UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED COMMISSION FILE NUMBER:
SEPTEMBER 30, 1998 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
Common Stock
(26,119,504 shares outstanding as of September 30, 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 periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
<PAGE>
INDEX
INTER-TEL, INCORPORATED AND SUBSIDIARIES
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets--September 30, 1998
and December 31, 1997 3
Condensed consolidated statements of operations--three and
nine months ended September 30, 1998 and September 30, 1997 4
Condensed consolidated statements of cash flows - three and
nine months ended September 30, 1998 and September 30, 1997 5
Notes to condensed consolidated financial statements --
September 30, 1998 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 7
PART II. OTHER INFORMATION 20
SIGNATURES 21
2
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PART I. FINANCIAL INFORMATION
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands) September 30, December 31,
1998 1997
---- ----
ASSETS
CURRENT ASSETS
Cash and equivalents $ 54,842 $ 88,805
Accounts receivable -- net 37,159 32,234
Inventories 21,149 21,539
Net investment in sales-leases 12,982 9,196
Prepaid expenses and other assets 6,319 5,625
--------- ---------
TOTAL CURRENT ASSETS 132,451 157,399
PROPERTY & EQUIPMENT 27,203 19,559
OTHER ASSETS 25,121 18,030
--------- ---------
$ 184,775 $ 194,988
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 12,652 $ 14,864
Other current liabilities 23,234 18,721
--------- ---------
TOTAL CURRENT LIABILITIES 35,886 35,585
DEFERRED TAX LIABILITY 7,799 11,343
OTHER LIABILITIES 5,066 4,555
SHAREHOLDERS' EQUITY
Common stock 102,560 99,229
Retained earnings 47,239 46,547
Equity adjustment for foreign
currency translation (278) (271)
--------- ---------
149,521 145,505
Less:
Treasury stock at cost (13,497) --
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 136,024 145,505
--------- ---------
$ 184,775 $ 194,988
========= =========
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Nine Months
Ended September 30, Ended September 30,
(In thousands except ------------------- -------------------
per share amounts) 1998 1997 1998 1997
---- ---- ---- ----
NET SALES $70,389 $56,915 $202,235 $162,061
Cost of sales 35,543 30,617 103,613 89,191
------- ------- -------- --------
GROSS PROFIT 34,846 26,298 98,622 72,870
------- ------- -------- --------
Research & development 3,283 1,873 8,539 5,852
Selling, general and administrative 22,474 17,844 65,019 51,035
In process research and development
and related acquisition expenses -- -- 24,229 --
------- ------- -------- --------
25,757 19,717 97,787 56,887
------- ------- -------- --------
OPERATING INCOME 9,089 6,581 835 15,983
Interest and other income 722 106 2,568 924
Interest expense (19) (12) (58) (37)
------- ------- -------- --------
INCOME BEFORE TAXES 9,792 6,675 3,345 16,870
Income taxes 4,023 2,697 1,744 6,798
------- ------- -------- --------
NET INCOME $ 5,769 $ 3,978 $ 1,601 $ 10,072
======= ======= ======== ========
NET INCOME PER SHARE:
Primary $ 0.22 $ 0.17 $ 0.06 $ 0.40
======= ======= ======== ========
Fully diluted $ 0.21 $ 0.16 $ 0.06 $ 0.39
======= ======= ======== ========
Average number of common
shares outstanding:
Primary 26,754 23,397 26,791 24,912
======= ======= ======== ========
Fully diluted 27,489 24,682 27,941 25,918
======= ======= ======== ========
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
(In thousands) 1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
NET INCOME $ 5,769 $ 3,978 $ 1,601 $ 10,072
Adjustments to reflect operating activities:
Depreciation and amortization 1,924 1,051 4,657 3,291
Purchased in process research and development -- -- 24,229 --
Changes in operating assets and liabilities (3,864) (1,044) (11,199) (2,488)
Other 1,189 2,492 (2,443) 6,725
-------- -------- -------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 5,018 6,477 16,845 17,600
INVESTING ACTIVITIES
Proceeds from disposal of property
and equipment 105 76 112 81
Cash used in acquisition -- -- (26,748) (825)
Additions to property and equipment (3,494) (1,630) (11,613) (8,050)
-------- -------- -------- --------
NET CASH USED IN INVESTING
ACTIVITIES (3,389) (1,554) (38,249) (8,794)
FINANCING ACTIVITIES
Payments for repurchase of common stock (13,644) (9,701) (13,644) (27,194)
Cash dividends paid (262) -- (799) --
Proceeds from stock issued under the
Employee Stock Purchase Plan -- -- 359 --
Proceeds from exercise of stock options 428 1,293 1,525 1,640
-------- -------- -------- --------
NET CASH USED IN
FINANCING ACTIVITIES (13,478) (8,408) (12,559) (25,554)
DECREASE IN CASH
AND EQUIVALENTS (11,849) (3,485) (33,963) (16,748)
CASH AND EQUIVALENTS
AT BEGINNING OF PERIOD 66,691 25,673 88,805 38,936
-------- -------- -------- --------
CASH AND EQUIVALENTS
AT END OF PERIOD $ 54,842 $ 22,188 $ 54,842 $ 22,188
======== ======== ======== ========
</TABLE>
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 1998
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation of
the results for the interim periods presented have been included. Operating
results for the three and nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report on Form
10-K for the year ended December 31, 1997.
NOTE B--EARNINGS PER SHARE
Diluted earnings per share assume that outstanding common shares were increased
by shares issuable upon the exercise of all outstanding stock options to which
market price exceeds exercise price less shares which could have been purchased
with related proceeds, if the effect would not be antidilutive.
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
(In thousands, except Three Months Ended Nine Months Ended
per share amounts) Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1998 Sept. 30, 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Numerator:
Net income $ 5,769 $ 3,978 $ 1,601 $10,072
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
Share - weighted average shares 26,754 23,397 26,791 24,912
Effect of dilutive securities:
Employee and director stock options 735 1,285 1,150 1,006
------- ------- ------- -------
Denominator for diluted earnings per
Share - adjusted weighted average
Shares and assumed conversions 27,489 24,682 27,941 25,918
======= ======= ======= =======
Basic earnings per share $ 0.22 $ 0.17 $ 0.06 $ 0.40
======= ======= ======= =======
Diluted earnings per share $ 0.21 $ 0.16 $ 0.06 $ 0.39
======= ======= ======= =======
</TABLE>
NOTE C--ACQUISITIONS
At the end of the second quarter, the Company acquired all of the common stock
of Integrated Telecom Services Corporation ("ITS") by issuing 140,000 shares of
the Company's common stock. At the time of the acquisition the transaction met
the requirements for pooling-of-interests accounting, and accordingly, the
operations of ITS were combined with those of the Company on a retroactive basis
during the period ended June 30, 1998. During the three months ended September
30, 1998, the Company repurchased shares of its common stock which resulted in
pooling-of-interests accounting no longer being available for the ITS
acquisition. Accordingly, during the three months ended September 30, 1998 the
Company revised
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the accounting for the transaction to the purchase accounting method. This
resulted in the operations of ITS being included with those of the Company at
the end of the second quarter when ITS was acquired and resulted in the
recording of goodwill of approximately $1.36 million, which is being amortized
over 10 years.
The change to purchase accounting from pooling-of-interests accounting had the
following impact on the operating results for the six months ended June 30,
1998:
As As
Reported Restated
-------- --------
Net sales $136,374 $131,846
Gross profit 65,259 63,776
Research and development 5,256 5,256
Selling, general and administrative 43,860 42,545
Special charge 897 --
In process research and development 24,229 24,229
Operating income (8,983) (8,254)
Other income and expenses 1,744 1,807
Net loss (4,601) (4,168)
Diluted loss per share $ (0.17) $ (0.16)
Diluted shares outstanding 26,949 26,809
PART I.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This interim report on Form 10-Q contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
statements include expectations, beliefs, intentions or strategies regarding
future operating results, future expenditures, future cash requirements, and
future industry conditions and involve risks and uncertainties. The Company's
actual results could differ materially from those projected in such
forward-looking statements as a result of many factors, including, without
limitation, those set forth under this section, entitled "Factors That May
Affect Future Results Of Operations" below and elsewhere in the report on Form
10-Q.
OVERVIEW
Inter-Tel is a single point of contact, full service provider of digital
business telephone systems, Internet Protocol ("IP") telephony products, CTI
applications, voice processing software and long distance calling services.
Inter-Tel's products include the AXXESS and Axxent digital business
communication platforms, the AXXESSORY TALK voice processing platform, the
Inter-Tel InterPrise IP gateway and software, the Inter-Tel Vocal'Net IP service
provider gateway and the Inter-Tel Vocal'Net Service Provider Software and
Centralized Accounting Software. Inter-Tel's services include Inter-Tel
NetSolutions, Inter-Tel's resale long distance service and Inter-Tel.net,
Inter-Tel's IP long distance network service. The Company also provides
maintenance, leasing and support services for its products and services.
RESULTS OF OPERATIONS
Net sales for the third quarter of 1998 increased 23.7% to $70.4 million,
compared to $56.9 million in the third quarter of 1997. Net sales increased
24.8% to $202.2 million in the first nine months of 1998, compared to $162.1
million in the first nine months of 1997. For the quarter and nine months ended
September 30, 1998, sales from wholesale distribution and direct sales offices
accounted for approximately $10.6 million and $31.4 million of the increases,
respectively. The remaining increases occurred in long distance sales and other
operations.
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The following table sets forth certain statement of operations data of the
Company expressed as a percentage of net sales for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1998 1997 1998 1997
---- ---- ---- ----
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of Sales 50.5 53.8 51.2 55.0
----- ----- ----- -----
Gross profit 49.5 46.2 48.8 45.0
Research and development 4.7 3.3 4.2 3.6
Selling, general and administrative 31.9 31.4 32.2 31.5
In-process research and development
and related acquisition expenses -- -- 12.0 --
----- ----- ----- -----
Operating income 12.9 11.5 0.4 9.9
Interest and other income 1.0 0.2 1.3 0.5
Interest expense 0.0 0.0 0.0 0.0
Income taxes 5.7 4.7 0.9 4.2
----- ----- ----- -----
Net income 8.2% 7.0% 0.8% 6.2%
===== ===== ===== =====
Gross profit for the third quarter of 1998 increased 32.5% to $34.8
million, or 49.5% of net sales, compared to $26.3 million, or 46.2% of net
sales, for the third quarter of 1997. Gross profit increased 35.3% to $98.6
million, or 48.8% of net sales, in the first nine months of 1998 compared to
$72.9 million, or 45.0% of net sales, in the first nine months of 1997. Gross
margin increased in the third quarter of 1998 primarily as a result of increased
sales of higher margin AXXESS digital communication platforms, call processing
software and voice processing software as a percentage of net sales. The
increases in gross margins were offset in part by an increased percentage of
sales through dealer channels during the third quarter, which typically generate
lower gross margins than sales of the Company's products through its direct
sales offices.
Research and development expenses for the third quarter of 1998 increased
to $3.3 million, or 4.7% of net sales, compared to $1.9 million, or 3.3% of net
sales, for the third quarter of 1997. Research and development expenses
increased to $8.5 million, or 4.2% of net sales, in the first nine months of
1998 compared to $5.9 million, or 3.6% of net sales, in the first nine months of
1997. The increases in absolute dollars and as a percentage of net sales in both
periods were primarily attributable to expenses relating to the addition of
engineering personnel in connection with the TMSI acquisition and the
development and introduction of new products, including the continuing
development and improvement of the Company's AXXESS digital communication
platforms, call processing and voice processing software, CTI products, unified
messaging, and TCP/IP intranet and internet voice solutions (the Company's
Vocal'Net and Inter-Tel.net products). The Company expects that research and
development expenses will continue to increase in absolute dollars as the
Company continues to develop new software and to enhance existing technologies
and products. These expenses may vary, however, as a percentage of net sales.
Selling, general and administrative expenses for the third quarter of 1998
increased to $22.5 million, or 31.9% of net sales, compared to $17.8 million, or
31.4% of net sales, for the third quarter of 1997. Selling, general and
administrative expenses increased to $65.0 million, or 32.2% of net sales, in
the first nine months of 1998 compared to $51.0 million, or 31.5% of net sales,
in the first nine months of 1997. The increases, both in absolute dollars and as
a percentage of sales, for the quarter and nine months ended September 30, 1998,
were attributable in part to costs associated with the start up and building of
the Inter-Tel.net network and retail distribution of Inter-Tel IP Telephony
products, hiring incentives for key employees, increased consulting expenses,
expanding its technical training staff, continued efforts to hire and train
additional sales personnel throughout Inter-Tel's direct sales offices, higher
sales commissions paid to the Company's sales force based upon increased levels
of net sales, and additional marketing resources for the expanded dealer
network, network services and long distance services. The Company expects that
selling, general and administrative expenses will continue to increase in
absolute dollars, but may vary as a percentage of net sales.
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In June 1998, the Company purchased certain assets and assumed certain
liabilities of Telecom Multimedia Systems, Inc. ("TMSI") for approximately $25.1
million plus related acquisition costs. The aggregate purchase price was
allocated to the fair value of the assets and liabilities acquired, of which
$24.2 million, or $14.5 million after taxes, was written-off as purchased
in-process research and development.
Other income in both periods consisted primarily of interest income and
foreign exchange rate gains and losses. Income from interest increased in both
comparable periods of 1998 based on a higher level of invested funds,
principally from the proceeds generated from the Company's public stock offering
in December 1997. Other changes in other income primarily reflected differences
in net foreign exchange rate gains and losses.
Net income for the third quarter was $5.8 million ($0.21 per diluted
share), compared to net income of $4.0 million ($0.16 per diluted share) for the
third quarter of 1997. Net income for the nine months ended September 30, 1998
was $1.6 million, or $0.06 per diluted share, reflecting the write-off of
in-process research and development costs, compared to net income of $10.1
million, or $0.39 per diluted share, in the first nine months of 1997. Without
the write-off of in-process research and development costs, net income for the
nine months ended September 30, 1998 would have been $16.1 million, or $0.58 per
diluted share, which would have constituted an increase of 60.2% compared to
1997. In addition, net income per share in 1998 is based on an additional 2.8
million and 2.0 million average shares outstanding for the third quarter and
nine months ended September 30, 1998, respectively, principally reflecting the
Company's public stock offering consummated in December 1997 and additional
stock option grants to the Company's employees.
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. dollars. Moreover, a significant amount
of contract manufacturing has been moved to domestic sources. The expansion of
international operations in the United Kingdom and Europe and increased sales,
if any, in Japan, Asia and elsewhere could result in higher international sales
as a percentage of total revenues; however, international revenues are currently
not a significant component of the Company's consolidated operations.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company had $54.8 million in cash and
equivalents, which represents a decrease of approximately $34.0 million from
December 31, 1997. The Company maintains a $7.0 million, unsecured revolving
line of credit with Bank One, Arizona, NA. The credit facility is annually
renewable and is available through June 1, 2000. 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 common shares. During the nine months ended September 30,
1998, approximately $26.7 million were used to purchase certain assets of TMSI
and an additional $13.6 million was expended to repurchase shares of the
Company's Common Stock. The remaining cash balances 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 $16.8 for the nine months
ended September 30, 1998, compared to net cash provided by operating activities
of $17.6 million for the same period in 1997. This increase in cash provided by
operating activities in 1998 was primarily the result of profitable operations
(excluding the write-off of in-process research and development costs associated
with the TMSI acquisition), and lower inventory levels, offset in part by
increased accounts receivable. During the first nine months of 1998, accounts
receivable increased approximately $4.9 million, while inventories decreased
approximately $390,000. 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. During the first nine months of
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1998, other assets and liabilities decreased primarily as a result of the change
in deferred taxes attributable to the write-off of in-process research and
development costs associated with the TMSI acquisition.
Net cash used in investing activities, primarily in the form of
acquisitions and capital expenditures, totaled $38.2 million and $8.8 million
for the nine months ended September 30, 1998 and 1997, respectively. This net
use of cash in 1998 was primarily the result of the purchase of certain assets
of TMSI and the related write-off of in-process research and development costs,
as well as additions to property and equipment. Cash used in acquisitions
totaled approximately $26.7 million in the first nine months of 1998. Capital
expenditures totaled approximately $11.6 million for the same period. The
Company anticipates additional capital expenditures during 1998, principally
relating to expenditures for equipment and management information systems used
in operations, facilities expansion and anticipated increased volumes of
operating leases offered by the Company to its customers, which must be
capitalized as fixed assets by the Company.
Net cash used in financing activities totaled $12.6 for the nine months
ended September 30, 1998 compared to $25.6 million for the same period in 1997.
Net cash used in financing activities during both periods was primarily due to
the initiation of separate stock repurchase programs under which the Board of
Directors authorized the repurchase of up to 2.5 million and 1.47 million shares
of the Company's common stock during the nine months ended September 30, 1998
and 1997, respectively. The Company expended approximately $13.6 million and
$27.2 million for stock repurchases through the nine month periods ended
September 30, 1998 and 1997, respectively, funded by existing cash balances
during each period. The Company reissued treasury shares through stock option
exercises and issuances, with the proceeds received totaling less than the cost
basis of the treasury stock reissued. Accordingly, the difference was recorded
during each period as a reduction to retained earnings. Net cash used for cash
dividends totaled $799,000 during the nine months ended September 30, 1998,
which was offset by cash provided by the exercise of stock options and stock
issuances pursuant to the Company's Employee Stock Purchase Plan.
The Company offers to its customers lease financing and other services,
including its Totalease program, through its Inter-Tel Leasing subsidiary. The
Company funds these programs in part through the sale to financial institutions
of rental income streams under the leases. Resold lease rentals totaling $121.6
million and $99.9 million remain unbilled at September 30, 1998 and December 31,
1997, respectively. The Company is obligated to repurchase such income streams
in the event of defaults by lease customers and, accordingly, maintains reserves
based upon loss experience and past due accounts. Although the Company to date
has been able to resell the rental streams from leases under its lease programs
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 were required to repurchase rental streams and
realize losses thereon in amounts exceeding its reserves, its operating results
could be materially adversely affected.
The Company believes that its cash balances, working capital and available
credit facilities, together with anticipated ongoing cash generated from
operations, will be sufficient to develop and expand its Inter-Tel.net network,
to finance acquisitions of additional resellers of telephony products and other
strategic acquisitions or corporate alliances, and to provide adequate working
capital for at least the next twelve months. However, to the extent that
additional funds are required in the future to address working capital needs and
to provide funding for capital expenditures, expansion of the business or the
Inter-Tel.net network or additional acquisitions, the Company may seek
additional financing. There can be no assurance that such additional financing
will be available when required or on acceptable terms.
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
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uncertainty exists in the software industry concerning the potential effects
associated with such compliance.
The Company has evaluated its level of exposure to the risks and costs
associated with Year 2000 problems for its information systems, billing and
collections software, and the Company's software products, including components
manufactured and or developed by the Company's suppliers and vendors. The
Company is currently in the process of updating its information systems which
are designed to be Year 2000 compliant. This decision was made in the ordinary
course of managing the company's information resources and not specifically
implemented to address Year 2000 compliance issues. The Company currently
expects its information systems to be Year 2000 compliant by the end of fiscal
1999, and anticipates no material disruptions in the services it provides to its
customers as a result of Year 2000 problems. However, no assurance can be given
that the Company's software products, including components manufactured and or
developed by the Company's suppliers and vendors, will contain all necessary
date code changes necessary to prevent processing errors potentially arising
from calculations using the Year 2000 date, or that such updates will be fully
completed in a timely manner or that such disruptions will not occur. The
Company also believes that the purchasing patterns of customers and potential
customers may be affected by Year 2000 issues in a variety of ways. If any of
the above systems or products are not Year 2000 compliant, however, the
Company's business, financial condition and results of operations could be
materially adversely affected. Please refer to the section entitled "Year 2000
Compliance" in "Factors That May Affect Results of Future Operations" below for
more detailed information.
FACTORS THAT MAY AFFECT RESULTS OF FUTURE OPERATIONS
IN ADDITION TO OTHER INFORMATION IN THIS INTERIM REPORT ON FORM 10-Q (THE
"10-Q"), THE FOLLOWING FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE
COMPANY'S BUSINESS. THE DISCUSSION IN THIS 10-Q CONTAINS FORWARD-LOOKING
STATEMENTS. FUTURE EVENTS ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS
CONTAINED IN THIS 10-Q ARE UNCERTAIN. ACTUAL EVENTS, AND THE COMPANY'S ACTUAL
RESULTS, MAY DIFFER MATERIALLY FROM THOSE PREDICTED, ASSUMED OR DISCUSSED IN
SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT MAY CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW AND IN
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS." THE CAUTIONARY STATEMENTS MADE IN THIS 10-Q SHOULD BE READ AS BEING
APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS, WHEREVER THEY APPEAR IN
THIS 10-Q.
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 to twenty-four 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. In July 1998, the Company also released 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 commercial acceptance of the AXXESS 5.0 platform, as well as
future upgrades and enhancements to this networking 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 and certain other
products that the Company purchased from TMSI. There can be no assurance that
any of 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
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Company anticipates, or if the Company is unable for any reason to capitalize on
any 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, and, accordingly,
operating results would be adversely affected 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, in light of the competition
pressures developing in this market, there can be no assurance that the
Company's products, and particularly Inter-Tel Vocal'Net and certain products
that the Company purchased from TMSI, 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 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 and certain products that
the Company purchased from TMSI 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, as well as other factors, 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
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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 and certain products and technology that the
Company purchased from TMSI will be required to demonstrate their functionality,
scalability and reliability, of which there can be no assurance. In addition,
there can be no assurance that these products and technology will comply with
industry standards or that industry standards will not change and render
Inter-Tel Vocal'Net or the Company's other IP telephony products obsolete. In
the event that these products fail 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 and other IP telephony products that the
Company purchased from TMSI 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. 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, the Vocal'Net Centralized Accounting
System ("CAS") and the product line that the Company purchased from TMSI 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 and
certain IP technology acquired from TMSI to develop and expand its own IP
network, Inter-Tel.net, to carry voice 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. Certain products that the Company purchased from TMSI are
also in the process of being tested and deployed in this network. 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.
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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, certain products and technology that the Company
acquired from TMSI, 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 core PABX 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 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 and AT&T's decision to divide itself
into three enterprises have impacted 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 also competes with RBOCs, cable television companies,
satellite and other wireless broadband service providers, and others for long
distance business as those companies 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
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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 several 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 likely faces significant competition from vendors such as
Cisco Systems, Inc., Bay Networks, Inc., 3Com Corporation, Motorola, Inc. and
MICOM Communications Corp., as these 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, cable companies
and other providers and existing IP carriers like IDC, 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, cable companies 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 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.
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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.
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 Company implemented various components of the new MIS software
during the second quarter and plans to roll-out additional components of the
software over the next nine to twelve months.
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. During June 1998, the Company completed its
purchase of certain assets of TMSI for cash of approximately $25 million plus
the assumption of certain liabilities and acquisition costs. The Company also
acquired Integrated Telecom Services Corporation ("ITS") in which the Company
issued approximately 140,000 shares of common stock, accounted for as a purchase
transaction. Acquisitions require a significant amount of the Company's
management attention and financial and operational resources, all of which are
limited. The integration of TMSI, ITS or any other 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 TMSI, ITS or any other 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 products through a limited number of contract
manufacturers located in the United States, the Philippines, the People's
Republic of China and Mexico. 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
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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 or applied for by the Company, or intellectual property of
TMSI that the Company has agree to purchase, 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, including patents,
trademarks, copyrights, or other 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.
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.
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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 multi-year terms 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 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
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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 evaluated its level of exposure to the risks and costs
associated with Year 2000 problems and is currently in the process of updating
its information systems which are designed to be Year 2000 compliant. This
decision was made in the ordinary course of managing the company's information
resources and not specifically implemented to address Year 2000 compliance
issues. The Company has contracted to upgrade the long distance billing system,
which is designed to be Year 2000 compliant. In addition, the Company is
reviewing its lease billing and collections system, which has been warranted to
be Year 2000 compliant. Currently, the total costs of each system is being
capitalized, and, the Company does not currently anticipate additional costs of
becoming Year 2000 compliant. The Company expects its information systems to be
Year 2000 compliant by the end of fiscal 1999, and anticipates no material
disruptions in the services it provides to its customers as a result of Year
2000 problems. If any of the above systems are not Year 2000 compliant, however,
the Company's business, financial condition and results of operations could be
materially adversely affected.
No assurance can be given that the Company's software products, including
components manufactured and or developed by the Company's suppliers and vendors,
will contain all necessary date code changes necessary to prevent processing
errors potentially arising from calculations using the Year 2000 date, or that
such updates will be fully completed in a timely manner or that such disruptions
will not occur. Our engineers have tested the Company's current product
offerings for Year 2000 compliance. Products currently manufactured by Inter-Tel
are designed to be Year 2000 compliant in accordance with our test procedures.
Costs to develop and update the Company's products for Year 2000 compliance have
been part of the research and development efforts on an ongoing basis. Any
disruption in manufacturing services provided by the Company as a result of Year
2000 noncompliance would materially adversely affect the Company's business,
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financial condition and results of operations. If any of the Company's products
are not Year 2000 compliant, the Company's business, financial condition and
results of operations could be materially adversely affected. Moreover, the
Company could also be materially adversely impacted by Year 2000 issues faced by
major distributors, suppliers, customers, vendors and financial service
organizations with which the Company interacts.
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 of the Company's customers and potential customers are
requesting information about Year 2000 compliance of the Company's products.
These customers and 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 customers to accelerate purchases with Year
2000 compliance warranties, 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. Any of the above items
for which the Company is unable to provide Year 2000 compliance to these
customers could materially adversely affect the Company's business, financial
condition and results of operations.
CONCENTRATION OF OWNERSHIP
As of September 30, 1998, Steven G. Mihaylo, the Company's Chairman of the
Board of Directors, Chief Executive Officer and President beneficially owned
approximately 21% of the outstanding shares of the Common Stock. As a result, he
has the ability to exercise significant influence over all matters requiring
shareholder approval. In addition, the concentration of ownership could have the
effect of delaying or preventing a change in control of the Company.
Any of the foregoing could result in a material adverse effect on the
Company's business, financial condition and operating results.
INTER-TEL, INCORPORATED AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS--NOT APPLICABLE
ITEM 2. CHANGES IN SECURITIES--NOT APPLICABLE
ITEM 3. DEFAULTS ON SENIOR SECURITIES--NOT APPLICABLE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS--NOT APPLICABLE
ITEM 5. OTHER INFORMATION
Pursuant to Rule 14a-4(c)(1) under the Securities Exchange Act of 1934,
in connection with the Company's annual meeting of shareholders, if a
stockholder of the Company fails to notify the Company at lest 45 days
prior to the month and day of mailing of the prior year's proxy
statement, then the proxies of management would be allowed to use their
discretionary voting authority when any such proposal is raised at the
Company's annual meeting of stockholders, without any discussion of the
matter in the proxy statement.
20
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
Exhibit 27 - Financial Data Schedule for September 30, 1998
Exhibit 27.1 - Restated Financial Data Schedule for June 30, 1998
Exhibit 27.2 - Restated Financial Data Schedule for March 31, 1998
Exhibit 27.3 - Restated Financial Data Schedule for December 31, 1997
Reports on Form 8-K -- None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTER-TEL, INCORPORATED
Date November 13, 1998 /s/ Steven G. Mihaylo
-------------------------------------
Steven G. Mihaylo,
Chairman of the Board,
Chief Executive Officer and President
Date November 13, 1998 /s/ Kurt R. Kneip
-------------------------------------
Kurt R. Kneip,
Vice President
and Chief Financial Officer
21
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL DATA SCHEDULE (EXHIBIT 27).
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS FOR THE NINE
MONTHS ENDED SEPTEMBER, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS
</LEGEND>
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 54,842
<SECURITIES> 0
<RECEIVABLES> 41,510
<ALLOWANCES> 4,351
<INVENTORY> 21,149
<CURRENT-ASSETS> 132,451
<PP&E> 51,235
<DEPRECIATION> 24,032
<TOTAL-ASSETS> 184,775
<CURRENT-LIABILITIES> 35,886
<BONDS> 0
0
0
<COMMON> 102,560
<OTHER-SE> 33,464
<TOTAL-LIABILITY-AND-EQUITY> 136,024
<SALES> 202,235
<TOTAL-REVENUES> 202,235
<CGS> 103,613
<TOTAL-COSTS> 103,613
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 58
<INCOME-PRETAX> 3,345
<INCOME-TAX> 1,744
<INCOME-CONTINUING> 1,601
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,601
<EPS-PRIMARY> 0.06
<EPS-DILUTED> 0.06
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL DATA SCHEDULE (EXHIBIT 27.1).
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS FOR THE SIX MONTHS
ENDED JUNE 30, 1998 RESTATED FOR ACCOUNTING FOR THE "ITS" ACQUISITION USING
PURCHASE ACCOUNTING INSTEAD OF POOLING-OF-INTERESTS ACCOUNTING. THE TRANSACTION
WAS ORIGINALLY ACCOUNTED FOR AS A POOLING, BUT INTER-TEL SUBSEQUENTLY
REPURCHASED SHARES OF ITS COMMON STOCK DURING THE THIRD QUARTER OF 1998,
PRECLUDING POOLING-OF-INTERESTS ACCOUNTING TREATMENT. THIS SCHEDULE IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<RESTATED>
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<CASH> 66,691
<SECURITIES> 0
<RECEIVABLES> 41,723
<ALLOWANCES> 4,096
<INVENTORY> 19,129
<CURRENT-ASSETS> 142,498
<PP&E> 48,163
<DEPRECIATION> 22,714
<TOTAL-ASSETS> 191,546
<CURRENT-LIABILITIES> 39,488
<BONDS> 0
0
0
<COMMON> 102,165
<OTHER-SE> 41,566
<TOTAL-LIABILITY-AND-EQUITY> 191,546
<SALES> 131,846
<TOTAL-REVENUES> 131,846
<CGS> 68,070
<TOTAL-COSTS> 68,070
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 39
<INCOME-PRETAX> (6,447)
<INCOME-TAX> (4,168)
<INCOME-CONTINUING> (4,168)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,168)
<EPS-PRIMARY> (0.16)
<EPS-DILUTED> (0.16)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL DATA SCHEDULE (EXHIBIT 27.2).
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS FOR THE THREE
MONTHS ENDED MARCH 31, 1998 RESTATED FOR ACCOUNTING FOR THE "ITS" ACQUISITION
USING PURCHASE ACCOUNTING INSTEAD OF POOLING-OF-INTERESTS ACCOUNTING. THE
TRANSACTION WAS ORIGINALLY ACCOUNTED FOR AS A POOLING, BUT INTER-TEL
SUBSEQUENTLY REPURCHASED SHARES OF ITS COMMON STOCK DURING THE THIRD QUARTER OF
1998, PRECLUDING POOLING-OF-INTERESTS ACCOUNTING TREATMENT. THIS SCHEDULE IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<RESTATED>
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<EXCHANGE-RATE> 1
<CASH> 90,977
<SECURITIES> 0
<RECEIVABLES> 36,427
<ALLOWANCES> 3,793
<INVENTORY> 20,428
<CURRENT-ASSETS> 160,115
<PP&E> 41,249
<DEPRECIATION> 20,052
<TOTAL-ASSETS> 201,121
<CURRENT-LIABILITIES> 33,575
<BONDS> 0
0
0
<COMMON> 99,685
<OTHER-SE> 51,005
<TOTAL-LIABILITY-AND-EQUITY> 201,121
<SALES> 63,758
<TOTAL-REVENUES> 63,758
<CGS> 32,617
<TOTAL-COSTS> 22,965
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,030
<INTEREST-EXPENSE> 9
<INCOME-PRETAX> 9,136
<INCOME-TAX> 3,774
<INCOME-CONTINUING> 5,362
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,362
<EPS-PRIMARY> .20
<EPS-DILUTED> .19
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL DATA SCHEDULE (EXHIBIT 27.3).
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS FOR THE YEAR ENDED
DECEMBER 31, 1997 RESTATED FOR ACCOUNTING FOR THE "ITS" ACQUISITION USING
PURCHASE ACCOUNTING INSTEAD OF POOLING-OF-INTERESTS ACCOUNTING. THE TRANSACTION
WAS ORIGINALLY ACCOUNTED FOR AS A POOLING, BUT INTER-TEL SUBSEQUENTLY
REPURCHASED SHARES OF ITS COMMON STOCK DURING THE THIRD QUARTER OF 1998,
PRECLUDING POOLING-OF-INTERESTS ACCOUNTING TREATMENT. THIS SCHEDULE IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<RESTATED>
<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> 35,585
<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>
