he served as Vice Chancellor of Louisiana State University from 1991
to 1993, Dean of the College of Engineering and Applied Sciences at Arizona
State University from 1989 to 1991, Vice President for Academic Affairs at
Arizona State University from 1987 to 1988, and Dean of the College of
Engineering and Applied Sciences from 1978 to 1987. Dr. Haden holds a doctoral
degree in Electrical Engineering from the University of Texas and has also
served on the faculty of the University of Oklahoma.
MR. STOUT has been a director of the Company since October 1994. Mr.
Stout has been President of Superlite Block, a manufacturer of concrete block,
since February 1993. Since 1996 Mr. Stout has also been President of Oldcastle
Architectural West, the parent company of Superlite Block and four other
concrete products plants. Prior thereto he was employed by Boorhem-Fields, Inc.
of Dallas, Texas, a manufacturer of crushed stone, as Chief Executive Officer
from 1990 to 1993 and as Chief Financial Officer from 1986 to 1990. Previously,
Mr. Stout was a Certified Public Accountant with Coopers & Lybrand.
The Board of Directors has an Audit Committee and a Compensation
Committee. The Audit Committee, consisting of Directors Anderson, Stout and
Esperseth, is charged with reviewing the Company's annual audit and meets with
the Company's independent auditors to review the Company's internal controls and
financial management practices. The Compensation Committee, consisting of
Messrs. Esperseth, Edens and Stout, recommends to the Board of Directors
compensation for the Company's key employees and administers the Company's stock
option plans.
ITEM 2. PROPERTIES
The Company maintains its corporate headquarters in 23,000 square feet of a
building located in Phoenix, Arizona pursuant to a lease that expires in 2000,
and its principal manufacturing operations in an 96,000 square foot building
located in Chandler, Arizona pursuant to a lease that
25
<PAGE>
expires in 2008. The Company also leases sales and support offices in a total of
30 locations in the United States and two locations overseas. The Company's
aggregate monthly payments under these leases are currently approximately
$271,000. The Company believes that its facilities will be adequate to meet its
current needs and that additional or alternative space will be available as
necessary in the future on commercially reasonable terms. See "Risk
Factors--Management of Growth; Implementation of New Management Information
Systems."
ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time in litigation incidental to its
business. The Company believes that the outcome of current litigation will not
have a material adverse effect upon its business, financial condition or results
of operations and will not disrupt the normal operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
1. On November 12, 1997, the Company called a Special Meeting of
Shareholders for a proposal to approve an amendment to the
Company's Restated Articles of Incorporation to increase the
authorized number of Common Shares to 100,000,000. A quorum
was not present at the meeting.
2. On November 13, 1997, the Company again called a Special
Meeting of Shareholders for a proposal to approve an amendment
to the Company's Restated Articles of Incorporation to
increase the authorized number of Common Shares to
100,000,000. A quorum was not present at the meeting.
3. On November 14, 1997, the Company again called a Special
Meeting of Shareholders for a proposal to approve an amendment
to the Company's Restated Articles of Incorporation to
increase the authorized number of Common Shares to
100,000,000. A quorum was present at the meeting.
The proposal to approve an amendment to the Company's Restated
Articles of Incorporation to increase the authorized number of
Common Shares to 100,000,000 received the following votes:
Votes Percentage
----- ----------
For: 9,899,140 82.71%
Against: 1,751,065 14.63%
Abstain: 318,963 2.66%
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND
RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated by reference
to Exhibit 13.0 and Page 38 of the Company's 1997 Annual Report to
Shareholders.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is incorporated by reference
to Exhibit 13.0 and Page 18 of the Company's 1997 Annual Report to
Shareholders.
26
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The information required by this Item is incorporated by reference
to Exhibit 13.0 and Pages 30 through 37 of the Company's 1997
Annual Report to Shareholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference
to Exhibit 13.0 and Pages 19 through 29 of the Company's 1997
Annual Report to Shareholders.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Certain information required by Part III is omitted from this report in
that the Registrant will file a definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this Report, and the information included therein is
incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors and executive officers is
included at the end of Part I, Item 1 on Pages 24 to 25 of this
report under the caption "Directors and Executive Officers of the
Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference
to Pages 6 to 8 of the Company's Proxy Statement relating to its
1998 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information required by this Item is incorporated by reference
to Pages4 and 5 of the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
27
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements
The following consolidated financial statements of Inter-Tel,
Incorporated, and subsidiaries, are incorporated by reference to
Exhibit 13.0 and Pages 19 to 29 of the Company's Annual Report:
Report of Ernst & Young LLP, Independent Auditors
Consolidated balance sheets--December 31, 1997 and 1996
Consolidated statements of income--years ended December 31, 1997,
1996 and 1995
Consolidated statements of shareholders' equity--years ended December
31, 1997, 1996 and 1995
Consolidated statements of cash flows--years ended December 31,
1997, 1996 and 1995
Notes to consolidated financial statements
2. Financial Statement Schedules
The following consolidated financial statement schedule of Inter-Tel,
Incorporated, and subsidiaries is filed as part of this Report and
should be read in conjunction with the Consolidated Financial
Statements of Inter-Tel, Incorporated and subsidiaries, and the notes
thereto.
Schedule for the three years ended December 31, 1997:
Page No.
--------
Schedule II--Valuation and Qualifying Accounts 31
Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or notes thereto.
3. Exhibits
3.1(10) Articles of Incorporation, as amended.
3.2(16) By-Laws, as amended.
10.15(1) Registrant's form of standard Distributor Agreement.
10.16(1) Registrant's form of standard Service Agreement.
28
<PAGE>
10.34(2) 1984 Incentive Stock Option Plan and forms of Stock
Option Agreement.
10.35(3) Agreement between Registrant and Samsung Semiconductor
and Telecommunications Company, Ltd. dated October 17,
1984.
10.37(3) Tax Deferred Savings Plan.
10.51(11) 1990 Directors' Stock Option Plan and form of Stock
Option Agreement.
10.52(15) Inter-Tel, Incorporated Long-Term Incentive Plan and
forms of Stock Option Agreements.
10.53(12) Agreement between Registrant and Maxon Systems, Inc.
dated February 27, 1990.
10.54(12) Agreement between Registrant and Varian Tempe
Electronics Center dated February 26, 1991.
10.55(12) Agreement between Registrant and Jetcrown Industrial
Ltd. dated February 18, 1993.
10.56(13) Employee Stock Ownership Plan.
10.57(14) Loan and Security Agreement dated March 4, 1997 between
Bank One, Arizona, N.A. and Registrant and Modification
Agreement dated July 25, 1997.
10.58 (16) Development, Supply and License Agreement between
Registrant and QUALCOMM dated January 17, 1996.
- ---------------------
(1) Previously filed with Registrant's Registration Statement on Form S-1 (File
No. 2-70437).
(2) Previously filed with Registrant's Registration Statement on Form S-8 (File
No. 2-94805).
(3) Previously filed with Registrant's Annual Report on Form 10-K for the year
ended November 30, 1984 (File No. 0-10211).
(10) Previously filed with Registrant's Annual Report on Form 10-K for the year
ended December 31, 1988 (File No. 0-10211).
(11) Previously filed with Registrant's Registration Statement on Form S-8 (File
No. 33-40353).
(12) Previously filed with Registrant's Registration Statement on Form S-1 (File
No. 33-70054).
(13) Previously filed with Registrant's Registration Statement on Form S-8 (File
No. 33-73620).
(14) Filed herewith.
(15) Previously filed with Registrant's Proxy Statement dated March 23, 1994.
(16) Previously filed with Registrant's Annual Report on Form 10-K for the year
ended December 31, 1995 (File No. 0-10211).
29
<PAGE>
(17) Filed herewith, except as noted.
(b) Reports on Form 8-K.
None.
(c) Exhibits.
13.0 Excerpts from Annual Report to Security Holders. (not
attached herewith; a copy of the excerpts of the Company's
Annual Report to Security Holders was filed with the
Securities and Exchange Commission and a complete copy of
the Annual Report is available upon request by writing to
Shareholder Relations, Inter-Tel, Incorporated, 120 N. 44th
Street, Suite 200, Phoenix, Arizona 85034)
23.0 Consent of Ernst & Young LLP, Independent Auditors. (Page
33)
24.1 Power of Attorney. (Page 31)
See Item 14(a) (3) also.
(d) Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 8.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Inter-Tel, Incorporated, has duly caused
this Report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTER-TEL, INCORPORATED
DATED: March 23, 1998 BY: /S/ Steven G. Mihaylo
-----------------------
Steven G. Mihaylo
Chairman and Chief Executive Officer
30
<PAGE>
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E
- --------------------------------------------------------------------------------------------------------
ADDITIONS
- --------------------------------------------------------------------------------------------------------
Charged Charged to
Balance at to Other Charged to Balance
Beginning Costs & Accounts Deductions at End of
DESCRIPTION of Period Expenses Describe Describe Period
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997
Deducted from asset accounts:
Allowance for doubtful
accounts $3,096 $2,194 $ 17 $1,585(1) $3,722
----- ----- --- ----- -----
Allowance for lease
accounts $2,706 $1,910 $ -- $ 647(1) $3,969
----- ----- --- ----- -----
Inventory allowance $2,979 $4,021 $ -- $1,260(2) $5,740
----- ----- --- ----- -----
Year ended December 31, 1996
Deducted from asset accounts:
Allowance for doubtful
accounts (4) $1,822 $1,801 $ 87 (3) $ 614(1) $3,096
----- ----- --- ----- -----
Allowance for lease
accounts $1,513 $1,945 $(87)(3) $ 665(1) $2,706
----- ----- --- ----- -----
Inventory allowance (4) $2,499 $ 609 $175 (5) $ 304(2) $2,979
----- ----- --- ----- -----
Year ended December 31, 1995
Deducted from asset accounts:
Allowance for doubtful
accounts (4) $1,181 $ 814 $ 71 (3) $ 244(1) $1,822
----- ----- --- ----- -----
Allowance for lease
accounts $1,198 $ 780 $(71)(3) $ 394(1) $1,513
----- ----- --- ----- -----
Inventory allowance (4) $1,795 $1,109 $ -- $ 405(2) $2,499
----- ----- --- ----- -----
- --------------------------------------------------------------------------------------------------------
</TABLE>
(1) Uncollectible accounts written off, net of recoveries.
(2) Inventory written off.
(3) Reclassed between appropriate valuation and qualifying accounts.
(4) Adjusted for pooling of Florida Telephone Systems, Inc.
(5) Acquired in purchase of NTL Corporation (dba ComNet of Ohio).
31
Exhibit 10.57
Loan and Security Agreement dated March 4, 1997 between Bank One, Arizona, N.A.
and Registrant and Modification Agreement dated July 25, 1997.
MODIFICATION AGREEMENT
----------------------
DATE: July 25, 1997
- -----
PARTIES: Borrower: INTER-TEL, INCORPORATED,
- -------- an Arizona corporation
Bank: BANK ONE, ARIZONA, NA, a national banking association
RECITALS:
- ---------
A. Bank has extended to Borrower credit ("Loan") in the principal amount of
$7,000,000.00 pursuant to the Loan Agreement, dated March 4, 1997 ("Loan
Agreement"), and evidenced by the Promissory Note, dated March 4, 1997 ("Note").
The unpaid principal of the Loan as of the date hereof is $0.00.
B. The Loan and/or guaranty of Loan is unsecured.
C. The Note, the Loan Agreement, any arbitration resolution, and all other
agreements, documents, and instruments evidencing, securing, or otherwise
relating to the Loan, are sometimes referred to individually and collectively as
the "Loan Documents".
D. Borrower has requested that Bank modify the Loan and the Loan Documents
as provided herein. Bank is willing to so modify the Loan and the Loan
Documents, subject to the terms and conditions herein.
AGREEMENT:
- ----------
For good and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, Borrower and Bank agree as follows:
1. ACCURACY OF RECITALS.
---------------------
Borrower acknowledges the accuracy of the Recitals.
2. MODIFICATION OF LOAN DOCUMENTS.
-------------------------------
2.1 The Loan Documents are modified as follows:
2.1.1 The maturity date of the Loan and the Note is changed from
July 31, 1997, to July 31, 1998. On the maturity date Borrower shall pay to Bank
the unpaid principal, accrued and unpaid interest, and all other amounts payable
by Borrower under the Loan Documents as modified herein.
2.1.2 The reference to Section 3.1 in Section 1 of the Loan
Agreement is modified to read in its entirety as follows:
3.1 Scheduled Commitment expiration date: July 31, 1998
2.1.3 The reference to Section 6.11.1 in Section 1 of the Loan
Agreement is modified to read in its entirety as follows:
6.11.1 Minimum Tangible Net Worth: $30,000,000.00
<PAGE>
2.1.4 The reference to Section 6.11.3 in Section 1 of the Loan
Agreement is modified to read in its entirety as follows:
6.11.3 Minimum Fixed Coverage Ratio: 1.75 to 1.0
2.1.5 The reference to Section 6.11.4 in Section 1 of the Loan
Agreement is modified to read in its entirety as follows:
6.11.4 Debt to Worth Ratio: 3.0 to 1.0
2.1.6 The reference to Section 7.7 in Section 1 of the Loan
Agreement is modified to read in its entirety as follows:
7.7 Capital Expenditures Limit: $10,000,000.00
2.1.7 Section 6.11.1 of the Loan Agreement is modified to read in
its entirety as follows:
6.11.1 Tangible Net Worth. Tangible Net Worth, calculated as of the end of each
fiscal quarter, of not less than the sum of (i) the amount for "Minimum Tangible
Net Worth" set forth in Section 1, plus (ii) an amount equal to fifty percent
(50%) of the aggregate net income (not less than zero) of Borrower and its
Subsidiaries for each fiscal quarter ending during the period (the "Calculation
Period") commencing on July 1, 1997 and ending on the date of calculation, plus
(iii) all net proceeds of any equity financing entered into by Borrower or any
of its Subsidiaries during the Calculation Period.
2.2 Each of the Loan Documents is modified to provide that it shall be
a default or an event of default thereunder if Borrower shall fail to comply
with any of the covenants of Borrower herein or if any representation or
warranty by Borrower herein is materially incomplete, incorrect, or misleading
as of the date hereof.
2.3 Each reference in the Loan Documents to any of the Loan Documents
shall be a reference to such document as modified herein.
3. RATIFICATION OF LOAN DOCUMENTS AND COLLATERAL.
----------------------------------------------
The Loan Documents are ratified and affirmed by Borrower and shall remain in
full force and effect as modified herein. Any property or rights to or interests
in property granted as security in the Loan Documents shall remain as security
for the Loan and the obligations of Borrower in the Loan Documents.
4. BORROWER REPRESENTATIONS AND WARRANTIES.
----------------------------------------
Borrower represents and warrants to Bank:
4.1 No default or event of default under any of the Loan Documents as
modified herein, nor any event, that, with the giving of notice or the passage
of time or both, would be a default or an event of default under the Loan
Documents as modified herein has occurred and is continuing.
4.2 There has been no material adverse change in the financial
condition of Borrower or any other person whose financial statement has been
delivered to Bank in connection with the Loan from the most recent financial
statement received by Bank.
4.3 Each and all representations and warranties of Borrower in the Loan
Documents are accurate on the date hereof.
4.4 Borrower has no claims, counterclaims, defenses, or set-offs with
respect to the Loan or
<PAGE>
the Loan Documents as modified herein.
4.5 The Loan Documents as modified herein are the legal, valid, and
binding obligations of Borrower, enforceable against Borrower in accordance with
their terms.
4.6 Borrower is validly existing under the laws of the State of its
formation or organization and has the requisite power and authority to execute
and deliver this Agreement and to perform the Loan Documents as modified herein.
The execution and delivery of this Agreement and the performance of the Loan
Documents as modified herein have been duly authorized by all requisite action
by or on behalf of Borrower. This Agreement has been duly executed and delivered
on behalf of Borrower.
5. BORROWER COVENANTS.
-------------------
Borrower covenants with Bank:
5.1 Borrower shall execute, deliver, and provide to Bank such
additional agreements, documents, and instruments as reasonably required by Bank
to effectuate the intent of this Agreement.
5.2 Borrower fully, finally, and forever releases and discharges Bank
and its successors, assigns, directors, officers, employees, agents, and
representatives from any and all actions, causes of action, claims, debts,
demands, liabilities, obligations, and suits, of whatever kind or nature, in law
or equity of Borrower, whether now known or unknown to Borrower, (i) in respect
of the Loan, the Loan Documents, or the actions or omissions of Bank in respect
of the Loan or the Loan Documents and (ii) arising from events occurring prior
to the date of this Agreement.
5.3 Contemporaneously with the execution and delivery of this
Agreement, Borrower has paid to Bank:
5.3.1 All accrued and unpaid interest under the Note and all
amounts, other than interest and principal, due and payable by Borrower under
the Loan Documents as of the date hereof.
5.3.2 All the internal and external costs and expenses incurred by
Bank in connection with this Agreement (including, without limitation, inside
and outside attorneys, title, filing, and recording costs, expenses, and fees).
5.3.3 A commitment fee of $17,500.00.
6. EXECUTION AND DELIVERY OF AGREEMENT BY BANK.
--------------------------------------------
Bank shall not be bound by this Agreement until (i) Bank has executed and
delivered this Agreement, (ii) Borrower has performed all of the obligations of
Borrower under this Agreement to be performed contemporaneously with the
execution and delivery of this Agreement, (iii) if required by Bank, Borrower
and any guarantor(s) of the Loan have executed and delivered to Bank an
arbitration resolution, and (iv) each guarantor of the Loan has executed the
Consent of Guarantor(s) below.
7. INTEGRATION, ENTIRE AGREEMENT, CHANGE, DISCHARGE, TERMINATION, OR WAIVER.
-------------------------------------------------------------------------
The Loan Documents as modified herein contain the complete understanding and
agreement of Borrower and Bank in respect of the Loan and supersede all prior
representations, warranties, agreements, arrangements, understandings, and
negotiations. No provision of the Loan Documents as modified herein may be
changed, discharged, supplemented, terminated, or waived except in a writing
signed by the parties thereto.
8. BINDING EFFECT.
----------------
The Loan Documents as modified herein shall be binding upon and shall inure to
the benefit of Borrower
<PAGE>
and Bank and their respective successors and assigns.
9. CHOICE OF LAW.
--------------
This Agreement shall be governed by and construed in accordance with the laws of
the State of Arizona, without giving effect to conflicts of law principles.
10. COUNTERPART EXECUTION.
----------------------
This Agreement may be executed in one or more counterparts, each of which shall
be deemed an original and all of which together shall constitute one and the
same document. Signature pages may be detached from the counterparts and
attached to a single copy of this Agreement to physically form one document.
DATED as of the date first above stated.
INTER-TEL, INCORPORATED, an Arizona corporation
By __________________________
Name Kurt R. Kneip
Title Vice President, Chief Financial Officer,
Secretary, and Assistant Treasurer
BANK ONE, ARIZONA, NA,
a national banking association
By __________________________
Name Craig S. Hoskin
Title Vice President
<PAGE>
LOAN AGREEMENT
--------------
DATE: March 4, 1997
- -----
PARTIES: Borrower: INTER-TEL, INCORPORATED, an Arizona corporation
- -------- ---------
Bank: BANK ONE, ARIZONA, NA, a national banking association
-----
AGREEMENT: For good and valuable consideration, the receipt and sufficiency of
which are hereby acknowledged, Borrower and Bank agree as follows:
1. SCHEDULE OF TERMS. The terms in Section 1 relate to the designated sections
of this Agreement.
2. Commitment Amount: $7,000,000.00.
3.1 Scheduled Commitment expiration date: July 31, 1997
3.3 Each of the following Persons acting alone is authorized to request
Advances:
Steven G. Mihaylo, Chairman and Chief Executive Officer
Kurt R. Kneip, Vice President, Chief Financial Officer, Secretary, and Assistant
Treasurer
John C. Abbott, Treasurer
Margaret Hollingsed, Assistant Treasurer
Each of the following Persons acting alone is authorized to request Letters
of Credit and to execute Letter of Credit Agreements:
Steven G. Mihaylo, Chairman and Chief Executive Officer
Kurt R. Kneip, Vice President, Chief Financial Officer, Secretary, and Assistant
Treasurer
John C. Abbott, Treasurer
Margaret Hollingsed, Assistant Treasurer
3.5.1 Commitment fee: $5,143.91.
3.5.2 Letter of Credit Issuance Fee:Rate: 1.00% per annum.
5.1 and 6.1 Purpose of Advances and Letters of Credit: Advances are to be
used to pay reimbursement Amounts under Letter of Credit Agreements and to
support working capital. Letters of Credit are to be used to finance inventory
purchases.
5.1.2 Fiscal year of Borrower: From January 1 to December 31.
6.4.1 Financial statements due within 45 days after the end of each
fiscal quarter, except the last in each fiscal year.
Financial statements requirements: Accrual Basis and GAAP.
Certification requirements: Borrower prepared financial
statements.
Person(s) to sign financial statements on behalf of Borrower:
Name: Kurt R. Kneip Title: Vice President, Chief Financial
Officer, Secretary, and Asst. Treasurer
<PAGE>
6.4.2 Financial statements due within 90 days after the end of each
fiscal year of Borrower.
Financial statements requirements: Accrual Basis and GAAP.
Certification requirements: Independent certified public
accountant satisfactory to Bank to audit financial statements and
deliver an unqualified opinion on the financial statements.
6.11.1 Minimum Tangible Net Worth: $40,000,000.00
6.11.2 Current Ratio: 1.5 to 1.0
6.11.3 Minimum Fixed Coverage Ratio 2.0 to 1.0
6.11.4 Debt to Worth Ratio 0.8 to 1.0
7.7 Capital expenditures limit: $8,000,000.00
7.8 Indebtedness limit: $1,000,000.00
7.9 Maximum Net Loss: $1,250,000.00
2. DEFINITIONS. In this Agreement, the following terms shall have the following
meanings and all capitalized financial terms used and not defined in this
Agreement shall have the meanings determined in accordance with GAAP:
"Advance" means an advance by Bank to Borrower hereunder.
"Agreement" means this Loan Agreement as it may be amended, modified, extended,
renewed, restated, or supplemented from time to time.
"Approvals and Permits" means each and all approvals, authorizations, bonds,
consents, certificates, franchises, licenses, permits, registrations,
qualifications, and other actions and rights granted by or filings with any
Persons necessary, appropriate, or desirable for ownership, lease, or use by
Borrower of its assets and property or for the conduct of the business and
operations of Borrower.
"Borrower Loan Documents" means the Loan Documents executed or delivered by
Borrower from time to time.
"Business Day" means a day of the year on which banks are not required or
authorized to close in Phoenix, Arizona.
"Collateral" means the property, interests in property, and rights to property
securing any or all Obligations from time to time.
"Commitment" means the agreement of Bank in Sections 3.1 and 3.2 to issue
Letters of Credit and to make Advances pursuant to the terms and conditions in
Letter of Credit Agreements and herein.
"Commitment Amount" means the amount specified in Section 1.
"Current Ratio" means the ratio calculated by dividing Current Assets by Current
Liabilities.
"Customer" means a customer of Borrower.
"Debt to Worth Ratio" means the ratio calculated by dividing (i) the sum of
Total Liabilities plus outstanding Letters of Credit, by (ii) Tangible Net
Worth.
<PAGE>
"ERISA" means the Employee Retirement Income Security Act of 1974 and the
regulations and published interpretations thereunder, as in effect from time to
time.
"Event of Default" has the meaning specified in the Note and the other Loan
Documents.
"Existing Letter(s) of Credit" means any and all letter(s) of credit issued by
Bank at the request of Borrower prior to the date of this Agreement, as to which
letter(s) of credit the date that is the Standard Number of Days after the last
date for payment of drafts drawn or drawn and accepted thereunder is after the
date of this Agreement.
"Fixed Coverage Ratio" means the ratio calculated by dividing (i) Net Income
before Interest, Lease and Tax Expense, by (ii) Interest, Lease and Current
Maturities Long Term Debt on a rolling four quarter basis.
"GAAP" means generally accepted accounting principles consistently applied.
"Governmental Authority" means any government, any court, and any agency,
authority, body, bureau, department, or instrumentality of any government.
"Letter of Credit Agreement" means Bank's standard form Application and
Agreement for Commercial Letter of Credit, Bank's standard form Application for
Standby Letter of Credit and Standby Letter of Credit Agreement, or other
standard application and agreement for letters of credit in use by Bank from
time to time.
"Letters of Credit" means the letters of credit in Bank's standard form from
time to time issued pursuant to Section 3.1 and any Existing Letters of Credit.
"Lien or Encumbrance" and "Liens and Encumbrances" mean, respectively, each and
all of the following: (i) any lease or other right to use; (ii) any assignment
as security, conditional sale, grant in trust, lien, mortgage, pledge, security
interest, title retention arrangement, other encumbrance, or other interest or
right securing the payment of money or the performance of any other liability or
obligation, whether voluntarily or involuntarily created and whether arising by
agreement, document, or instrument, under any law, ordinance, regulation, or
rule (federal, state, local, or foreign), or otherwise; and (iii) any option,
right of first refusal, other right to acquire, or other interest, or right.
"Loan Documents" means this Agreement, the Note, the Letter of Credit Agreements
executed and delivered by Borrower in connection with Letters of Credit from
time to time, and any other agreements, documents, or instruments from time to
time evidencing, guarantying, securing, or otherwise relating to the Note, as
they may be amended, modified, extended, renewed, or supplemented from time to
time.
"Loan Party" means Borrower and each other Person that from time to time is or
becomes obligated to Bank under any Loan Document or grants any Collateral.
"Material Adverse Change" means any change in the assets, business, financial
condition, operations, prospects, or results of operations of any Loan Party or
any other event or condition that (i) materially and adversely affects the
likelihood of performance by any Loan Party of any of the Obligations, (ii)
materially and adversely affects the ability of any Loan Party to perform any of
the Obligations, (iii) materially and adversely affects the legality, validity,
or binding nature of any of the Obligations or any Lien or Encumbrance securing
any of the Obligations, or (iv) materially and adversely affects the priority of
any Lien or Encumbrance securing any of the Obligations.
"Note" means the Promissory Note, dated of even date herewith, of Borrower
payable to Bank, as it may be amended, modified, extended, renewed, restated, or
supplemented from time to time.
"Obligations" means the obligations of the Loan Parties under the Loan Documents
(including, without limitation, the obligation to pay Reimbursement Amounts).
<PAGE>
"Permitted Exceptions" means Liens and Encumbrances in favor of Bank, leases of
inventory for fair consideration in the ordinary course of Borrower's business,
Liens and Encumbrances shown on financial statements of Borrower delivered to
Bank prior to the date of this Agreement, Liens and Encumbrances otherwise
disclosed to Bank in writing prior to the date of this Agreement, other Liens
and Encumbrances consented to by Bank in writing from time to time in its
absolute and sole discretion and purchase money security interests.
"Person" means a natural person, a partnership, a joint venture, an
unincorporated association, a limited liability company, a corporation, a trust,
any other legal entity, or any Governmental Authority.
"Reimbursement Amount" means the amount Borrower is obligated to pay to Bank
under a Letter of Credit Agreement in respect of a draft drawn or drawn and
accepted under the respective Letter of Credit, which amount shall be the amount
of the draft or acceptance and all costs, expenses, fees, and other amounts then
payable by Borrower to Bank under the Letter of Credit Agreement.
"Standard Number of Days" means the standard number of days established by Bank
from time to time to allow for delivery to Bank of drafts drawn under letters of
credit issued by Bank and presented to financial institutions other than Bank
for delivery to Bank. Bank may change such number of days at any time and from
time to time in its absolute and sole discretion without notice to Borrower and
may have a different number of days for commercial letters of credit and standby
letters of credit.
"Subsidiary" means any company, foreign or domestic, more than 50% of the voting
shares of which are owned by Borrower.
"Tangible Net Worth" means Total Assets less the sum of total Intangible Assets
and Total Liabilities.
"Total Assets" means all assets calculated in accordance with GAAP.
"Total Liabilities" means all liabilities calculated in accordance with GAAP.
"Unmatured Event of Default" means any condition or event that with notice,
passage of time, or both would be an Event of Default.
3. LETTERS OF CREDIT AND LOAN FACILITY
3.1 Letters of Credit.
3.1.1 Issuance of Letters of Credit. Subject to the terms and
conditions of this Agreement and the Letter of Credit Agreements and subject to
the policies, procedures, and requirements of Bank in effect from time to time
for issuance of Letters of Credit (including, without limitation, payment of
letter of credit fees), Bank agrees to issue, from time to time on or before the
scheduled Commitment expiration date set forth in Section 1, Letters of Credit
upon request by and for the account of Borrower, provided that as to each
requested Letter of Credit Borrower has delivered to Bank a completed and
executed Letter of Credit Agreement, and provided further that the date that is
the Standard Number of Days after the last date for payment of drafts drawn or
drawn and accepted under a requested Letter of Credit is before the scheduled
Commitment expiration date set forth in Section 1. Each reference in this
Agreement to "issue" or "issuance" or other forms of such words in relation to
Letters of Credit shall also include any extension or renewal of a Letter of
Credit. Upon occurrence of an Event of Default or an Unmatured Event of Default,
Bank, in its absolute and sole discretion and without notice, may suspend the
commitment to issue Letters of Credit. In addition, upon occurrence of an Event
of Default, Bank, in its absolute and sole discretion and without notice, may
terminate the commitment to issue Letters of Credit.
3.1.2 Issuance Procedure. To obtain a Letter of Credit, Borrower shall
complete and execute a Letter of Credit Agreement and submit it to the letter of
credit department of Bank. Upon receipt of a completed and executed Letter of
Credit Agreement, Bank will process the application in accordance with the
policies, procedures,
<PAGE>
and requirements of Bank then in effect. If the application meets the
requirements of Bank and is within the policies of Bank then in effect, Bank
will issue the requested Letter of Credit.
3.1.3 Reimbursement of Bank for Payment of Drafts Drawn or Drawn and
Accepted Under Letters of Credit. The obligation of Borrower to reimburse Bank
for payment by Bank of drafts drawn or drawn and accepted under a Letter of
Credit shall be as provided in the respective Letter of Credit Agreement. Bank
will notify Borrower of payment by Bank of a draft drawn or drawn and accepted
under a Letter of Credit and of the respective Reimbursement Amount and will
give Borrower the election (i) to pay the Reimbursement Amount pursuant to the
respective Letter of Credit Agreement or (ii) to pay the Reimbursement Amount by
Bank making an Advance subject to the terms and conditions of this Agreement and
applying the proceeds of the Advance to pay the Reimbursement Amount. If
Borrower does not communicate to Bank its election within two Business Days
after notification by Bank of payment of the draft or acceptance, Borrower shall
be deemed to have elected to pay the Reimbursement Amount by Bank making an
Advance hereunder, provided that if the terms and conditions in this Agreement
for an Advance hereunder are not satisfied, Borrower shall be deemed to have
elected to pay the Reimbursement Amount pursuant to the Letter of Credit
Agreement. Each Advance to pay a Reimbursement Amount shall be dated the date
that Bank pays the respective draft or acceptance and shall accrue interest from
and after such date. If Borrower is to pay the Reimbursement Amount pursuant to
the Letter of Credit Agreement, Borrower shall also pay to Bank interest on the
Reimbursement Amount from and including the date Bank pays the respective draft
or acceptance at the Interest Rate (defined in the Note) until the Reimbursement
Amount and such interest are paid in full, provided that if Borrower fails to
pay the Reimbursement Amount and accrued interest thereon within five (5) days
after notification by Bank to Borrower of payment of the respective draft or
acceptance, interest thereafter shall accrue at the Default Rate (as such term
is defined in the Note). Such interest shall be computed on the basis of a
360-day year and accrue on a daily basis for the actual number of days elapsed.
Notwithstanding the above, if Borrower elects or is deemed to have elected to
pay the Reimbursement Amount pursuant to the Letter of Credit Agreement and
fails to pay the Reimbursement Amount and interest thereon within five (5) days
after notification by Bank to Borrower, Bank, in its absolute and sole
discretion and without notice to Borrower and regardless of whether the terms
and conditions in this Agreement for Advances are satisfied, may make an Advance
under this Agreement in the amount of the Reimbursement Amount and accrued
interest thereon and apply the proceeds of such Advance to pay the Reimbursement
Amount and accrued interest.
3.2 Loan Facility. Subject to the terms and conditions of this Agreement,
Bank agrees to make Advances to Borrower from time to time on or before the
scheduled Commitment expiration date specified in Section 1. Advances shall be
on a revolving basis. Advances repaid may be re-borrowed subject to the terms
and conditions herein. Although the outstanding principal of the Note may be
zero from time to time, the Loan Documents shall remain in full force and effect
until the Commitment terminates and all Obligations are paid and performed in
full. Upon occurrence of an Event of Default or an Unmatured Event of Default,
Bank, in its absolute and sole discretion and without notice, may suspend the
commitment to make Advances. In addition, upon occurrence of an Event of
Default, Bank, in its absolute and sole discretion and without notice, may
terminate the commitment to make Advances. The obligation of Borrower to repay
Advances is evidenced by the Note.
3.3 Letters of Credit and Advances. Letters of Credit may be issued and
Advances may be made by Bank at the oral or written request of the respective
Person or Persons designated in Section 1. Such Person or Persons are hereby
authorized by Borrower to request Letters of Credit and Advances, to execute and
deliver Letter of Credit Agreements on behalf of Borrower, and to direct
disposition of the proceeds of Advances until written notice of the revocation
of such authority is received from Borrower by Bank and Bank has had a
reasonable time to act upon such notice. Bank shall have no duty to monitor for
Borrower or to report to Borrower the use of Letters or Credit or proceeds of
Advances. Advances shall be disbursed by Bank in the manner agreed upon by Bank
and Borrower from time to time.
3.4 Limit on Letters of Credit and Advances. Anything in the Loan Documents
to the contrary notwithstanding, the sum from time to time of (i) the aggregate
amount of outstanding and undrawn Letters of Credit, (ii) the aggregate amount
of outstanding and unpaid drafts drawn or drawn and accepted under Letters of
Credit, (iii) the aggregate amount of unpaid Reimbursement Amounts, and (iv) the
amount of outstanding and unpaid Advances shall not exceed the Commitment
Amount.
<PAGE>
3.5 Fees. Borrower agrees to pay to Bank the following fees, which shall be
earned by Bank on the date due under the Loan Documents and shall be
non-refundable to Borrower:
3.5.1 Commitment Fee. A fee for the Commitment in the amount set forth
in Section 1, payable on or before the date hereof.
3.5.2 Attorneys' Costs, Expenses, and Fees. Attorneys costs, expenses,
and fees for Bank's counsel in the amount specified by Bank, payable on or
before the date hereof.
3.5.3 Letter of Credit Issuance Fee. A fee for the issuance of the
Letter of Credit computed on the amount of the Letter of Credit and at the rate
per annum set forth in Section 1, payable upon issuance of the Letter of Credit.
3.6 Mandatory Prepayments. If for any reason at any time the sum of (i) the
aggregate amount of outstanding and undrawn Letters of Credit, (ii) the
aggregate amount of outstanding and unpaid drafts drawn or drawn and accepted
under Letters of Credit, (iii) the aggregate amount of unpaid Reimbursement
Amounts, and (iv) the amount of outstanding and unpaid Advances exceeds the
Commitment Amount, Borrower, without notice or demand, shall immediately make a
payment to Bank in an amount equal to the sum of (A) such excess and (B) accrued
and unpaid interest thereon.
3.7 Collateral Upon Event of Default. Upon an Event of Default and demand
by Bank in its absolute and sole discretion, Borrower shall immediately deliver
to Bank as security for all Obligations immediately available funds in an amount
equal to the sum of (i) aggregate amount of outstanding and undrawn letters of
Credit, and (ii) the aggregate amount of outstanding and unpaid drafts drawn or
drawn and accepted under Letters of Credit. Borrower hereby grants to Bank a
security interest in all such funds delivered to Bank to secure payment and
performance of the Obligations.
4. CONDITIONS PRECEDENT TO EACH ADVANCE AND LETTER OF CREDIT. Bank shall be
obligated to issue a Letter of Credit or make an Advance when requested by
Borrower only if the representations and warranties by the Loan Parties in the
Loan Documents are accurate on and as of this Agreement and on and as of the
date of issuance of the Letter of Credit or of making the Advance before and
after giving effect to the Letter of Credit or the Advance and the application
of the proceeds of the Advance. Delay or failure by Bank to insist on
satisfaction of any condition of issuance of a Letter of Credit or making an
Advance shall not be a waiver of such condition precedent or any other condition
precedent. If Borrower is unable to satisfy any condition precedent of issuance
of a Letter of Credit or making an Advance, the issuance of the Letter of Credit
or the making of the Advance shall not preclude Bank from thereafter declaring
the condition or event causing such inability to be an Event of Default.
5. BORROWER REPRESENTATIONS AND WARRANTIES.
5.1 Closing Representations and Warranties. Borrower represents and
warrants to Bank as of the date of this Agreement:
5.1.1 Purpose of Advances and Letters of Credit. Borrower intends to
use Advances and Letters of Credit only for the purposes described in Section 1.
5.1.2 Accurate Information. All information in any loan application,
financial statement, certificate, or other document and all other information
delivered by or on behalf of Borrower to Bank in obtaining the Commitment is
correct and complete. There are no omissions therefrom that result in any such
information being incomplete, incorrect, or misleading as of the date thereof.
There has been no Material Adverse Change as to Borrower since the date of such
information. All financial statements heretofore delivered to Bank by Borrower
accurately present the financial condition and results of operations of Borrower
as at the dates thereof and for the periods covered thereby. The fiscal year of
Borrower is as set forth in Section 1.
<PAGE>
5.1.3 Legal Proceedings; Hearings, Inquiries, and Investigations.
Except as disclosed to Bank in writing prior to the date of this Agreement, (i)
no legal proceeding is pending or, to the best knowledge of Borrower, threatened
before any arbitrator, other private adjudicator, or Governmental Authority to
which Borrower is a party or by which Borrower or any assets or property of
Borrower may be bound or affected that if resolved adversely to Borrower could
result in a Material Adverse Change, and (ii) no hearing, inquiry, or
investigation relating to Borrower or any assets or property of Borrower is
pending or, to the best knowledge of Borrower, threatened by any Governmental
Authority.
5.1.4 Taxes. Borrower has filed or caused to be filed all tax returns
(federal, state, local, and foreign) required to be filed by Borrower and has
paid all taxes and other amounts shown thereon to be due (including, without
limitation, any interest and penalties).
5.1.5 No Event of Default or Unmatured Event of Default. No Event of
Default and no Unmatured Event of Default has occurred and is continuing.
5.1.6 No Approvals. No approval, authorization, bond, consent,
certificate, franchise, license, permit, registration, qualification, or other
action or grant by or filing with any Person is required in connection with the
execution, delivery, or performance by Borrower of the Borrower Loan Documents.
5.1.7 No Conflicts. The execution, delivery, and performance by
Borrower of the Borrower Loan Documents will not conflict with, or result in a
violation of or a default under: any applicable law, ordinance, regulation, or
rule (federal, state, or local); any judgment, order, or decree of any
arbitrator, other private adjudicator, or Governmental Authority to which
Borrower is a party or by which Borrower or any of the assets or property of
Borrower is bound; any of the Approvals or Permits; or any agreement, document,
or instrument to which Borrower is a party or by which Borrower or any of the
assets or property of Borrower is bound.
5.1.8 Execution and Delivery and Binding Nature of Borrower Loan
Documents. The Borrower Loan Documents have been duly executed and delivered by
or on behalf of Borrower. The Borrower Loan Documents are legal, valid, and
binding obligations of Borrower, enforceable in accordance with their terms
against Borrower, except as such enforceability may be limited by bankruptcy,
insolvency, moratorium, reorganization, or similar laws and by equitable
principles of general application.
5.1.9 Approvals and Permits; Assets and Property. Borrower has obtained
and there are in full force and effect all Approvals and Permits. Borrower owns
or leases all assets and property necessary for conduct of the business and
operations of Borrower. Such assets and property are not subject to any Liens
and Encumbrances, other than Permitted Exceptions.
5.1.10 ERISA. Borrower is in compliance with ERISA. No Reportable Event
or Prohibited Transaction (as defined in ERISA) or termination of any plan has
occurred and no notice of termination has been filed with respect to any plan
established or maintained by Borrower and subject to ERISA. Borrower has not
incurred any material funding deficiency within the meaning of ERISA or any
material liability to the Pension Benefit Guaranty Corporation in connection
with any such plan established or maintained by Borrower. Borrower is not a
party to any Multiemployer Plan (as defined in ERISA).
5.1.11 Environmental Matters. To the best knowledge of Borrower after
due investigation, Borrower is in compliance in all material respects with all
environmental, all health, and all safety laws, ordinances, regulations, and
rules (federal, state, and local) applicable to Borrower, the assets or property
of Borrower, the business or operations of Borrower, or the products or services
of Borrower. Borrower does not have any material existing or contingent
liability in connection with any disposal, generation, manufacture, processing,
production, release, storage, transportation, treatment, or use of any hazardous
or toxic substance or waste.
5.1.12 Investment Company Act; Public Utility Holding Company Act.
Borrower is not an "investment company" or a company controlled by an
"investment company" within the meaning of the Investment Company Act of 1940,
as amended. Borrower is not a "holding company" within the meaning of the Public
Utility Holding Company Act of 1935, as amended.
<PAGE>
5.1.13 Margin Securities. Borrower is not engaged in the business of
extending credit for the purpose of purchasing or carrying margin stock (within
the meaning of Regulation U issued by the Board of Governors of the Federal
Reserve System). No proceeds of any Advance will be used to purchase or carry
any margin stock or extend credit to others for the purpose of purchasing or
carrying margin stock or for any purpose that violates or is inconsistent with
Regulation X of the Board of Governors.
5.1.14 Corporation, Limited Liability Company, or Partnership
Existence, Authority, and Authorization. If Borrower is a corporation, a limited
liability company, or a partnership, Borrower is validly existing, and in the
case of a corporation or limited liability company is in good standing, under
the laws of the jurisdiction of its formation or organization and has the
requisite power and authority to execute, deliver, and perform the Borrower Loan
Documents. The execution, delivery, and performance by Borrower of the Borrower
Loan Documents have been duly authorized by all requisite action by or on behalf
of Borrower and will not conflict with, or result in a violation of or a default
under, the certificate of incorporation or bylaws, the limited liability company
operating agreement, or the partnership agreement of Borrower, as the case may
be. If Borrower is not formed or organized under the law of the State of
Arizona, Borrower is qualified to do business as a foreign corporation, limited
liability company, or partnership, as the case may be, and in the case of a
corporation or limited liability company is in good standing, under the law of
the State of Arizona.
5.2 Representations and Warranties Upon Requests for Advances or Letters of
Credit. Each request for an Advance or a Letter of Credit shall be a
representation and warranty by Borrower to Bank that the representations and
warranties in this Section 5 are correct and complete as of the date of the
Advance or Letter of Credit and that the conditions precedent in Section 4 are
satisfied as of the date of the Advance or Letter of Credit.
5.3 Representations and Warranties Upon Delivery of Financial Statements,
Documents, and Other Information. Each delivery by Borrower to Bank of financial
statements, other documents, or information after the date of this Agreement
(including, without limitation, documents and information delivered in obtaining
an Advance) shall be a representation and warranty that such financial
statements, other documents, or information is correct and complete, that there
are no omissions therefrom that result in such financial statements, other
documents, or information being incomplete, incorrect, or misleading as of the
date thereof, and that such financial statements accurately present the
financial condition and results of operations of Borrower as at the dates
thereof and for the periods covered thereby.
6. BORROWER AFFIRMATIVE COVENANTS. Until the Commitment terminates in full,
until all Letters of Credit expire or are drawn in full, until all drafts drawn
under or drawn and accepted under Letters of Credit are paid in full, and until
the Obligations are paid and performed in full, Borrower agrees that:
6.1 Use of Advances. Borrower shall use Advances only for the purposes
described in Section 1.
6.2 Further Assurances, Costs and Expenses of Borrower's Performance of
Covenants and Satisfaction of Conditions. Borrower shall promptly, or shall
cause each Subsidiary to promptly, execute, acknowledge, and deliver and, as
appropriate, cause to be duly filed and recorded such additional agreements,
documents, and instruments and do or cause to be done such other acts as Bank
may reasonably request from time to time to better assure, perfect, preserve,
and protect the rights and remedies of Bank under the Loan Documents. Borrower
shall, or shall cause each Subsidiary to, perform all of its obligations and
satisfy all conditions under the Loan Documents at its sole cost and expense.
6.3 Books and Records; Access By Bank. Borrower shall, or shall cause each
Subsidiary to, maintain a single, standard, modern system of accounting
(including, without limitation, a single, complete, and accurate set of books
and records of its assets, business, financial condition, liabilities,
operations, property, prospects, and results of operations) in accordance with
good accounting practices. Borrower shall furnish, or cause to be furnished, to
Bank all information concerning Borrower and each Subsidiary and the assets,
business, financial condition, liabilities, operations, property, prospects, and
results of operation of Borrower and each Subsidiary as Bank reasonably requests
from time to time. During business hours Borrower shall give, or cause each
Subsidiary to give,
<PAGE>
representatives of Bank access to all assets, property, books, records,
documents and personnel of Borrower and each Subsidiary and shall permit Bank
representatives to inspect such assets and property, to audit, copy, examine,
and make excerpts from the books, records, and documents, and to make inquiry of
Borrower and Borrower's personnel, and each Subsidiary and Subsidiary's
personnel, and receive answers. Borrower shall, and shall cause the personnel of
Borrower and each Subsidiary to, cooperate and assist Bank and Bank's
representatives. In this regard, without limitation, Bank shall have the right
to conduct semi-annual inspections of the receivables and inventory of Borrower
and each Subsidiary. In addition, Bank shall have the right to verify any
information provided by Borrower and each Subsidiary to Bank by inquiry to any
appropriate third Persons.
6.4 Information and Statements. Borrower shall furnish to Bank:
6.4.1 Fiscal Period Financial Statements. As soon as available and in
any event within the number of days set forth in Section 1 after the end of each
fiscal period of Borrower set forth in Section 1, except the last period in each
fiscal year of Borrower, copies of the balance sheet of Borrower and each
Subsidiary on a consolidated basis as of the end of such fiscal period and
statements of income and retained earnings and a statement of cash flow of
Borrower and each Subsidiary on a consolidated basis for such fiscal period and
for the portion of the fiscal year of Borrower and each Subsidiary ending with
such fiscal period, in each case setting forth in comparative form the figures
for the corresponding period for the preceding fiscal year, all in reasonable
detail, prepared in accordance with the requirements in Section 1, containing
the certifications specified in Section 1 and signed on behalf of Borrower and
each Subsidiary by the person(s) named in Section 1.
6.4.2 Annual Financial Statements. As soon as available and in any
event within the number of days set forth in Section 1 after the end of each
fiscal year of Borrower and each Subsidiary, copies of the balance sheet of
Borrower and each Subsidiary on a consolidated basis as of the end of such
fiscal year and statements of income and retained earnings and a statement of
cash flow of Borrower and each Subsidiary on a consolidated basis for such
fiscal year, in each case setting forth in comparative form the figures for the
preceding fiscal year of Borrower and each Subsidiary, all in reasonable detail
and prepared in accordance with the requirements in Section 1, containing the
certifications specified in Section 1.
6.5 Law; Judgments; Material Agreements; Approvals and Permits. Borrower
shall comply, or shall cause each Subsidiary to comply, with all laws,
ordinances, regulations, and rules (federal, state, local, and foreign) and all
judgments, orders, and decrees of any arbitrator, other private adjudicator, or
Government Authority relating to Borrower and each Subsidiary or the assets,
business, operations, or property of Borrower and each Subsidiary. Borrower
shall comply, or shall cause each Subsidiary to comply, in all material respects
with all material agreements, documents, and instruments to which Borrower and
each Subsidiary is a party or by which Borrower and each Subsidiary or any of
the assets or property of Borrower and each Subsidiary is bound or affected.
Borrower shall, or shall cause each Subsidiary to, obtain and maintain in full
force and effect all Approvals and Permits and shall comply with all conditions
and requirements of all Approvals and Permits.
6.6 Taxes and Other Indebtedness. Borrower shall, or shall cause each
Subsidiary to, pay and discharge (i) before delinquency all taxes, assessments,
and governmental charges or levies imposed upon it, upon its income or profits,
or upon any of its assets or property, (ii) when due all lawful claims
(including, without limitation, claims for labor, materials, and supplies),
that, if unpaid, might become a Lien or Encumbrance upon any of its assets or
property, and (iii) when due, all its other indebtedness.
6.7 Assets and Property. Borrower shall, or shall cause each Subsidiary to,
maintain, keep, and preserve all of its assets and property (tangible and
intangible) necessary or useful in the proper conduct of its business and
operations in good working order and condition, ordinary wear and tear excepted.
6.8 Insurance. In addition to any insurance required under any of the other
Loan Documents, Borrower shall maintain workmen's compensation insurance,
product and public liability insurance, insurance on its assets and property now
or hereafter owned, and such other forms of insurance as is customary in the
industry of Borrower, against such casualties, risks, and contingencies, in such
amounts, and with such insurance companies as are
<PAGE>
satisfactory to Bank, in its reasonable discretion. Borrower shall deliver to
Bank from time to time as Bank may request, schedules setting forth all
insurance then in effect and copies of the policies.
6.9 Environmental Laws. Without limiting the generality of Section 6.5,
Borrower shall comply, or shall cause each Subsidiary to comply, with all
environmental, all health, and all safety laws, ordinances, regulations, and
rules (federal, state, local, and foreign) applicable to Borrower and each
Subsidiary, the business or operations of Borrower and each Subsidiary, the
assets or property of Borrower and each Subsidiary, or the products or services
of Borrower and each Subsidiary. Borrower and each Subsidiary may use and store
for its own use hazardous or toxic substances. Borrower shall not, and shall not
permit each Subsidiary to, dispose of, generate, manufacture, process, produce,
release, transport, or treat or otherwise store or use any hazardous or toxic
substances or wastes. Borrower shall notify, or shall cause each Subsidiary to
notify, Bank immediately of any environmental inquiry or claim from any
Governmental Authority or other Person relating to Borrower and each Subsidiary
or any assets, property, business, operations, product, or service of Borrower
and each Subsidiary.
6.10ERISA. Borrower shall fund, or shall cause each Subsidiary to fund,
each Defined Benefit Plan and Defined Contribution Plan (as such terms are
defined in ERISA) established or maintained by or for Borrower and each
Subsidiary so that there is never an Accumulated Funding Deficiency (as defined
in Section 412 of the Internal Revenue Code of 1986, as amended).
6.11Financial Covenants. Except as otherwise noted, all financial
computations shall be made in accordance with GAAP. Until the Commitment
terminates in full and until the Obligations are paid and performed in full, or,
if so specified in Section 1, for the respective period(s) specified in Section
1, Borrower agrees that Borrower and each Subsidiary shall maintain on a
consolidated basis:
6.11.1 Tangible Net Worth. Tangible Net Worth of not less than the
amount set forth in Section 1.
6.11.2 Current Ratio. A Current Ratio of not less than the ratio set
forth in Section 1.
6.11.3 Fixed Coverage Ratio. A Fixed Coverage Ratio of not less than
the amount set forth in Section 1.
6.11.4 Debt to Worth Ratio. A Debt to Worth ratio not to exceed the
amount set forth in Section 1.
6.12Corporation, Limited Liability Company, or Partnership Existence. If
Borrower and any Subsidiary is a corporation, a limited liability company, or a
partnership, Borrower and each such Subsidiary shall continue to be validly
existing, and in the case of a corporation or a limited liability company in
good standing, under the law of the jurisdiction of its organization or
formation. If any Subsidiary is not formed or organized under the laws of the
State of Arizona, each such Subsidiary shall continue to be qualified to do
business as a foreign corporation, limited liability company, or partnership, as
the case may be, and in the case of a corporation or limited liability company,
to be in good standing, under the law of the jurisdiction of its organization or
formation.
7. BORROWER NEGATIVE COVENANTS. Until the Commitment terminates in full, until
all Letters of Credit expire or are drawn in full, until all drafts drawn or
drawn and accepted under Letters of Credit are paid in full, and until the
Obligations are paid and performed in full, Borrower agrees, without first
obtaining Bank's written consent:
7.1 Corporation, Limited Liability Company, and Partnership Restrictions.
If Borrower and any Subsidiary is a corporation, a limited liability company, or
a partnership, Borrower shall not, and shall not permit any such Subsidiary to,
issue any material amount of capital stock or other securities of or any limited
liability company interest or partnership interest in Borrower and each
Subsidiary or grant any material amount of option(s), right-of-first-refusal,
warrant, or other right to purchase or acquire any capital stock or other
securities of or any limited liability company interest or partnership interest
in Borrower and each Subsidiary. Borrower shall not be dissolved or liquidated.
Borrower shall not amend, modify, restate, supplement, or terminate its
certificate of incorporation or bylaws, its limited liability company operating
agreement, or its partnership agreement, as the case
<PAGE>
may be. If a corporation, Borrower shall not reorganize itself or consolidate
with or merge into any other corporation or any limited liability company or
permit any other corporation or any limited liability company to be merged into
Borrower; provided that a merger of any Subsidiary into another Subsidiary shall
not constitute a violation of this restriction. With respect to any transactions
described in this paragraph between or among Borrower and its Subsidiaries,
Bank's consent shall not be unreasonably withheld or delayed. Anything in the
foregoing to the contrary notwithstanding, Borrower may make such changes to its
certificate of incorporation and by-laws without Bank's prior consent as may
from time to time be required by a governmental authority with jurisdiction over
Borrower, so long as such changes do not result in a change of ownership or
control of Borrower, or any other change which may materially adversely affect
Bank's rights under the Loan Documents.
7.2 Change in or Reacquisition of Ownership Interests in Borrower. In
addition to any requirement in any other Loan Document, if Borrower and any
Subsidiary is a corporation, a limited liability company, or a partnership,
Borrower shall not, and shall not permit any such Subsidiary to, repurchase any
material amount of capital stock of or any limited liability company interest or
partnership interest in Borrower and each Subsidiary or any material amount of
option(s), right-of-first refusal, warrant or other right to purchase any
material amount of capital stock or other securities of or any limited liability
company interest or partnership interest in Borrower and each Subsidiary. In
addition, Borrower shall not, and shall not permit any such Subsidiary to,
suffer to occur or exist, whether occurring voluntarily or involuntarily, after
the date of this Agreement any change in the legal or beneficial ownership of
any capital stock of or limited liability company interest or partnership
interest in Borrower and each Subsidiary, without the prior written consent of
Bank in its absolute and sole discretion.
For the purposes of the foregoing, repurchase by Borrower during any calendar
year of an amount of its capital stock not in excess of 15% of its aggregate
issued and outstanding capital stock shall not be considered a "material amount"
of the capital stock of Borrower.
7.3 Name, Fiscal Year, Accounting Method, and Lines of Business. Borrower
shall not, and shall not permit each Subsidiary to, change its name (Bank's
consent to such change not to be unreasonably withhold or delayed). Borrower
shall not, and shall not permit each Subsidiary to, change its fiscal year, or
method of accounting. Borrower shall not, and shall not permit each Subsidiary
to, directly or indirectly, engage in any business other than the telecom
products, telecom networks, voice processing software, long distance services,
specialized computer-telephone software applications, telephone systems,
telephonic switches and telephones, maintenance, leasing and support services,
long distance calling services, and voice mail and other telecommunications
applications business, discontinue any material lines(s) of business, or
substantially alter its method of doing business.
7.4 Acquisitions, Loans, Investments, Guaranties, Subordinations. Borrower
shall not, and shall not permit each Subsidiary to, directly or indirectly (i)
acquire by purchase, lease, or otherwise all or substantially all the assets of
any other Person, (ii) make any loan or advance to any other Person, (iii)
purchase or otherwise acquire any capital stock or other securities of any other
Person, any limited liability company interest or partnership interest in any
other Person, or any warrants or other options or rights to acquire any capital
stock or securities of any other Person or any limited liability company
interest or partnership interest in any other Person, (iv) make any capital
contribution to any other Person, (v) otherwise invest in or acquire any
interest in any other Person, (vi) guaranty or otherwise become obligated in
respect of any indebtedness of any other Person, or (vii) subordinate any claim
against or obligation of any other Person to Borrower to any other indebtedness
of such Person. For purposes of clarification as used in this paragraph 7.4, the
term "Person" shall include, without limitation, Borrower and/or each
Subsidiary, as the case may be. With respect to any transactions described in
this paragraph between or among Borrower and its Subsidiaries, Bank's consent
shall not be unreasonably withheld or delayed.
Notwithstanding the above, Borrower may otherwise invest in or acquire any
interest in any other Person, not to exceed $10,000,000.00 in any one instance
or $30,000,000.00 in the aggregate in any one year.
7.5 Disposition of All or Substantially All Assets. Borrower shall not, and
shall not permit each Subsidiary to, sell, transfer, lease, or otherwise dispose
of all or any substantial part of the assets, business, operations, or property
of Borrower or each Subsidiary. With respect to any transactions described in
this paragraph between or among Borrower and its Subsidiaries, Bank's consent
shall not be unreasonably withheld or delayed.
<PAGE>
7.6 Negative Pledge. Except for Permitted Exceptions, Borrower shall not,
and shall not permit each Subsidiary to, grant or suffer to exist any Lien or
Encumbrance upon any assets or property of Borrower or each Subsidiary.
7.7 Capital Expenditures. Borrower shall not, and shall not permit each
Subsidiary to, in any twelve (12) month period, acquire additional fixed assets
that have an aggregate total cost to Borrower and Subsidiaries in excess of the
amount set forth in Section 1, excluding acquisitions. Compliance with the
foregoing covenant shall be measured annually as of the end of each fiscal year
of Borrower.
7.8 Indebtedness. Borrower shall not, and shall not permit each Subsidiary
to, assume, create, incur, or permit to exist any indebtedness, except (i)
existing indebtedness disclosed on financial statements delivered to Bank prior
to the date of this Agreement, (ii) the Obligations, and (iii) other
indebtedness and trade obligations and normal accruals in the ordinary course of
business not yet due and payable, in the case of (i), (ii), and (iii) in excess
in the aggregate of the amount set forth in Section 1.
7.9 Maximum Net Loss. The maximum net loss for any quarter, cumulative for
any four quarters or any two consecutive quarters shall not exceed the
amount-set forth in Section 1.
8. BANK'S OBLIGATIONS TO BORROWER ONLY. The obligations of Bank under this
Agreement are for the benefit of Borrower only. No other Person shall have any
rights hereunder or be a third-party beneficiary hereof.
9. PROVISIONS IN NOTE GOVERN THIS AGREEMENT. This Agreement is subject to
certain terms and provisions in the Note, to which reference is made for a
statement of such terms and provisions.
10. COUNTERPART EXECUTION AND FACSIMILE DELIVERY. This Agreement may be executed
in one or more counterparts, each of which shall be deemed an original and all
of which together shall constitute one and the same document. Signature pages
may be detached from the counterparts and attached to a single copy of this
Agreement to physically form one document. Delivery of executed copies of this
Agreement may be made by facsimile transmission with the same effect as delivery
of executed originals of this Agreement.
DATED as of the date first above stated.
BANK ONE, ARIZONA, NA,
a national banking association
By:____________________________________
Name: Craig S. Hoskin
Title: Vice President
INTER-TEL, INCORPORATED,
an Arizona corporation
By:_____________________________________
Name: Kurt R. Kneip
Title: Vice President, Chief Financial Officer, Secretary, and Assistant
Treasurer
EXHIBIT 13.0
EXCERPTS FROM ANNUAL REPORT TO SECURITY HOLDERS
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Ernst & Young LLP, Independent Auditors
Shareholders and Board of Directors
Inter-Tel, Incorporated
We have audited the accompanying consolidated balance sheets of Inter-Tel,
Incorporated and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Inter-Tel,
Incorporated and subsidiaries at December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
/s/Ernst & Young LLP
Phoenix, Arizona
February 20, 1998
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
- --------------------------------------------------------------------------------
(In thousands, except share amounts) 1997 1996
ASSETS
CURRENT ASSETS
Cash and equivalents $ 88,805 $ 38,936
Accounts receivable, less allowances of
$3,722 in 1997 and $3,096 in 1996 32,234 29,998
Inventories, less allowances of $5,740 in
1997 and $2,979 in 1996 21,539 21,280
Net investment in sales-leases 9,196 8,243
Prepaid expenses and other assets 5,625 7,008
- --------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 157,399 105,465
PROPERTY, PLANT & EQUIPMENT 19,559 11,189
OTHER ASSETS` 18,030 15,957
- --------------------------------------------------------------------------------
$ 194,988 $ 132,611
- --------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 14,864 $ 8,915
Other current liabilities 18,721 16,841
- --------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 33,585 25,756
DEFERRED TAX LIABILITY 11,343 8,635
OTHER LIABILITIES 4,555 3,286
SHAREHOLDERS' EQUITY
Common stock, no par value - authorized 100,000,000
shares, issued and outstanding - 26,687,766 shares
in 1997 and 25,888,572 shares in 1996 99,229 59,875
Retained earnings 46,547 35,464
Currency translation adjustment (271) (359)
- --------------------------------------------------------------------------------
145,505 94,980
Less receivable from Employee Stock Ownership Trust - (46)
- --------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 145,505 94,934
- --------------------------------------------------------------------------------
$ 194,988 $ 132,611
================================================================================
See accompanying notes.
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1997, 1996 and 1995
- --------------------------------------------------------------------------------
(In thousands, except per share data) 1997 1996 1995
NET SALES $ 223,569 $ 185,884 $ 150,533
Cost of sales 122,363 104,966 87,696
- --------------------------------------------------------------------------------
GROSS PROFIT 101,206 80,918 62,837
Research and development 7,998 6,581 5,764
Selling, general and administrative 69,942 56,386 43,578
Special charge -- 4,542 1,315
- --------------------------------------------------------------------------------
OPERATING INCOME 23,266 13,409 12,180
- --------------------------------------------------------------------------------
Other income 1,383 1,974 1,674
Interest expense (47) (77) (106)
- --------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 24,602 15,306 13,748
INCOME TAXES
Current 8,850 3,480 1,007
Deferred 1,070 2,784 4,242
- --------------------------------------------------------------------------------
9,920 6,264 5,249
- --------------------------------------------------------------------------------
NET INCOME $ 14,682 $ 9,042 $ 8,499
- --------------------------------------------------------------------------------
NET INCOME PER SHARE
Basic $ 0.59 $ 0.35 $ 0.37
Diluted $ 0.57 $ 0.34 $ 0.36
- --------------------------------------------------------------------------------
Average common shares outstanding 24,836 25,780 23,056
Average common shares outstanding
assuming dilution 25,983 26,572 23,766
- --------------------------------------------------------------------------------
See accompanying notes.
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Currency Receivable
(In thousands, except Common Treasury Retained Translation From
share amounts) Stock Stock Earnings Adjustment ESOP Total
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 $ 27,585 $ -- $ 17,923 $ (122) $ (264) $ 45,122
Issuance of 4,000,000 shares of
common stock 30,670 30,670
Exercise of stock options 503 503
Tax benefit from stock options 208 208
Net income 8,499 8,499
Gain on currency translation 10 10
Collection from ESOP 105 105
- -------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 58,966 -- 26,422 (112) (159) 85,117
Exercise of stock options 611 611
Tax benefit from stock options 417 417
Escrow share cancellation from
prior stock acquisition (119) (119)
Net income 9,042 9,042
Loss on currency translation (247) (247)
Collection from ESOP 113 113
- -------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 59,875 -- 35,464 (359) (46) 94,934
Stock repurchase (27,194) (27,194)
Exercise of stock options 642 4,533 (3,332) 1,843
Tax benefit from stock options 1,967 1,967
Net income 14,682 14,682
Gain on currency translation 88 88
Collection from ESOP 46 46
Stock issued under
Employee Stock Purchase Plan 256 256
Issuance of 3,000,000 shares of
common stock 36,489 22,661 59,150
Dividends (267) (267)
- -------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $ 99,229 $ -- $ 46,547 $ (271) $ -- $ 145,505
=========================================================================================================================
</TABLE>
See accompanying notes.
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
(In thousands) 1997 1996 1995
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 14,682 $ 9,042 $ 8,499
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 4,578 4,097 2,267
Provision for losses on receivables 4,104 3,746 1,594
Provision for inventory valuation 4,021 609 1,109
Net contribution to ESOP 46 113 105
Increase/(decrease) in other liabilities 1,269 (604) 1,111
(Gain)/loss on sale of property and equipment (25) 3,421 16
Deferred income taxes 1,070 2,784 4,242
Effect of exchange rate changes 88 (247) 10
Changes in operating assets and liabilities (1,633) (15,704) (18,141)
- ----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 28,200 7,257 812
- ----------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Additions to property and equipment (12,449) (6,951) (7,921)
Proceeds from sale of property and equipment 63 159 9
Cash used in acquisitions -- (1,780) --
- ----------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING
ACTIVITIES (12,386) (8,572) (7,912)
- ----------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net proceeds from stock offering 59,150 -- 30,670
Proceeds from exercise of stock options 1,843 611 503
Proceeds from stock issued under the
Employee Stock Purchase Plan 256 -- --
Treasury stock purchases (27,194) -- --
- ----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 34,055 611 31,173
- ----------------------------------------------------------------------------------------------------------
INCREASE (DECREASE)
IN CASH AND EQUIVALENTS 49,869 (704) 24,073
CASH AND EQUIVALENTS AT BEGINNING
OF YEAR 38,936 39,640 15,567
- ----------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS AT END OF YEAR $88,805 $ 38,936 $ 39,640
- ----------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE A -- SIGNIFICANT ACCOUNTING POLICIES
Description of Business. Inter-Tel is a single point of contact, full
service provider of digital business telephone systems, call processing
software, voice processing software, call accounting software, Internet Protocol
(IP) telephony software, computer telephone integration applications and long
distance calling services. Inter-Tel's products and services include the AXXESS
and Inter-Tel Axxent digital business communication software platforms, the
AXXESSORY Talk voice processing platform, the Inter-Tel Vocal'Net IP telephony
gateway, the Inter-Tel Vocal'Net Service Provider Software and Centralized
Accounting Software and Inter-Tel.net, an IP telephony packet switched long
distance service. The Company also provides maintenance, leasing and support
services for its products.
Principles of Consolidation. The consolidated financial statements
include the accounts of Inter-Tel, Incorporated and all significant subsidiaries
(the Company). Intercompany accounts and transactions have been eliminated in
consolidation.
Cash and Equivalents. Cash and equivalents include all highly liquid
investments with a remaining maturity of three months or less at date of
acquisition. Excess cash and equivalents are primarily invested in mutual funds
comprised of foreign and domestic high quality dollar denominated money market
instruments rated A-1 by Standard & Poor's Ratings Group, or equivalent.
Inventories. Inventories, consisting principally of telephone systems,
computer equipment and related components, are stated at the lower of cost
(first-in, first-out method) or market.
Property, Plant and Equipment. Property, plant and equipment is stated
at cost. Depreciation is computed using the straight-line method over the
estimated useful life of the related property which range from 3 years to 12
years. Leasehold improvements are depreciated over the shorter of the related
lease terms or the estimated useful lives of the improvements.
Excess of Purchase Price Over Net Assets Acquired. Purchase prices of
acquired businesses that are accounted for as purchases have been allocated to
the assets and liabilities acquired based on the estimated fair values on the
respective acquisition dates. Based on these values, the excess purchase prices
over the fair value of the net assets acquired are being amortized over 3 to 40
years. Accumulated amortization through December 31, 1997 was $866,744.
Sales-Leases. The discounted present values of minimum rental payments
under sales-type leases are recorded as sales, net of provisions for continuing
administration and other expenses over the lease period. The costs of systems
installed under these sales-leases, net of residual values at the end of the
lease periods, are recorded as costs of sales. Gains or losses resulting from
the sale of rental income from such leases are recorded as adjustments to the
original sales amounts.
Income Taxes. Deferred income taxes result from temporary differences
in the recognition of revenues and expenses for financial reporting and income
tax purposes.
Advertising. The cost of advertising is expensed as incurred. The
Company incurred $577,000; $437,000 and $318,000 in advertising costs during
1997, 1996, and 1995, respectively.
Stock Based Compensation. The Company grants stock options for a fixed
number of shares to employees with an exercise price equal to the fair market
value of the shares at the date of grant. The company accounts for stock option
grants in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," ("APB 25") and accordingly,
recognizes no compensation expense for these stock option grants.
<PAGE>
Recently Issued Accounting Standards. In 1996, the Company adopted
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards ("SFAS") Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS No. 121"),
which requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. SFAS 121 also addresses the accounting for long-lived assets
that are expected to be disposed of. The Company adopted SFAS 121 in the first
quarter of 1996 and the adoption did not have a material impact to the
operations of the Company. During the fourth quarter of 1996, the Company
decided to replace its management information system ("MIS") software with an
integrated solution from a more established vendor and accordingly wrote off the
software license and implementation costs relating to the system software being
replaced. The special pre-tax charge of $4.5 million reflects the costs
associated with the Company's decision to abandon its current MIS software in
favor of different system software.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
("SFAS No. 128"), adopted by the Company on December 31, 1997. SFAS No. 128
replaced the previously reported primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants, and
convertible securities. Diluted earnings per share is very similar to the
previously reported primary earnings per share. All earnings per share amounts
for all periods have been presented, and where necessary, restated to conform to
the SFAS No. 128 requirements. The impact of SFAS No. 128 on the calculation of
fully diluted earnings per share for each of the periods presented was not
material.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. The adoption of SFAS 131 will have no impact
on the Company's consolidated results of operations, financial position or cash
flows.
Recent Pronouncements. In October 1997, the American Institute of
Certified Public Accountants issued Statement of Position 97-2, "Software
Revenue Recognition" ("SOP 97-2"). SOP 97-2 provides guidance on when revenue
should be recognized and in what amounts for licensing, selling, leasing, or
otherwise marketing computer software. SOP 97-2 is effective for financial
statements for fiscal years beginning after December 15, 1997. Earlier
application for financial statements or information that has not been issued is
encouraged. The Company is in the process of evaluating if the adoption of
SOP97-2 will have an impact, if any, on its software revenue recognition
practices.
Contingencies. The Company is a party to certain litigation in the
normal course of business. Management does not anticipate that the resolution of
such matters will have a material adverse effect on the Company's consolidated
financial position.
Use of Estimates. The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
Reclassifications. Certain reclassifications have been made to the 1996
and 1995 financial statements to conform to the 1997 presentation.
<PAGE>
NOTE B -- ACQUISITIONS
Effective November 29, 1996, the Company acquired 100% of the stock of
NTL Corporation ("ComNet") for cash and a short-term note. The transaction has
been accounted for as a purchase transaction, and accordingly, the results of
its operations have been included in the consolidated results of operations
since the transaction date. The purchase price has been allocated to the assets
and liabilities based on fair values at acquisition. The purchase price over net
assets acquired (goodwill) is being amortized over 5 to 10 years, based on the
lives of the underlying assets. The acquisition did not include certain
components of ComNet's business. Accordingly, separate operating results for
ComNet's telecommunications business are not available. ComNet's
telecommunication revenues for 1996 were approximately $9.0 million.
NOTE C -- NET INVESTMENT IN SALES-LEASES
Net investment in sales-leases represents the value of sales-leases
presently held under the Company's Totalease program. The Company currently
sells the rental income from some of the sales-leases. The Company maintains
reserves against potential recourse following the resales based upon loss
experience and past due accounts. Activity during the years was as follows:
Year Ended December 31
(In thousands) 1997 1996 1995
Sales of rental income $ 57,812 $ 42,985 $ 25,106
Sold income remaining
unbilled at end of year $ 99,900 $ 65,970 $ 37,256
Allowance for uncollectible
minimum lease payments
and recourse liability at
end of year $ 3,969 $ 2,706 $ 1,513
The Company does not expect any significant losses from the recourse
provisions related to the sale of rental income. The Company is compensated for
administration and servicing of rental income sold.
NOTE D -- PROPERTY, PLANT & EQUIPMENT
December 31
(In thousands) 1997 1996
Computer systems and equipment $28,570 $20,236
Transportation equipment 1,665 1,737
Furniture and fixtures 4,043 3,301
Leasehold improvements 1,693 1,037
Land 2,619 321
----- -------
38,590 26,632
Less: Accumulated depreciation
and amortization 19,031 15,443
------ ------
$19,559 $11,189
====== ======
<PAGE>
NOTE E -- OTHER ASSETS
December 31
(In thousands) 1997 1996
Net investment in sales-leases $13,402 $11,497
Excess of purchase price over net
assets acquired, net 4,380 4,334
Other assets 248 126
------ -------
$18,030 $15,957
======= =======
NOTE F-- OTHER CURRENT LIABILITIES
December 31
(In thousands) 1997 1996
Compensation and employee benefits $8,163 $6,176
Deferred revenues 2,947 2,889
Other accrued expenses 7,611 7,776
----- -------
$18,721 $16,841
======= =======
NOTE G -- CREDIT LINE
The Company maintains a $7,000,000 unsecured bank credit line at prime
rate to cover international letters of credit and for other purposes. The credit
agreement matures July 31, 1998 and contains certain restrictions and financial
covenants. At December 31, 1997, $390,000 of the credit line was committed under
letter of credit arrangements.
NOTE H -- LEASES
Rental expense amounted to $4,342,000; $3,538,000; and $2,995,000; in
1997, 1996 and 1995, respectively. Noncancellable operating leases are primarily
for buildings. Certain of the leases contain provisions for renewal options and
scheduled rent increases. At December 31, 1997, future minimum commitments under
noncancellable leases, including a five year lease for its headquarters facility
and a 15 year lease for its distribution and support facility, are: 1998 --
$3,444,000; 1999 -- $2,570,000; 2000 -- $1,788,000; 2001 -- $1,230,000; 2002 --
$733,000; thereafter -- $2,610,000.
NOTE I -- INCOME TAXES
The Company accounts for income taxes under SFAS Statement No. 109,
"Accounting for Income Taxes" ("Statement No. 109"). Under Statement No. 109,
the liability method is used in accounting for income taxes. Under this method,
deferred tax assets and liabilities are determined (and classified as current or
long-term) based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
Significant components of the Company's deferred tax liabilities and
assets as of December 31, are as follows:
(In thousands) 1997 1996
Deferred tax liabilities:
Lease--sales and reserves $15,624 $ 12,502
Accelerated depreciation -- 179
------- --------
Total deferred tax liabilities 15,624 12,681
------- --------
<PAGE>
Deferred tax assets:
Inventory basis differences 2,580 1,553
Accounts receivable reserves 1,357 1,135
Maintenance reserve 259 317
Accrued vacation pay 604 557
Foreign loss carryforwards 1,047 794
Other -- net 1,858 1,223
------- --------
Deferred tax assets 7,705 5,579
Less valuation reserve 1,047 794
------- --------
Net deferred tax assets 6,658 4,785
------- --------
Net deferred tax liabilities $ 8,966 $ 7,896
======= =======
During 1997 and 1996, the Company incurred losses of $722,000 and
$730,000 with respect to foreign operations. At December 31, 1997, the Company
had foreign loss carryforwards of approximately $3,100,000, which will begin to
expire in 1999. The valuation allowance increased by $253,000 in 1997 and
$248,000 in 1996 due to increases in foreign loss carryforward benefits.
Federal and state income taxes consisted of the following:
(In thousands) 1997 1996 1995
Federal $ 8,290 $ 5,414 $ 4,789
State 1,630 850 460
----- --- ---
$ 9,920 $ 6,264 $ 5,249
===== ===== =====
The principal reasons for the difference between total income tax
expense and the amount computed by applying the statutory federal income tax
rate to income before taxes are as follows:
1997 1996 1995
Federal tax at statutory rates
applied to pre-tax income 35% 34% 34%
State tax net of federal benefit 4 4 2
Valuation reserve increase
for foreign losses 1 2 2
Other - net -- 1 --
--- --- ---
40% 41% 38%
=== === ===
NOTE J -- EQUITY TRANSACTIONS
Stock Split. Retroactive adjustments have been made, as appropriate, to
Common Stock and per share amounts to reflect the 2-for-1 stock split effected
in the form of a stock dividend in October 1997.
Treasury Stock. During the second quarter of 1997, the Company
initiated a stock repurchase program under which the Board of Directors
authorized the repurchase of up to 1,470,000 shares (on a pre-Stock Split basis)
of the Common Stock. The Company expended approximately $27.2 million for stock
repurchases during 1997, which was funded primarily through existing cash
balances. The Company reissued shares through November through stock option
exercises and issuances. The proceeds received for the stock reissued was less
than its cost basis. Accordingly, the difference was recorded as a reduction to
retained earnings.
Public Stock Offering. In a public offering in December 1997, the
Company sold 3,000,000 shares of Common Stock. Net proceeds from the offering
were approximately $59,150,000. In conjunction with the offering, all remaining
treasury shares were reissued first and the remaining shares issued from
previously unissued Common Stock.
Dividend Policy. On September 24, 1997, the Company's Board of
Directors declared a cash dividend (the "Cash Dividend") of $0.01 for every
share of Common Stock, payable to
<PAGE>
shareholders of record as of December 31, 1997, with dividend payments to
commence on or about January 15, 1998. Prior to the Cash Dividend, the Company
had declared no cash dividends on its Common Stock since incorporation.
Stock Option Plans. Under the Company's 1994 and 1997 Long-Term
Incentive Plans, selected officers and key employees are granted options to
purchase Common Stock of the Company at not less than fair market value at date
of grant. The options are exercisable at the end of their ten-year term, but may
become exercisable in annual installments. In some instances, predetermined
performance goals and share market value increases must be met to allow the
options to be exercised before the end of the option term.
Under other previous stock option plans, directors, officers and key
employees may purchase Common Stock of the Company at amounts not less than the
fair market value at the date of grant. These options generally have a term of
five to ten years and are exercisable over four to five years commencing one
year from the date of grant, except for director stock option grants, which are
exercisable commencing six months from the date of grant.
In November 1993, the Board of Directors authorized the Inter-Tel,
Incorporated Long-Term Incentive Plan ("the 1994 Long Term Plan"). A total of
2,000,000 shares of Common Stock has been reserved for issuance under the 1994
Long Term Plan. Options must be granted at not less than 100% of the fair market
value of the Company's stock at the dates of grant. Options generally vest over
four or five years and expire five to ten years from the date of grant.
In July 1990, the Company adopted the Director Stock Option Plan ("the
Director Plan") and reserved a total of 500,000 shares of Common Stock for
issuance thereunder. Commencing with the adoption of the Plan, each Eligible
Director received a one-time automatic grant of an option to purchase 5,000
shares of the Company's Common Stock. In addition, each Eligible Director shall
be granted an option to purchase 5,000 shares upon the date five (5) days after
such person became Director, and an additional option to purchase 5,000 shares
five (5) days after the date of annual reelection as Director. All options
granted have a five-year term and fully vest at the end of six months from the
grant date.
In February 1997, the Board of Directors authorized the Inter-Tel,
Incorporated 1997 Long-Term Incentive Plan ("the 1997 Long Term Plan"). A total
of 2,400,000 shares of Common Stock has been reserved for issuance under the
1997 Long Term Plan. Options must be granted at not less than 100% of the fair
market value of the Company's stock at the dates of grant. Options generally
vest over four or five years and expire ten years from the date of grant.
Option activity for the past three years under all plans is as follows:
Number of Shares
1997 1996 1995
Outstanding at beginning of year 2,192,300 1,695,000 1,649,000
Granted 1,523,000 788,000 321,024
Exercised (511,426) (205,000) (217,774)
Expired or canceled (241,350) (85,700) (57,250)
--------- -------- --------
Outstanding at end of year 2,962,524 2,192,300 1,695,000
--------- --------- ---------
Exercise price range $2.88-$25.88 $2.88-$10.22 $1.13-$7.25
Exercisable at end of year 587,774 578,700 334,166
Weighted-average fair value of
options granted $8.42 $2.36 $1.72
At December 31, 1997, the Company has reserved 4,400,050 shares of
Common Stock for issuance in connection with the stock option plans.
<PAGE>
For the stock option plans discussed above, the Company has adopted the
disclosure only provisions of SFAS No. 123 "Accounting for Stock-Based
Compensation," ("SFAS No. 123"). Accordingly, no compensation cost has been
recognized in the accompanying financial statements for the stock option plans.
The following table summarizes information about stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Number Number
Outstanding at Weighted-Average Weighted Exercisable at Weighted
Range of December 31, Remaining Average December 31, Average
Exercise Price 1997 Contractual Life Exercise Price 1997 Exercise Price
<S> <C> <C> <C> <C> <C>
$2.88 - $4.31 718,579 6 years $3.01 410,579 $3.01
$4.81 - $7.06 698,950 7 years $5.79 74,700 $6.43
$7.25 - $10.25 1,432,995 8 years $8.14 102,495 $8.41
$15.13 - $25.88 112,000 9 years $22.14 -- N/A
</TABLE>
During 1997, the weighted average exercise price of options granted,
exercised, and expired or canceled was $8.42, $4.36 and $5.62, respectively.
Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant date for awards in 1997, 1996
and 1995 consistent with the provisions of SFAS No. 123, the estimated fair
value of the options would be amortized to expense over the option's vesting
period and the Company's net income and net income per share would have been
decreased to the pro forma amounts indicated below for the year ended December
31:
(in thousands, except per share amounts) 1997 1996 1995
Net income as reported $14,682 $9,042 $8,499
Pro forma net income $14,345 $8,950 $8,455
Pro forma earnings per diluted share $0.55 $0.34 $0.36
Pro forma results disclosed are based on the provisions of SFAS No. 123
using the Black-Scholes option valuation model and are not likely to be
representative of the effects on pro forma net income for future years. In
addition, the Black-Sholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the estimating models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model using the low end of reasonable
assumptions for input variables rather than attempting to identify a best-point
estimate. The option pricing model utilized the following weighted average
assumptions for 1997, 1996 and 1995, respectively: risk free interest rates of
5.0% in each year; dividend yields of 0.25% in 1997 and 0% in 1996 and 1995;
volatility factors of the expected market price of the Company's stock averaged
.30; and a weighted average expected life of the option of 3.0 years for
employee stock options which vest over four to five year periods with a weighted
average vesting period of 2.5 years and 1.5 years for Company director options
which vest at the end of six months from the grant date.
<PAGE>
1997 Employee Stock Purchase Plan. In April 1997, the Board of
Directors and stockholders adopted the Employee Stock Purchase Plan (the
"Purchase Plan") and reserved 500,000 shares for issuance to eligible employees.
Under the Purchase Plan, employees are granted the right to purchase shares of
Common Stock at a price per share that is 85% of the lesser of the fair market
value of the shares at: (i) the participant's entry date into each six-month
offering period, or (ii) the end of each six-month offering period. Employees
may designate up to 10% of their compensation for the purchase of stock. Under
the Plan, the Company sold 36,018 shares for approximately $256,000 ($7.12 per
share) to employees in 1997. At December 31, 1997, 463,982 shares remained
authorized under the Plan.
NOTE K - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
(in thousands, except per share amounts)
1997 1996 1995
Numerator:
Net Income $14,682 $9,042 $8,499
------ ----- -----
Denominator:
Denominator for basic earnings per
share - weighted average shares 24,836 25,780 23,056
Effect of dilutive securities:
Employee and director stock options 1,147 792 710
----- --- ---
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 25,983 26,572 23,766
------ ------ ------
Basic earnings per share $ 0.59 $ 0.35 $ 0.37
====== ====== ======
Diluted earnings per share $ 0.57 $ 0.34 $ 0.36
====== ====== ======
Options which are antidilutive because the exercise price was greater
than the average market price of the common shares, are not included in the
computation of diluted earnings per share. The number of options to purchase
shares of Common Stock that were outstanding during 1997 that were antidilutive
were immaterial, because the market price of the Company's stock was generally
higher during the course of the year than the prices at which options were
granted.
NOTE L -- RETIREMENT PLANS
The Company has two retirement plans for the benefit of all of its
employees. Under its 401(k) Retirement Plan, participants may contribute an
amount not exceeding 15 percent of compensation received during participation in
the Plan. The Company makes voluntary annual contributions to the Plan based on
a percentage of contributions made by Plan participants of up to 10 percent of
compensation. Contributions to the Plan totaled $491,000; $394,000 and $328,000
in 1997, 1996 and 1995, respectively.
In 1992, the Company initiated an Employee Stock Ownership Plan (ESOP),
advancing $500,000 to the ESOP Trust for the purpose of purchasing Common Stock
of the Company. The Trust purchased 307,000 shares of the Company's Common Stock
in July 1992. The loan was paid in full during 1997. As the principal amount of
the loan was repaid to the Company through Company annual contributions, the
equivalent number of shares released were allocated to employees' accounts to be
held until retirement. Total shares so allocated were 32,380; 69,424 and 64,580
in 1997, 1996 and 1995, respectively. Contributions to the ESOP totaled $62,500
in 1997, and $125,000 each 1996 and 1995 and are based upon the historic cost of
the shares purchased by the ESOP. After the final
<PAGE>
allocation of shares in 1997, the ESOP plan was "frozen," so that all eligible
participants as of July 1, 1997 became 100% vested in their accounts, regardless
of length of service. No further purchases are anticipated through the ESOP, and
the Company does not anticipate making future allocations of shares from this
plan.
NOTE M -- FINANCIAL INSTRUMENTS
Concentration of Credit Risk. Financial instruments that potentially
subject the Company to significant concentrations of credit risk consist
principally of cash investments, trade accounts receivable, and net investment
in sales-leases. The Company maintains cash and equivalents not invested in
money market funds with a major bank in its marketplace. The Company performs
periodic evaluations of the relative credit standing of the financial
institution. Concentrations of credit risk with respect to trade accounts
receivable and net investment in sales-leases are limited due to the large
number of entities comprising the Company's customer base.
Fair Value of Financial Instruments. The carrying amount of cash and
equivalents, accounts receivable, net investment in sales-leases, and accounts
payable reported in the consolidated balance sheets approximate their fair
value.
NOTE N -- SUPPLEMENTAL CASH FLOW
(In thousands) 1997 1996 1995
Cash paid for:
Interest $ 47 $ 77 $ 106
Income taxes $ 5,914 $ 4,213 $ 1,885
-------- -------- --------
Changes in operating assets and liabilities:
Increase in receivables $ (7,294) $ (8,569) $(16,368)
Increase in inventories (4,280) (1,309) (5,997)
(Increase) decrease in prepaid
expenses and other assets 4,407 (6,268) (500)
Increase in long-term other assets (2,028) (4,024) (1,676)
Increase in accounts payable
and other current liabilities 7,562 4,466 6,400
-------- -------- --------
$ (1,633) $(15,704) $(18,141)
======== ======== ========
NOTE O -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
A summary of the quarterly results of operations for the years ended
December 31, 1997 and 1996 follows: (In thousands, except per share amounts)
<TABLE>
<CAPTION>
1997 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
<S> <C> <C> <C> <C>
Net sales $50,322 $54,823 $56,915 $61,508
Gross margin 22,170 24,401 26,298 28,336
Net income 2,670 3,424 3,978 4,610
Net income per share
Basic $0.10 $0.13 $0.17 $0.19
Diluted $0.10 $0.13 $0.16 $0.18
Average number of common
shares outstanding -- Basic 25,901 25,438 23,397 24,606
Average number of common
shares outstanding -- Diluted 26,450 26,623 24,682 26,179
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1996 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
<S> <C> <C> <C> <C>
Net sales $42,213 $43,736 $47,435 $52,500
Gross margin 19,312 19,108 19,616 22,882
Net income 2,899 2,784 2,689 670
Net income per share
Basic $0.11 $0.11 $0.10 $0.03
Diluted $0.11 $0.10 $0.10 $0.03
Average number of common
shares outstanding -- Basic 25,546 25,748 25,858 25,885
Average number of common
shares outstanding -- Diluted 26,341 26,567 26,607 26,579
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other parts of this Annual Report to Shareholders on
Form 10-K contain forward-looking statements that involve risks and
uncertainties. The words "expects," "anticipates," "believes," "intends," "will"
and similar expressions identify forward-looking statements which are based on
information available to the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statements. The Company's
actual results could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set
forth in "Factors That May Affect Results of Future Operations" and else where
in this 10-K.
General
Inter-Tel is a single point of contact, full service provider of
digital business telephone systems, IP telephony products, CTI applications,
voice processing software and long distance calling services. Inter-Tel's
products and services include the AXXESS and Inter-Tel Axxent digital business
communication platforms, the AXXESSORY Talk voice processing platform, the
Inter-Tel Vocal'Net IP telephony gateway and the Inter-Tel.net private IP
telephony network. The Company also provides maintenance, leasing and support
services for its products. The Company's Common Stock is quoted on the NASDAQ
National Market System under the symbol INTL.
The Company has developed networks of direct sales offices, dealers and
value added resellers (VARs) which sell the Company's products. In recent
periods, the Company has focused on expanding its direct sales capabilities and
its dealer and VAR network. The Company has acquired a number of resellers of
telephony products and integrated these operations with its existing direct
sales operations in the same geographic areas and in other strategic markets.
Sales of systems through the Company's dealers and VARs typically
generate lower gross margins than sales through the Company's direct sales
organization, although direct sales typically require higher levels of selling,
general and administrative expenses. In addition, the Company's long distance
and network services typically generate lower gross margins than sales of
software and system products. Accordingly, the Company's margins may vary from
period to period depending upon distribution channel and product mix. In the
event that sales through dealers or sales of long distance services increase as
a percentage of net sales, the Company's overall gross margin could decline.
The Company's operating results depend upon a variety of factors,
including the volume and timing of orders received during a period, the mix of
products sold and the mix of distribution channels, general economic conditions,
patterns of capital spending by customers, the timing of new product
announcements and releases by the Company and its competitors, pricing
pressures, the cost and effect of acquisitions and the availability and cost of
products and components from the Company's suppliers. Historically, a
substantial portion of the Company's net sales in a given quarter have been
recorded in the third month of the quarter, with a concentration of such net
sales in the last two weeks of the quarter. In addition, the Company is subject
to seasonal variations in its operating results, as net sales for the first and
third quarters are frequently less than those experienced during the fourth and
second quarters, respectively.
<PAGE>
The markets served by the Company have been characterized by rapid
technological changes and increasing customer requirements. The Company has
sought to address these requirements through the development of software
enhancements and improvements to existing systems and the introduction of new
products and applications. The Company's research and development efforts over
the last several years have been focused primarily on developing new products
such as the Inter-Tel Vocal'Net Server, Inter-Tel Axxent system and Inter-Tel
VisualMail; enhancing the CTI capabilities of the AXXESS digital communications
platform; and expanding the capacity of the Company's AXXESS and AXXESSORY Talk
systems. Current efforts are related to the support of industry standard CTI
interfaces, the development of additional applications and features, the
enhancement of the Inter-Tel Vocal'Net Gateway Server and Service Provider
Package, and the development of a LAN-based Communications Server incorporating
the Company's Call Processing and Voice Processing software. New applications
under development also include Basic Rate ISDN, PBX networking, the
Inter-Tel.net private IP telephony service and enhanced unified messaging. The
software-based architecture of the AXXESS system facilitates maintenance and
support, upgrades, and incorporation of additional features and functionality.
The Company offers to its customers a package of lease financing and
other services under the name Totalease. Totalease provides to customers lease
financing, maintenance and support services, fixed price upgrades and other
benefits. The Company finances this program through the periodic resale of lease
rental streams to financial institutions.
Net sales of the Company have increased substantially in each of the
past three years. Such increases were 20.3%, 23.5%, and 21.5% in 1997, 1996 and
1995, respectively, over the preceding year.
<PAGE>
Results of Operations
The following table sets forth certain statement of operations data of
the Company expressed as a percentage of net sales for the periods indicated:
Year Ended December 31
1997 1996 1995
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of sales 54.7 56.5 58.3
---- ---- ----
Gross margin 45.3 43.5 41.7
Research and development 3.6 3.5 3.8
Selling, general and administrative 31.3 30.3 28.9
Special charge -- 2.5 0.9
---- ---- ----
Operating income 10.4 7.2 8.1
Interest and other income 0.6 1.1 1.1
Interest expense 0.0 0.0 0.1
Income taxes 4.4 3.4 3.5
---- ---- ----
Net income 6.6% 4.9% 5.6%
---- ---- ----
Year Ended December 31, 1997 Versus Year Ended December 31, 1996
Net Sales. Net sales increased 20.3% to $223.6 million in 1997 from
$185.9 million in 1996. Sales from the Company's direct sales offices and from
wholesale distribution accounted for approximately $26.3 million of the
increase. The remaining increases occurred in long distance sales and other
operations.
Gross Profit. Gross profit increased to $101.2 million, or 45.3% of net
sales in 1997 from $80.9 million, or 43.5% of net sales in 1996. This increase
was primarily a result of higher sales, as a percentage of total net sales, of
AXXESS digital communication platforms, call processing software and voice
processing software. In addition, gross margin increased based on a percentage
increase in sales through the Company's direct sales offices compared to its
dealer network.
Research and Development. Research and development expenses increased
to $8.0 million, or 3.6% of net sales in 1997 from $6.6 million, or 3.5% of net
sales, in 1996. These expenses in both 1997 and 1996 were directed principally
toward the continued development of the AXXESS and Inter-Tel Axxent software and
systems, unified messaging and voice processing software, Inter-Tel Vocal'Net
and certain CTI applications. The Company expects that research and development
expenses will continue to increase in absolute dollars as the Company continues
to develop and enhance existing and new technologies and products. These
expenses may vary, however, as a percentage of net sales.
Selling, general and administrative. Selling, general and
administrative expenses increased to $69.9 million, or 31.3% of net sales in
1997 from $56.4 million, or 30.3% of net sales, in 1996. This reflected
increased selling, incentive, training and other compensation costs attributable
to the increased sales through the Company's direct sales offices, additional
personnel to support the direct dealer network and expansion of long distance
operations, development of the Inter-Tel.net network and expenses associated
with international operations. Such increase is also attributable to the hiring
of additional sales and technical training staff, expansion of its credit
management group, and increases in reserves for accounts receivable. The Company
expects that selling, general and administrative expenses will increase in
absolute dollars, but may vary as a percentage of net sales.
Interest and Other Income. Other income decreased approximately
$591,000 in 1997 principally as a result of lower levels of cash available for
investment.
Net Income. Net income increased 62.4% to $14.7 million, or $.57 per
diluted share, in 1997 compared to net income of $9.0 million, or $.34 per
diluted share, in 1996. Excluding the
<PAGE>
special charge in 1996 related to the write-off of its MIS software, net income
would have been $11.8 million, or $.44 per diluted share.
Year Ended December 31, 1996 Versus Year Ended December 31, 1995
Net Sales. Net sales increased 23.5% to $185.9 million in 1996 from
$150.5 million in 1995. Sales from direct sales offices accounted for
approximately $14.7 million of the increase, with wholesale distribution sales
increasing approximately $12.2 million. The remaining increases occurred in long
distance sales and other operations.
Gross Profit. Gross profit increased to $80.9 million, or 43.5% of net
sales in 1996 from $62.8 million, or 41.7% of net sales in 1995. This reflected
the transition to the direct dealer network and the expansion of AXXESS software
and systems sales.
Research and Development. Research and development expenses increased
to $6.6 million, or 3.5% of net sales in 1996 from $5.8 million, or 3.8% of net
sales, in 1995. These expenses in both 1996 and 1995 were directed principally
to the continued development of the AXXESS and Inter-Tel Axxent software and
systems, unified messaging and voice processing software, Inter-Tel Vocal'Net
and Inter-Tel Vocal'Net server, and certain CTI applications.
Selling, general and administrative. Selling, general and
administrative expenses increased to $56.4 million, or 30.3% of net sales in
1996, from $43.6 million, or 28.9% of net sales, in 1995. This reflected
increased incentive and other compensation, costs associated with the
implementation of the Company's information systems, additional personnel to
support the direct dealer network and expanded long distance operations, and
expenses associated with the expansion of international operations.
Special Charge. During the fourth quarter of 1996, the Company decided
to replace its MIS system software with an integrated solution from a more
established vendor and accordingly wrote off the software license and
implementation costs relating to the system software being replaced. The special
pre-tax charge of $4.5 million ($.10 per share after tax), reflects the costs
associated with the Company's decision to abandon its current MIS software in
favor of different system software.
Interest and Other Income. Other income increased in 1996 principally
from the investment of the funds received from the August 1995 public offering
and funds generated through operating cash flow.
Net Income. Net income increased 6.4% to $9.0 million, or $.34 per
diluted share, in 1996 including the special charge recognized in the fourth
quarter compared to $8.5 million, or $.36 per diluted share, in 1995. Excluding
the special charges in both periods, net income would have been $11.8 million,
or $.44 per diluted share, for 1996 compared to $9.3 million, or $.39 per
diluted share for 1995. In addition, net income per diluted share in 1996 was
based on additional average shares outstanding in 1996, primarily reflecting the
public stock offering of 4.0 million shares of Common Stock in August 1995.
Inflation/Currency Fluctuation
Inflation and currency fluctuations have not previously had a material
impact on Inter-Tel's operations. International procurement agreements have
traditionally been denominated in U.S. currency. Moreover, a significant amount
of contract manufacturing has been or is expected to be moved to domestic
sources. The expansion of international operations in the United Kingdom and
Europe and increased sales, if any, in Japan and other parts of Asia could
result in higher international sales as a percentage of total revenues; however,
international revenues are currently not significant.
<PAGE>
Liquidity and Capital Resources
At December 31, 1997, the Company had $88.8 million in cash and
equivalents, which represents a increase of approximately $49.9 million from
December 31, 1996. The Company maintains a $7.0 million unsecured revolving line
of credit with Bank One, Arizona, NA. This credit facility is annually renewable
and is available through July 31, 1998. Under the credit facility, the Company
has the option to borrow at a prime rate or adjusted LIBOR interest rate.
Historically, the credit facility has been used primarily to support
international letters of credit to suppliers. In December 1997, the Company
received net proceeds of approximately $59.2 million from a public stock
offering of 3,000,000 shares. The proceeds may be used to develop and expand
Inter-Tel.net and for potential acquisitions, strategic alliances, working
capital and general corporate purposes.
Net cash provided by operating activities totaled $28.2 million for the
year ended December 31, 1997, compared to $7.3 million for the same period in
1996. The increase in cash generated in 1997 was primarily the result of
profitable operations including non cash depreciation charges. In addition, cash
used in operating assets and liabilities declined significantly in 1997 to $1.6
million, compared to cash used of $15.7 million in 1996. During 1997, increases
in accounts receivable and inventory were principally funded by accounts
payable. The Company continues to expand its dealer network, which has required
and is expected to continue to require working capital for increased accounts
receivable and inventories.
Net cash used in investing activities, primarily in the form of capital
expenditures, totaled $12.5 million and $7.0 million in 1997 and 1996,
respectively. These capital expenditures were related primarily to the expansion
of facilities, equipment and management information systems used in operations.
Net cash provided by financing activities totaled $34.1 million in 1997
compared to $611,000 for the same period in 1996. During the second quarter of
1997, the Company initiated a stock repurchase program under which the Board of
Directors authorized the repurchase of up to 1,470,000 shares (on a pre-Stock
Split basis) of the Common Stock. The Company expended approximately $27.2
million for stock repurchases during 1997, which was funded primarily through
existing cash balances. The Company reissued shares through November through
stock option exercises and issuances. The proceeds received for the stock
reissued was less than its cost basis. Accordingly, the difference was recorded
as a reduction to retained earnings. The Company reissued all remaining
authorized, but then unissued shares upon the completion of the Company's
offering of 3,000,000 shares of Common Stock in December 1997. The Company
received net proceeds of $59.2 million from the offering. Such stock was
reissued from the offering at greater than the cost basis. The difference was
recorded as an increase to Common Stock.
The Company offers to its customers lease financing and other services,
including its Totalease program, through its Inter-Tel Leasing subsidiary. The
Company funds its Totalease program in part through the sale to financial
institutions of rental income streams under the leases. Resold Totalease rentals
totaling $99.9 million remain unbilled at December 31, 1997. The Company is
obligated to repurchase such income streams in the event of defaults by lease
customers and, accordingly, maintains reserves based on loss experience and past
due accounts. Although the Company to date has been able to resell the rental
streams from leases under the Totalease program profitably and on a
substantially current basis, the timing and profitability of lease resales could
impact the Company's business and operating results, particularly in an
environment of fluctuating interest rates and economic uncertainty. If the
Company is required to repurchase rental streams and realizes losses thereon in
amounts exceeding its reserves, its operating results will be adversely
affected.
The Company believes that the net proceeds from the Company's offering
of 3,000,000 shares of Common Stock completed on December 1, 1997 and its
working capital and credit facilities, together with cash generated from
operations, will be sufficient to develop and expand its Inter-Tel.net network,
to finance acquisitions of additional resellers of telephony products and other
strategic acquisitions or corporate alliances, and to provide adequate working
capital for at least the next twelve months. However, to the extent that
additional funds are required in the future to address working capital needs and
to provide funding for capital expenditures, expansion of the business or
<PAGE>
the Inter-Tel.net network or additional acquisitions, the Company will seek, if
at all, additional financing. There can be no assurance that additional
financing will be available when required or on acceptable terms.
Impact of Recently Issued Accounting Standards
In February 1997, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 128, "Earnings Per Share" ("SFAS No. 128"), adopted by the
Company on December 31, 1997. Statement 128 replaced the previously reported
primary and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants, and convertible securities. Diluted
earnings per share is very similar to the previously reported primary earnings
per share. All earnings per share amounts for all periods have been presented,
and where necessary, restated to conform to the Statement 128 requirements. The
impact of SFAS No. 128 on the calculation of fully diluted earnings per share
for each of the periods presented was not material.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. The adoption of SFAS 131 will have no impact
on the Company's consolidated results of operations, financial position or cash
flows.
EXHIBIT 22.1
SUBSIDIARIES OF INTER-TEL, INCORPORATED
Listed below are all the subsidiaries of Inter-Tel, Incorporated, as
well as the jurisdiction under the laws of which each was organized, and the
percentage of the outstanding voting stock of each owned by Inter-Tel,
Incorporated.
Percentage State or
of Voting Jurisdiction
Name Stock Owned of Organization
- ---- ----------- ---------------
Inter-Tel Integrated Systems, Inc. 100% Arizona
Inter-Tel Technologies, Inc. (formerly
Inter-Tel Communications, Inc.) 100% Arizona
Inter-Tel Leasing, Inc. 100% Arizona
Inter-Tel Midwest, Inc. 100% Delaware
Inter-Tel Incorporated-New Jersey 100% Delaware
Inter-Tel NetSolutions, Inc. 100% Texas
Inter-Tel DataCom, Inc. 100% Delaware
Southwest Telephone Systems, Inc. 100% New Mexico
American Telcom Corp. of Georgia, Inc. 100% Georgia
Access West, Inc. 100% Delaware
Inter-Tel Integrated Systems (UK), Ltd. 100% United Kingdom
Inter-Tel Japan, Inc. 100% Japan
Florida Telephone Systems, Inc. 100% Florida
NTL Corporation dba ComNet of Ohio 100% Ohio
EXHIBIT 23.0--CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference on page 34 in this Annual
Report (Form 10-K) of our report dated February 20, 1998 included in the
1997 Annual Report to Shareholders of Inter-Tel, Incorporated.
Our audit also included the financial statement schedule of Inter-Tel,
Incorporated listed in Item 14(a). This schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based upon our
audits. In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
We also consent to the incorporation by reference in Registration
Statement (Form S-3 No. 33-58161), Registration Statement (Form S-3 No.
33-61437), Registration Statement (Form S-3 No. 333-01735), Registration
Statement (Form S-3 No. 333-12433), Registration Statement (Form S-3 No.
333-39221), Registration Statement (Form S-8 No. 2-94805), Registration
Statement (Form S-8 No. 33-40353), Registration Statement (Form S-8 No.
33-73620) and in Registration Statement (Form S-8 No. 333-41197) of our report
dated February 20, 1998, with respect to the consolidated financial statements
incorporated herein by reference and our report included in the preceding
paragraph with respect to the financial statement schedule included in this
Annual Report (Form 10-K) of Inter-Tel, Incorporated.
Phoenix, Arizona /S/ ERNST & YOUNG LLP
March 27, 1998
EXHIBIT 24.1--POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Steven G. Mihaylo and Kurt R. Kneip,
jointly and severally, his attorneys-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this
Report on Form 10-K, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
Signature Title Date
/S/ Steven G. Mihaylo Chairman and Chief March 23, 1998
- --------------------- Executive Officer
Steven G. Mihaylo
/S/ Kurt R. Kneip Vice President and March 23, 1998
- --------------------- Chief Financial Officer
Kurt R. Kneip
/S/ J. Robert Anderson Director March 23, 1998
- ---------------------
J. Robert Anderson
/S/ Gary D. Edens Director March 23, 1998
- ---------------------
Gary D. Edens
/S/ Maurice H. Esperseth Director March 23, 1998
- ------------------------
Maurice H. Esperseth
/S/ C. Roland Haden Director March 23, 1998
- ---------------------
C. Roland Haden
/S/ Norman Stout Director March 23, 1998
- ---------------------
Norman Stout
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM THE INTER-TEL,
INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 88,805
<SECURITIES> 0
<RECEIVABLES> 35,956
<ALLOWANCES> 3,722
<INVENTORY> 21,539
<CURRENT-ASSETS> 157,399
<PP&E> 38,590
<DEPRECIATION> 19,031
<TOTAL-ASSETS> 194,988
<CURRENT-LIABILITIES> 33,585
<BONDS> 0
0
0
<COMMON> 99,229
<OTHER-SE> 46,276
<TOTAL-LIABILITY-AND-EQUITY> 194,988
<SALES> 223,569
<TOTAL-REVENUES> 223,569
<CGS> 122,363
<TOTAL-COSTS> 122,363
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,104
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 24,602
<INCOME-TAX> 9,920
<INCOME-CONTINUING> 14,682
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,682
<EPS-PRIMARY> 0.59
<EPS-DILUTED> 0.57
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS RESTATED SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM THE INTER-TEL,
INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS
ALL INFORMATION FOR THIS PERIOD IS THE SAME AS
PREVIOUSLY STATED, WITH THE EXCEPTION OF THE NEW
EARNINGS PER SHARE REPORTING REQUIREMENTS (SHOWN
BELOW):
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 38,936
<SECURITIES> 0
<RECEIVABLES> 33,094
<ALLOWANCES> 3096
<INVENTORY> 21,280
<CURRENT-ASSETS> 105,465
<PP&E> 26,632
<DEPRECIATION> 15,443
<TOTAL-ASSETS> 132,611
<CURRENT-LIABILITIES> 25,756
<BONDS> 0
0
0
<COMMON> 59,875
<OTHER-SE> 35,059
<TOTAL-LIABILITY-AND-EQUITY> 132,611
<SALES> 185,884
<TOTAL-REVENUES> 185,884
<CGS> 104,966
<TOTAL-COSTS> 104,966
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 3,746
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 15,306
<INCOME-TAX> 6,264
<INCOME-CONTINUING> 9,042
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,042
<EPS-PRIMARY> 0.35
<EPS-DILUTED> 0.34
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS RESTATED SUMMARY FINANCIAL
INFORMATION EXTRACTED FROM THE INTER-TEL,
INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1995 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS
ALL INFORMATION FOR THIS PERIOD IS THE SAME AS
PREVIOUSLY STATED, WITH THE EXCEPTION OF THE NEW
EARNINGS PER SHARE REPORTING REQUIREMENTS (SHOWN
BELOW):
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<EXCHANGE-RATE> 1
<CASH> 39,640
<SECURITIES> 0
<RECEIVABLES> 31,611
<ALLOWANCES> 1,822
<INVENTORY> 20,580
<CURRENT-ASSETS> 98,139
<PP&E> 24,747
<DEPRECIATION> 12,934
<TOTAL-ASSETS> 118,767
<CURRENT-LIABILITIES> 22,516
<BONDS> 0
0
0
<COMMON> 58,966
<OTHER-SE> 26,151
<TOTAL-LIABILITY-AND-EQUITY> 118,767
<SALES> 150,533
<TOTAL-REVENUES> 150,533
<CGS> 87,696
<TOTAL-COSTS> 87,696
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,594
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 13,748
<INCOME-TAX> 5,249
<INCOME-CONTINUING> 8,499
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,499
<EPS-PRIMARY> 0.37
<EPS-DILUTED> 0.36
</TABLE>
