UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended Commission File Number:
March 31, 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
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Common Stock
(26,815,383 shares outstanding as of March 31, 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
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<PAGE>
INDEX
INTER-TEL, INCORPORATED AND SUBSIDIARIES
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets--March 31, 3
1998 and December 31, 1997
Condensed consolidated statements of income--three 4
months ended March 31, 1998 and March 31, 1997
Condensed consolidated statements of cash flows 5
--three months ended March 31, 1998 and
March 31, 1997
Notes to condensed consolidated financial 6
statements--March 31, 1998
Item 2. Management's Discussion and Analysis of Financial 7
Condition and Results of Operations
PART II. OTHER INFORMATION 19
SIGNATURES 20
2
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PART I. FINANCIAL INFORMATION
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands) March 31, December 31,
1998 1997
---- ----
ASSETS
CURRENT ASSETS
Cash and equivalents $ 90,977 $ 88,805
Accounts receivable - net 32,634 32,234
Inventories 20,428 21,539
Net investment in sales-leases 10,764 9,196
Prepaid expenses and other assets 5,312 5,625
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TOTAL CURRENT ASSETS 160,115 157,399
PROPERTY & EQUIPMENT 21,196 19,559
OTHER ASSETS 19,810 18,030
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$ 201,121 $ 194,988
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 12,702 $ 14,864
Other current liabilities 20,877 18,721
--------- ---------
TOTAL CURRENT LIABILITIES 33,579 33,585
DEFERRED TAXES AND OTHER LIABILITIES 16,852 15,898
SHAREHOLDERS' EQUITY
Common stock 99,685 99,229
Retained earnings 51,374 46,547
Equity adjustment for foreign
currency translation (369) (271)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 150,690 145,505
--------- ---------
$ 201,121 $ 194,988
========= =========
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(In thousands, except Three Months Ended
per share amounts) March 31, 1998 March 31, 1997
-------------- --------------
NET SALES $ 63,758 $ 50,322
Cost of sales 32,617 28,152
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GROSS PROFIT 31,141 22,170
Research & development 2,428 1,845
Selling, general, and administrative 20,537 16,052
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22,965 17,897
OPERATING INCOME 8,176 4,273
Interest and other income 969 223
Interest expense (9) (7)
-------- --------
INCOME BEFORE TAXES 9,136 4,489
Income taxes 3,774 1,819
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NET INCOME $ 5,362 $ 2,670
======== ========
NET INCOME PER SHARE
Basic $ .20 $ .10
======== ========
Diluted $ .19 $ .10
======== ========
Average number of common shares
Outstanding - Basic 26,741 25,901
======== ========
Average number of common shares
Outstanding - Diluted 28,242 26,450
======== ========
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
(In thousands) March 31, 1998 March 31, 1997
-------------- --------------
<S> <C> <C>
OPERATING ACTIVITIES
NET INCOME $ 5,362 $ 2,670
Adjustments to reflect operating activities:
Depreciation and amortization 1,252 1,069
Changes in operating assets and liabilities (3,528) (166)
Other 1,721 1,795
-------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 4,807 5,368
INVESTING ACTIVITIES
Proceeds from disposal of property and equipment 7 --
Additions to property and equipment (2,832) (1,709)
Cash used in acquisition -- (825)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (2,825) (2,534)
FINANCING ACTIVITIES
Cash dividends paid (267) --
Proceeds from exercise of stock options 457 73
-------- --------
NET CASH PROVIDED BY FINANCING
ACTIVITIES 190 73
INCREASE IN CASH
AND EQUIVALENTS 2,172 2,907
CASH AND EQUIVALENTS AT
BEGINNING OF PERIOD 88,805 38,936
-------- --------
CASH AND EQUIVALENTS AT
END OF PERIOD $ 90,977 $ 41,843
======== ========
</TABLE>
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
March 31, 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 months ending March 31, 1998 are not necessarily
indicative of the results that may be expected for the year ended 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
Primary 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.
The following table sets forth the computation of basic and diluted earnings per
share:
(In thousands, except Three Months Ended
per share amounts) March 31, 1998 March 31, 1997
-------------- --------------
Numerator:
Net Income $ 5,362 $ 2,670
======= =======
Denominator:
Denominator for basic earnings per
share - weighted average shares 26,741 25,901
Effect of dilutive securities:
Employee and director stock options 1,501 549
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Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 28,242 26,450
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Basic earnings per share $ 0.20 $ 0.10
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Diluted earnings per share $ 0.19 $ 0.10
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NOTE C--SUBSEQUENT EVENT
On May 11, 1998, the Company agreed to purchase certain assets of Telecom
Multimedia Systems, inc. ("TMSI") for approximately $25 million in cash plus the
assumption of certain liabilities and acquisition costs. The acquisition is
subject to customary closing conditions, including obtaining regulatory
approvals and other consents.
This acquisition will be accounted for as a purchase transaction. In addition,
Inter-Tel anticipates that a substantial portion of the purchase price will be
written off as in-process research and development in the quarter in which the
transaction closes.
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PART I.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview
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
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.
This Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Actual results could differ materially from
those projected in the forward-looking statements as a result of many risk
factors, including, without limitation, those set forth under "Factors That May
Affect Future Results Of Operations" below.
Results of Operations
Net sales increased 26.7% to $63.8 million in the first quarter of 1998
from $50.3 million in the first quarter of 1997. Sales from direct sales offices
accounted for approximately $6.2 million of the increase, while wholesale
distribution sales decreased approximately $500,000. The remaining increases
occurred in long distance sales and other operations.
The following table sets forth selected statements of income data as a
percentage of net sales:
Three months and year
Ended March 31,
1998 1997
---- ----
Net sales 100.0% 100.0%
Cost of sales 51.2 55.9
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Gross profit 48.8 44.1
Research and development 3.8 3.7
Selling, general and administrative 32.2 31.9
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Operating income 12.8 8.5
Interest and other income 1.5 0.4
Interest expense 0.0 0.0
Income taxes 5.9 3.6
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Net income 8.4% 5.3%
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Gross profit for the first quarter of 1998 increased 40.5% to $31.1
million, or 48.8% of net sales, from $22.2 million, or 44.1% of net sales, in
the first quarter of 1997. The increase in gross margin was attributable to the
different sales mix of products and services, and sales through different
distribution channels. In particular, the Company received higher margins from
sales of AXXESS digital communication platforms, and related call processing
software and voice processing software, offset, in part, by lower margins on
sales through dealer channels and sales of long distance calling services.
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Research and development expenses for the first quarter of 1998
increased 31.6% to $2.4 million, or 3.8% of net sales, from $1.8 million, or
3.7% of net sales, for the first quarter of 1997. This increase was primarily
attributable to expenses relating to the continued development of the AXXESS and
Inter-Tel Axxent software and systems, unified messaging and voice processing
software, Inter-Tel.Net and Vocal'Net server, and 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 expenses in the first quarter of
1998 increased to $20.5 million, or 32.2% of net sales, from $16.1 million, or
31.9% of net sales, in the first quarter of 1997. This reflected increased
selling, incentive, training and other compensation costs attributable to the
increased sales through the Company's direct sales offices, additional personnel
and marketing expenses to support the operations of Inter-Tel.net, the expanded
direct dealer network and expanded long distance operations, and expenses
associated with the expansion of international operations. In addition, the
Company increased its sales and technical training staff and incurred additional
consulting expenses during the transition to and implementation of the
management information systems. 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 in both periods consisted primarily of
interest income and foreign exchange rate gains and losses and increased in the
first quarter of 1998 primarily due to the investment of proceeds from the 1997
follow-on public offering of the Company's Common Stock.
Net income for the first quarter of 1998 was $5.4 million, or $.19 per
diluted share ($.20 per share-basic), compared to net income of $2.7 million, or
$.10 per diluted share ($.10 per share-basic) for the first quarter of 1997, an
increase of 100.8%.
Inflation/Currency Fluctuation
Inflation and currency fluctuations have not previously had a material
impact on Inter-Tel's operations. International procurement agreements have
traditionally been denominated in U.S. currency. Moreover, a significant amount
of contract manufacturing has been moved to domestic sources. The expansion of
international operations in the United Kingdom and Europe and anticipated
increased sales in Japan and Asia and elsewhere could result in higher
international sales as a percentage of total revenues, but international
revenues are currently not significant.
Liquidity and Capital Resources
At March 31, 1998, the Company had $91.0 million in cash and
equivalents, which represents a increase of approximately $2.2 million from
December 31, 1997. 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 $4.8 million for the
three months ended March 31, 1998, compared to $5.4 million for the same period
in 1997. The operating cash flow in the first quarter of 1998 was primarily the
result of profitable operations including non-cash depreciation charges. Cash
used in operating assets and liabilities increased in the three month period
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ended March 31, 1998 to $3.5 million, compared to cash used of $166,000 in the
same period of 1997. During the first quarter of 1998, increases in accounts
receivable and investment in sales-leases were partially offset by reduced
inventories. The Company continues to expand sales to 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 $2.8 million in the three months ended March 31, 1998,
compared to $2.5 million for the same period of 1997. 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 $190,000 in the three
months ended March 31, 1998 compared to $73,000 for the same period in 1997,
related primarily to proceeds from the exercise of stock options, less cash
dividends paid.
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 $104.5 million remain unbilled at March 31, 1998. 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.
On May 11, 1998, the Company agreed to purchase certain assets of
Telecom Multimedia Systems, Inc. ("TMSI") for approximately $25 million in cash
plus the assumption of certain liabilities and acquisition costs. The
acquisition is subject to customary closing conditions, including obtaining
regulatory approvals and other consents.
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 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 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 is not expected to
have an impact on the Company's consolidated results of operations, financial
position or cash flows.
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes new rules for
the reporting and display of comprehensive income and its components; however
the adoption of this Statement had no impact on the Company's net income or
shareholders' equity. SFAS No. 130 requires unrealized gains or losses
9
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on the Company's foreign currency translation adjustments, which prior to
adoption were reported separately in shareholders' equity to be included in
other comprehensive income. During the first quarter of 1998 and 1997, the
amounts were not material.
Factors That May Affect Results of Future Operations
This Quarterly Report to Shareholders on Form 10-Q ("10-Q") contains
forward-looking statements that involve risks and uncertainties. The statements
contained in this 10-Q that are not purely historical are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including without limitation statements regarding the Company's expectations,
beliefs, intentions or strategies regarding the future. All forward-looking
statements included in this document are based on information available to the
Company on the date hereof, and the Company assumes no obligation to update any
such forward-looking statements. The cautionary statements made in this 10-Q
should be read as being applicable to all related forward-looking statements
wherever they appear in this document. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth under "Factors That May
Affect Results of Future Operations" below and elsewhere in this 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.
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. 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 and certain products that the Company has agreed to purchase
from TMSI. 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 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
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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, and particularly 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 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 has agreed to purchase 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
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.
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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 that the Company has agreed
to purchase 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 will comply with industry
standards or that industry standards will not change and render Inter-Tel
Vocal'Net or TMSI 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 certain products that the
Company has agreed to purchase 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
Software ("CAS") and certain products that the Company has agreed to purchase
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
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 has agreed to purchase from TMSI may also subsequently
be 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.
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
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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 that the Company has agreed to
purchase 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 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 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 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.
13
<PAGE>
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 will face 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, 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.
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 plans to broadly utilize the new MIS software beginning in
the second quarter of 1998.
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.
14
<PAGE>
The Company has made strategic acquisitions in the past and expects to
continue to do so in the future. On May 11, 1998, the Company agreed to purchase
certain assets of TMSI for cash of approximately $25 million plus the assumption
of certain liabilities and acquisition costs. 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 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 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 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 or applied for by the Company, or any intellectual property
of TMSI that the Company has agreed 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
15
<PAGE>
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.
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
16
<PAGE>
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
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
17
<PAGE>
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 to be Year 2000 compliant. The total costs of the new
information systems software implementation are currently being capitalized; and
the Company does not currently anticipate that the costs of becoming Year 2000
compliant will be material. The Company expects its information systems to be
Year 2000 compliant by the end of fiscal 1999, and anticipates no 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 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. Any disruption in services provided by the Company as a result of
Year 2000 noncompliance would materially adversely affect the Company's
business, financial condition and results of operations. Moreover, the Company
could be 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 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.
18
<PAGE>
Concentration of Ownership
As of March 31, 1998, Steven G. Mihaylo, the Company's Chairman of the
Board of Directors and Chief Executive Officer beneficially owned approximately
20% 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.
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
1. On April 23, 1998, at the Company's annual meeting of
shareholders, the shareholders of the Company elected the
following directors, each of whom was a nominee of the Company:
Name Votes For Votes Withheld
---- --------- --------------
Steven G. Mihaylo 22,705,275 27,550
J. Robert Anderson 22,696,653 36,172
Gary D. Edens 22,699,953 32,872
Maurice H. Esperseth 22,702,322 30,503
C. Roland Haden 22,705,497 27,328
Norman Stout 22,701,953 30,872
ITEM 5. OTHER INFORMATION--Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
Exhibits:
11.1 Computation of Earnings per Share
27 Financial Data Schedule
Reports on Form 8-K:
No reports filed during quarter
19
<PAGE>
- --------------------------------------------------------------------------------
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTER-TEL, INCORPORATED
May 14, 1998 /s/ Steven G. Mihaylo
- --------------- --------------------------
Steven G. Mihaylo
Chairman of the Board and
Chief Executive Officer
May 14, 1998 /s/ Kurt R. Kneip
- --------------- --------------------------
Kurt R. Kneip
Vice President and
Chief Financial Officer
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS FOR THE QUARTER
ENDED MARCH 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS
</LEGEND>
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