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, 1999 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
(25,907,862 shares outstanding as of September 30, 1999)
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 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
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets--September 30, 1999 3
and December 31, 1998
Condensed consolidated statements of operations - three and 4
nine months ended September 30, 1999 and September 30, 1998
Condensed consolidated statements of cash flows - three and 5
nine months ended September 30, 1999 and September 30, 1998
Notes to condensed consolidated financial statements -
September 30, 1999 6
Item 2. Management's Discussion and Analysis of Financial 7
Condition and Results of Operations
PART II. OTHER INFORMATION 22
SIGNATURES 22
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,
1999 1998
--------- ---------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 63,564 $ 63,124
Accounts receivable - net 47,729 41,116
Inventories 18,589 19,663
Net investment in sales-leases 15,401 13,979
Prepaid expenses and other assets 4,753 2,781
--------- ---------
TOTAL CURRENT ASSETS 150,036 140,663
PROPERTY & EQUIPMENT 35,080 28,969
OTHER ASSETS 34,623 27,398
--------- ---------
$ 219,739 $ 197,030
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 19,513 $ 14,956
Other current liabilities 34,899 29,390
--------- ---------
TOTAL CURRENT LIABILITIES 54,412 44,346
DEFERRED TAXES 2,597 5,026
OTHER LIABILITIES 6,273 4,972
SHAREHOLDERS' EQUITY
Common stock, no par value-authorized
100,000,000 shares, issued and outstanding
- 29,029,987 in 1998 104,432 104,539
Less: shareholder loans (1,096) --
Retained earnings 69,780 54,194
Accumulated other comprehensive income (13) (196)
--------- ---------
173,103 158,537
Less: Treasury stock at cost (16,646) (15,851)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 156,457 142,686
--------- ---------
$ 219,739 $ 197,030
========= =========
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
(In thousands except Three Months Nine Months
per share amounts) Ended September 30, Ended September 30,
---------------------- ----------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
NET SALES $ 81,800 $ 70,389 $ 225,113 $ 202,235
Cost of sales 41,811 35,543 113,933 103,613
--------- --------- --------- ---------
GROSS PROFIT 39,989 34,846 111,180 98,622
Research & development 3,896 3,283 10,928 8,539
Selling, general and administrative 25,511 22,437 70,715 64,977
In-process research and
development and acquisition
related expenses -- -- -- 22,755
--------- --------- --------- ---------
29,407 25,720 81,643 96,271
OPERATING INCOME 10,582 9,126 29,537 2,351
Interest and other income 863 722 1,788 2,568
Interest expense (29) (19) (54) (58)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 11,416 9,829 31,271 4,861
Income taxes 4,347 4,038 11,889 2,351
--------- --------- --------- ---------
NET INCOME $ 7,069 $ 5,791 $ 19,382 $ 2,510
========= ========= ========= =========
NET INCOME PER SHARE:
Basic $ 0.27 $ 0.22 $ 0.75 $ 0.09
========= ========= ========= =========
Diluted $ 0.26 $ 0.21 $ 0.72 $ 0.09
========= ========= ========= =========
Average common shares outstanding 25,880 26,754 25,934 26,791
========= ========= ========= =========
Average common shares outstanding
assuming dilution 27,040 27,489 27,009 27,941
========= ========= ========= =========
</TABLE>
4
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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) 1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
NET INCOME $ 7,069 $ 5,791 $ 19,382 $ 2,510
Adjustments to reflect operating activities:
Depreciation and amortization 2,250 1,887 6,574 4,615
Purchased in process research and development -- -- -- 22,755
Changes in operating assets and liabilities 1,165 (3,849) (11,346) (12,066)
Other (64) 1,189 6,870 (2,443)
-------- -------- -------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 10,420 5,018 21,480 15,371
INVESTING ACTIVITIES
Proceeds from disposal of property and
equipment and operating leases 2 105 2,001 112
Additions to property and equipment and
operating leases (4,274) (3,494) (13,654) (11,613)
Cash used in acquisition (3,068) -- (3,788) (25,274)
-------- -------- -------- --------
NET CASH USED IN INVESTING
ACTIVITIES (7,340) (3,389) (15,441) (36,775)
FINANCING ACTIVITIES
Payments for repurchase of common stock -- (13,644) (6,682) (13,644)
Cash dividends paid (258) (262) (780) (799)
Net proceeds from stock issued under the
Employee Stock Purchase Plan -- -- 421 359
Proceeds from exercise of stock options 429 428 1,442 1,525
-------- -------- -------- --------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES 171 (13,478) (5,599) (12,559)
INCREASE (DECREASE) IN CASH
AND EQUIVALENTS 3,251 (11,849) 440 (33,963)
CASH AND EQUIVALENTS
AT BEGINNING OF PERIOD 60,313 66,691 63,124 88,805
-------- -------- -------- --------
CASH AND EQUIVALENTS
AT END OF PERIOD $ 63,564 $ 54,842 $ 63,564 $ 54,842
======== ======== ======== ========
</TABLE>
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 1999
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, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999. 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, 1998.
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, 1999 Sept. 30, 1998 Sept. 30, 1999 Sept. 30, 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Numerator:
Net income $ 7,069 $ 5,791 $19,382 $ 2,510
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
share - weighted average shares 25,880 26,754 25,934 26,791
Effect of dilutive securities:
Employee and director stock options 1,160 735 1,075 1,150
------- ------- ------- -------
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 27,040 27,489 27,009 27,941
======= ======= ======= =======
Basic earnings per share $ 0.27 $ 0.22 $ 0.75 $ 0.09
======= ======= ======= =======
Diluted earnings per share $ 0.26 $ 0.21 $ 0.72 $ 0.09
======= ======= ======= =======
</TABLE>
NOTE C--ACQUISITIONS
In July 1999, Inter-Tel purchased certain assets and assumed certain liabilities
of Matrix Telecommunications, Inc. ("Matrix"). The purchase price was $3.7
million plus expenses. Matrix is based in Seattle, Washington and specializes in
database design and systems integration for small- to medium-size businesses
which utilize advanced telecommunications products and services. The transaction
was accounted for using the purchase method of accounting. The operations
related to Matrix were not significant to the Company's consolidated operations.
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NOTE D - SEGMENT INFORMATION
The Company adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131") in the fiscal year ended December 31, 1998. SFAS 131 establishes standards
for reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS 131 also establishes
standards for related disclosures about products and services and geographic
areas. Operating segments are identified as components of an enterprise about
which separate discrete financial information is available for evaluation by the
chief operating decision maker, or decision making group, in making decisions
how to allocate resources and assess performance. The Company's chief decision
maker, as defined under SFAS 131, is the Chief Executive Officer. To date, the
Company has viewed its operations as principally one segment: telephone systems,
telecommunications software and hardware, and related long distance calling
services. These services are provided through the Company's direct sales offices
and dealer network to business customers throughout the United States, Europe,
Asia and South America. As a result, the financial information disclosed herein
in all material respects represents all of the financial information related to
the Company's principal operating segment.
The Company's revenues are generated predominantly in the United States.
Total revenues generated from U.S. customers totaled $79.9 million and $68.8
million of total revenues for the quarters ended September 30, 1999 and 1998,
respectively and $220.0 million and $196.8 million of total revenues for the
nine months ended September 30, 1999 and 1998, respectively. The Company's
revenues from international sources were primarily generated from customers
located in the United Kingdom, Europe, Asia and South America. In the third
quarters of 1999 and 1998, revenues from customers located internationally
accounted for 2.3% and 2.7% of total revenues, respectively. In the nine months
ended September 30, 1999 and 1998, revenues from customers located
internationally accounted for 2.3% and 2.3% of total revenues, respectively.
NOTE E - SUBSEQUENT EVENTS
On October 18, 1999, the Company announced an agreement to purchase selected
assets and assume certain liabilities from Executone Business Information
Systems, Inc. ("Executone"), which develops and markets applications-oriented
telephony systems. The purchase price is $44.3 million plus expenses and assumed
liabilities. If consummated, the transaction will be accounted for using the
purchase method of accounting. The proposed purchase is subject to approval of
the Executone shareholders, antitrust clearance, SEC review of Executone's proxy
materials and other customary closing conditions.
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 risk factors, including without
limitation those set forth under this section, under the section entitled
"Factors That May Affect Future Results Of Operations" below and elsewhere in
this report on Form 10-Q.
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-
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Tel's award-winning products and services include the AXXESS and Inter-Tel
Axxent digital business communication platforms, the AXXESSORY TALK voice
processing platform, the InterPrise voice and data routers and the Inter-Tel.net
private IP long distance network. The Company also provides maintenance, leasing
and support services for its products.
RESULTS OF OPERATIONS
Net sales for the third quarter of 1999 increased 16.2% to $81.8 million,
compared to $70.4 million in the third quarter of 1998. Net sales increased
11.3% to $225.1 million in the first nine months of 1999, compared to $202.2
million in the first nine months of 1998. For the quarter and nine months ended
September 30, 1999, sales from wholesale distribution and direct sales offices
accounted for approximately $7.5 million and $15.6 million, respectively, of the
increase in net sales. The increase in net sales was also attributable to
increases in sales through the Company's network services operations.
The following table sets forth certain statement of operations data of the
Company expressed as a percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
Sept. 30, 1999 Sept. 30, 1998 Sept. 30, 1999 Sept. 30, 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net Sales 100.0% 100.0% 100.0% 100.00%
Cost of Sales 51.1 50.5 50.6 51.2
------ ------ ------ ------
Gross profit 48.9 49.5 49.4 48.8
Research and development 4.8 4.6 4.9 4.2
Selling, general and administrative 31.2 31.9 31.4 32.1
In-process research and development
and related acquisition expenses -- 0.0 0.0 11.3
------ ------ ------ ------
Operating income 12.9 13.0 13.1 1.2
Interest and other income 1.0 1.0 0.8 1.2
Interest expense 0.0 0.0 0.0 0.0
Income taxes 5.3 5.8 5.3 1.2
------ ------ ------ ------
Net income 8.6% 8.2% 8.6% 1.2%
====== ====== ====== ======
</TABLE>
Gross profit for the third quarter of 1999 increased 14.8% to $40.0
million, or 48.9% of net sales, compared to $34.8 million, or 49.5% of net
sales, for the third quarter of 1998. Gross profit increased 12.7% to $111.2
million, or 49.4% of net sales, in the first nine months of 1999 compared to
$98.6 million, or 48.8% of net sales, in the first nine months of 1998. Gross
margin decreased in the third quarter of 1999 primarily as a result of sales
discounting, and sales channel and product mix. The Company offered pricing
discounts on sales of smaller business systems during the third quarter. In
addition, a larger portion of the Company's sales increases were through the
network services group, which contributed to lower overall gross margin.
Although the gross margin decreased for the quarter, gross margin was higher for
the nine months ended September 30, 1999 compared to 1998 primarily due to the
higher percentage of sales through direct sales offices in 1999 compared to
dealer channel sales which typically generate lower gross margins.
Research and development expenses for the third quarter of 1999 increased
to $3.9 million, or 4.8% of net sales, compared to $3.3 million, or 4.6% of net
sales, for the third quarter of 1998. Research and development expenses
increased to $10.9 million, or 4.9% of net sales, in the first nine months of
1999 compared to $8.5 million, or 4.2% of net sales, in the first nine months of
1998. The increases in absolute dollars and as a percentage of net sales in both
periods were primarily attributable to expenses relating to the development and
introduction of new products, including the continuing development and
improvement of the Company's AXXESS digital communication networking platforms,
call processing and voice processing software, CTI products, unified messaging,
and TCP/IP intranet and internet voice solutions (which are branded as the
Company's Vocal'Net, InterPrise and Inter-Tel.net products). The Company
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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 in the future,
however, as a percentage of net sales.
Selling, general and administrative expenses for the third quarter of 1999
increased in absolute dollars to $25.5 million compared to $22.4 million for the
third quarter of 1998. Selling, general and administrative expenses increased to
$70.7 million in the first nine months of 1999 compared to $65.0 million in the
first nine months of 1998. The increases in absolute dollars for the quarter and
nine months ended September 30, 1999, were attributable in part to 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; increased provisions for bad debts; and providing additional marketing
resources for new IP product introductions and network and long distance
services. Selling, general and administrative expenses decreased as a percentage
of net sales for the quarter to 31.2% from 31.9% for the third quarter of 1998,
and also decreased as a percentage of net sales to 31.4% from 32.1% for the nine
months ended September 30, 1999. These decreases were largely attributable to
increased net sales and cost-cutting measures. The Company expects that selling,
general and administrative expenses will continue to increase in absolute
dollars, but may vary in the future as a percentage of net sales.
In June 1998, the Company purchased certain assets and liabilities of
Telecom Multimedia Systems, Inc. ("TMSI") for approximately $25 million plus
related acquisition costs. The aggregate purchase price was allocated to the
fair value of the assets and liabilities acquired, of which $22.8 million, or
$13.7 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 was comparable in
the third quarter but decreased for the nine months of 1999 based on a lower
level of invested funds, principally relating to the repurchase of shares of the
Company's common stock during the second half of 1998 and in the third quarter
of 1999. Other changes in other income primarily reflected differences in net
foreign exchange rate gains and losses.
Net income for the third quarter was $7.1 million ($0.26 per diluted
share), an increase of 22.1% compared to net income of $5.8 million ($0.21 per
diluted share) for the third quarter of 1998. Net income for the nine months
ended September 30, 1999 was $19.4 million, or $0.72 per diluted share, an
increase of 672% compared to net income of $2.5 million, or $0.09 per diluted
share, in the first nine months of 1998, which included the write-off of
in-process research and development costs noted above. Excluding such write-off,
net income for the nine months ended September 30, 1999 increased 19.9% compared
to 1998.
INFLATION/CURRENCY FLUCTUATION
Inflation and currency fluctuations have not to date materially impacted
Inter-Tel's operations. International procurement agreements have traditionally
been denominated in U.S. currency. Moreover, a significant amount of contract
manufacturing has been moved to domestic sources. The expansion of international
operations in the United Kingdom and Europe and increased sales, if any, in
Japan and Asia and elsewhere could result in higher international sales as a
percentage of total revenues; however, international revenues are currently not
a significant component of the Company's consolidated operations.
9
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LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company had $63.6 million in cash and
equivalents, which represented an increase of approximately $440,000 from
December 31, 1998. The Company maintains a $7.0 million, unsecured revolving
line of credit with Bank One, Arizona, NA. The credit facility is renewable
annually and is available through June 1, 2000. Under this 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. The remaining cash balances may be
used to further develop and expand Inter-Tel.net, for potential acquisitions,
strategic alliances, and for working capital and general corporate purposes.
Net cash provided by operating activities totaled $21.5 for the nine months
ended September 30, 1999, compared to net cash provided by operating activities
of $15.4 million for the same period in 1998. The operating cash flow in the
first nine months of 1999 was primarily the result of profitable operations
including non-cash depreciation and amortization charges. During the first nine
months of 1999, accounts receivable increased approximately $6.6 million ($2.7
million of which was attributable to an acquisition), while inventories
decreased approximately $1.1 million. During the first nine months of 1999,
increases in accounts receivable, net investment in sales-leases, prepaid
expenses and other assets were offset in part by reductions in inventories. The
Company seeks to expand sales through its direct sales office and dealer
networks, which is expected to require working capital for any increased
accounts receivable and inventories.
Net cash used in investing activities, primarily in the form of cash used
in acquisitions, capital expenditures and additions to operating leases offered
to customers, less proceeds from the disposal of some operating leases, totaled
$15.4 million in the nine months ended September 30, 1999, compared to $36.8
million for the same period of 1998. The net cash used in 1998 was primarily the
result of the purchase of certain assets of TMSI and related write-off of
in-process research and development costs. Cash used in acquisitions totaled
$3.8 million in 1999 compared to $25.3 million in the first nine months of 1998.
Capital expenditures, including additions to operating leases, totaled
approximately $13.7 million in 1999 and $11.6 million for 1998. The Company
anticipates additional capital expenditures during 1999, principally relating to
acquisition expenditures, including the prospective acquisition of assets and
assumption of liabilities of Executone and Tri-Com Communications, Inc.,
expenditures for equipment used in operations, facilities expansion, and funding
of a joint venture with Hypercom Corporation (see Factors That May Affect
Results of Future Operations below).
Net cash used in financing activities totaled $5.6 million in the nine
months ended September 30, 1999 compared to $12.6 million for the same period in
1998. Cash used in 1999 was related primarily to payments for the repurchase of
the Company's common stock of $6.7 million, offset by proceeds from the exercise
of stock options and stock issued under the Company's Employee Stock Purchase
Plan ("ESPP"), less cash dividends paid. During the second quarter of 1999, the
Company initiated a stock repurchase program under which the Board of Directors
authorized the repurchase of up to 2,500,000 shares of the Company's common
stock. The Company stock repurchases in the second quarter of 1999 were funded
primarily by existing cash balances. The Company reissued treasury shares with a
cost basis of approximately $5.9 million in connection with stock option and
ESPP exercises and issuances. The proceeds received for the treasury stock
reissued was less than its cost basis. Accordingly, the difference was recorded
as a reduction to retained earnings.
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 $154.8 million and $131.3 remained unbilled at September 30, 1999 and
December 31, 1998, respectively. 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
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rates and economic uncertainty. If the Company is required to repurchase rental
streams and realizes losses thereon in amounts exceeding its reserves, its
operating results will be adversely affected.
The Company believes that 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 provide initial cash contributions to fund the Cirilium venture with Hypercom
Corporation (see also "Factors That May Affect Results of Future Operations), to
finance acquisitions of additional resellers of telephony products and other
strategic acquisitions or corporate alliances, and to provide adequate working
capital through the date of the closing of the Executone acquisition. The
Company is currently engaged in negotiations to provide additional credit
facilities as needed. 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.
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 few years, 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 Gateway
Server and the Inter-Tel Vocal'Net Service Provider Package. In April 1999, the
Company released the InterPrise 400 voice and data router, the first of a family
of voice and data convergence products that will be released over the next year.
Also, during October 1999, the Company released AXXESS 5.1 and AXXESSORY TALK
5.1 software into production. During the past 12 months, sales of the Company's
AXXESS digital communications platforms and related software have comprised a
substantial portion of the Company's net sales. The Company expects that its
future success will continue to depend, in large part, upon the increasing
commercial acceptance of the InterPrise products and the AXXESS platform, as
well as future upgrades and enhancements to these products and networking
platforms. The Company's future success will also depend upon the market
acceptance of its other new products and enhancements, including the products
that the Company has agreed to purchase from Executone, pursuant to its
announcement on October 18, 1999. There can be no assurance that any of these
introduced products and enhancements will be successful. Due to the complexity
of the Company's products, the Company has in the past and expects in the future
to experience delays in the development and release of new products or product
enhancements. 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
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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, design
modifications required to correct bugs or 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 is highly uncertain. 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 competitive pressures developing in this
market, there can be no assurance that the Company's products, and particularly
Inter-Tel Vocal'Net and the Inter-Tel InterPrise products, 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 the Inter-Tel
InterPrise products will comply with telecommunications laws 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
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increased pressure on legislatures to impose such regulations. The Company
cannot predict the likelihood that any future legislation or regulation will be
enacted, nor the financial impact, if any, of such resulting legislation or
regulation. In the future, the Company may also develop and introduce other
products with new or additional telecommunications capabilities or services,
which could be subject to existing federal government regulations or result in
the imposition of new government regulations, either in the United States or
elsewhere.
RISKS ASSOCIATED WITH INTER-TEL VOCAL'NET AND INTER-TEL INTERPRISE; DEPENDENCE
UPON IP NETWORK INFRASTRUCTURES; RISK OF SYSTEM FAILURE; SECURITY RISKS
Over the past 24 months, the Company has introduced the Inter-Tel Vocal'Net
Server, the Inter-Tel Service Provider Package, and Inter-Tel InterPrise
products. The Company has also introduced several new software releases to
provide new features and enhancements to the Inter-Tel Vocal'Net product line.
There can be no assurance the functionality, scalability, and reliability of the
Inter-Tel Vocal'Net, Inter-Tel Service Provider Package and Inter-Tel InterPrise
product lines will be accepted in the market. 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.
In September 1999, the Company announced the signing of a memorandum of
understanding with Hypercom Corporation to form a jointly owned company,
Cirilium, which will comprise parts of the Company's and Hypercom's packet
telephony experience, products and services, including Inter-Tel's Vocal'Net
products and technology. The Company and Hypercom are currently in the process
of structuring the jointly owned company and its strategy. The voice
communications over IP networks market, as well as the market for data telephony
products, services and applications in general, is intensely competitive.
Accordingly, the Company can offer no assurance that its expectations for the
Cirilium venture with Hypercom will be attained.
The market acceptance of the Cirilium venture and other IP telephony
products that the Company acquired through its purchase of assets from TMSI in
June 1998, 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 Inter-Tel Vocal'Net Service Provider
Package, the Inter-Tel InterPrise products 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.
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DEVELOPMENT AND MAINTENANCE OF INTER-TEL.NET NETWORK
The Company is currently utilizing its Inter-Tel Vocal'Net technology and
Inter-Tel InterPrise products to develop and expand its own IP network,
Inter-Tel.net, to carry voice traffic. The Inter-Tel.net network is currently in
the process of deployment and, accordingly, is subject to risks. 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, Atlanta, Houston,
Los Angeles, Dallas, and Miami/Ft. Lauderdale. Certain products that the Company
purchased from TMSI have been or are in the process of being tested and deployed
in this network. If the domestic or international market for IP network products
fails to develop or develops more slowly than the Company anticipates, or should
the business experience difficulty in the integration of the TMSI technology,
the Company's Inter-Tel.net network could become financially burdensome to
maintain or obsolete, which could materially and adversely affect the Company's
business, financial condition and results of operations.
The Company is dependent on third-party or affiliate 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 these suppliers or affiliates raise rates, change
pricing structures, experience power or bandwidth outages, or delays in
provision of local circuits, the Company may be materially adversely affected.
The Company faces the risk that there could 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. The Company
may also experience speed and scalability issues from products developed by
suppliers or affiliates, which could materially and adversely affect the
Company's business.
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 Inter-Tel InterPrise products,
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 and key systems 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 (the telephony assets of which the Company
has agreed to purchase), 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 Company also expects to compete against large data
routing companies, like Cisco Systems and 3Com, which have recently acquired
telecommunications technology.
In the market for voice processing applications, including voice mail, the
Company competes against AVT, Active Voice, 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 and other competitors. These companies have
significantly greater resources than the Company and are consolidating rapidly
with other long distance companies and RBOCs, providing them with potentially
even greater resources and advantages. The Company also
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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 has direct sales offices.
In the market for IP telephony products, the Company competes against
existing IP telephony gateway providers such as Clarent, Lucent, NetSpeak
Corporation, VocalTec Communications Ltd., Nokia IP Products, Net2Phone, 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 faces significant competition from vendors such as
Cisco Systems, Inc., Nortel, 3Com Corporation, Motorola, Inc. and MICOM
Communications Corp., as these established data vendors have entered the market
for IP telephony products. Such companies currently produce products that, when
equipped with voice capabilities, could represent a considerable threat to the
Company within that market. In addition, most of the above data router vendors
have greater name recognition, more established positions in the market, and
long-standing relationships with data network customers. Moreover, should the
market for IP telephony products become fully developed or develop at a rapid
rate, large computer companies such as IBM and Microsoft, or large telephone
companies such as AT&T, MCI, Sprint Corporation, or Qwest, 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 Net2Phone, 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. 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.
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.
PRODUCT PROTECTION AND INFRINGEMENT
The Company's future success will depend in part upon its proprietary
technology. The Company currently holds patents for six telecommunication and
unified messaging products. The Company has also 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 also relies 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, 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
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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. In this
regard, the Company recently received a letter from one of its primary
competitors alleging that the Company's AXXESS digital communications platform
utilizes inventions covered by certain of such competitor's patents. The Company
is currently in the process of investigating this matter. When any such claims
are asserted against the Company, the Company may seek to purchase a license
under the third party's intellectual property rights. Purchasing such licenses
can be expensive, and there can be no assurance that a license will be available
on prices or other 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.
MANAGEMENT OF GROWTH; IMPLEMENTATION OF NEW MANAGEMENT INFORMATION SYSTEMS
The growth in the Company's business has placed, and is expected to
continue to place, a significant strain on the Company's personnel, management
and other resources. The Company's ability to manage any future growth
effectively will require it to attract, train, motivate and manage new employees
successfully, to integrate new employees into its overall operations and to
continue to improve its operational, financial and management information
systems.
The Company has made strategic acquisitions in the past and expects to
continue to do so in the future. In this regard, in October 1999, the Company
agreed to purchase certain assets and to assume certain liabilities of
Executone, which develops and markets applications-oriented telephony systems.
Acquisitions such as these require a significant amount of the Company's
management attention and financial and operational resources, all of which are
limited. The integration of any acquired assets or entities, or prospective
acquisition candidates 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 the Executone acquisition,
or any potential future acquisitions, will have a positive impact on the
business relationships of the Company or the acquired entity with its respective
suppliers or customers. In addition, there can be no assurance that the Company
will be able to successfully integrate acquired assets or operations or achieve
any of the intended benefits of the Executone acquisition or any potential
future acquisition. Finally, there can be no assurance that the management or
technical, marketing or other personnel that join Inter-Tel from the Executone
acquisition or any future acquisition will remain employed with Inter-Tel
following such acquisition. If the Company is unable to retain such personnel,
many of the assets and resources that made the target attractive may be lost.
Failure to successfully address these risks in the context of an acquisition
could cause the business and results of operations to suffer.
Moreover, the Company has substantially implemented various components of
MIS systems and software beginning in 1998 and completed the deployment of this
software in June 1999. Full
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implementation of this system software and the transition from the old system
software has required and will continue to require substantial financial
resources, time and personnel.
DEPENDENCE ON 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
relatively small number of suppliers and manufacturers and, accordingly, product
availability could be limited. However, the Company believes that alternate
sources of supply are available for virtually every component. All of the
Company's proprietary products are manufactured according to specifications and
conditions set by the Company. Each manufacturer must meet the Company's
specifications relating to the manufacturing process and quality assurance
before such manufacturer is selected by the Company. The Company currently
manufactures its products through 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 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 any supplier, or the Company's inability to develop in a timely
manner alternative or additional sources if and when required, could adversely
affect the Company's business, financial condition and operating results.
Although the Company does not have long-term supply contracts with any of its
contract manufacturers, to date it has been able to obtain supplies of
components and products in a timely manner. 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.
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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. There can be no assurance that any such dealer will not
promote the products of the Company's competitors to the detriment of the
Company's products. The loss of any significant dealer or group of dealers,
including those who distribute the Executone products, 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, could 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, Regional Bell Operating
Companies ("RBOCs"), Local Exchange Carriers ("LECs") and Competitive Local
Exchange Carriers ("CLECs"). The Company relies principally on these 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 carriers at prices favorable
to the Company. The Company's ability to continue to expand its long distance
and network services depends upon its ability to continue to secure reliable
long distance and network services from a number of long distance carriers,
RBOCs, LECs and CLECs 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; EXTENDED SALES CYCLE; 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, in particular the Executone
acquisition, 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
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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.
In the past 18 months, the Company introduced AXXESS networking systems and
software, which are typically sold to larger customers at a higher average
selling price. Our AXXESS networking products have a relatively high sales price
per unit, and often represent a significant and strategic decision by an
enterprise regarding its communications infrastructure. Accordingly, the
purchase of our products typically involves significant internal procedures
associated with the evaluation, testing, implementation and acceptance of new
technologies. This evaluation process frequently results in a lengthy sales
process, typically ranging from three months to more than nine months, and
subjects the sales cycle associated with the purchase of our products to a
number of significant risks, including budgetary constraints and internal
acceptance reviews. The length of our sales cycle also may vary substantially
from customer to customer. While our customers are evaluating our products and
before placing an order with us, we may incur substantial sales and marketing
expenses and expend significant management effort. Consequently, if sales
forecasted from a specific customer for a particular quarter are not realized in
that quarter, the Company's operating results could be materially adversely
affected.
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, investors' reactions to the acquisitions the
Company makes, general conditions in the telecommunications industry, the market
for Internet-related products and services 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 prices of technology companies in general,
and for Internet-based voice and data communications companies 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.
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YEAR 2000 READINESS
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, 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
readiness.
The Company has evaluated its level of exposure to the risks and costs
associated with Year 2000 problems and has substantially updated its information
systems with systems that are designed to be Year 2000 ready. The Company has
upgraded its long distance billing system, which is warranted by the
manufacturer to be Year 2000 ready. In addition, the Company has reviewed and
tested its lease billing and collections system, which is Year 2000 ready. The
Company has completed an assessment using outside vendors to perform detailed
reviews of the readiness of other information systems devices in use in the
Company's business. Anticipated upgrades or remediation performed for devices
that are not Year 2000 ready are included in the Company's capital expenditure
budget for 1999, and are expected to be either completed before year-end or
deemed unnecessary to the continuing operation of the business. The total cost
of each system is being or will be capitalized and depreciated in the normal
course of business. The Company believes that its critical information systems
are substantially Year 2000 ready and secondary systems and devices deemed
necessary for the operation of the business will be completed by the end of the
fourth quarter. The Company currently 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 ready, 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. In particular, although the Company undertakes due diligence
investigation of potential acquisition target companies with respect to their
level of Year 2000 readiness, the Company can give no assurance that the
products and internal systems of the companies that it acquires, including those
of Executone, are Year 2000 ready. Products currently manufactured by Inter-Tel
are designed to be Year 2000 ready and recent testing of such products by our
engineers have indicated that such products are Year 2000 ready in accordance
with our test procedures. Costs to develop and update the Company's products for
Year 2000 readiness have been part of the Company's ongoing research and
development efforts. Any disruption in manufacturing services provided by the
Company as a result of Year 2000 noncompliance could materially adversely affect
the Company's business, financial condition and results of operations. If any of
the Company's products or systems (including products and internal systems the
Company obtains through acquisitions of other companies) are not Year 2000
ready, or if certain non-ready products and systems are not replaced or
upgraded, 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 readiness. 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 readiness of the Company's products.
These customers and potential customers may also choose to defer purchasing Year
2000 ready 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 readiness 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
20
<PAGE>
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 readiness to these customers could materially adversely affect
the Company's business, financial condition and results of operations.
Inter-Tel is completing programs and has developed evolution strategies for
customers who own non-Year 2000 ready Inter-Tel products. Inter-Tel has begun
extensive efforts to alert customers who have such non-Year 2000 ready products,
including direct mailings, phone contacts and participation in user and industry
groups. Inter-Tel also has a Year 2000 web site that provides Year 2000 product
information.
Inter-Tel is continuing contingency planning to address potential increases
in demand for customer support resulting from the Year 2000 date change. The
Plan includes a team of employees dedicated to the specific problems of the Year
2000 change including monitoring key internal systems to insure continuation of
operations, and ongoing customer service in the beginning of the new year.
CONCENTRATION OF OWNERSHIP
As of September 30, 1999, 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.
21
<PAGE>
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 by February 6,
2000, 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits: Exhibit 27.1 - Financial Data Schedule for September 30, 1999
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 12, 1999 /s/ Steven G. Mihaylo
----------------------------------------
Steven G. Mihaylo,
Chairman of the Board,
Chief Executive Officer and President
Date November 12, 1999 /s/ Kurt R. Kneip
----------------------------------------
Kurt R. Kneip,
Vice President
and Chief Financial Officer
22
<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 SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1
<CASH> 63,564
<SECURITIES> 0
<RECEIVABLES> 53,586
<ALLOWANCES> 5,857
<INVENTORY> 18,589
<CURRENT-ASSETS> 150,036
<PP&E> 63,619
<DEPRECIATION> 28,539
<TOTAL-ASSETS> 219,739
<CURRENT-LIABILITIES> 54,412
<BONDS> 0
0
0
<COMMON> 104,432
<OTHER-SE> 52,025
<TOTAL-LIABILITY-AND-EQUITY> 219,739
<SALES> 225,113
<TOTAL-REVENUES> 225,113
<CGS> 113,933
<TOTAL-COSTS> 113,933
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 54
<INCOME-PRETAX> 31,271
<INCOME-TAX> 11,889
<INCOME-CONTINUING> 19,382
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,382
<EPS-BASIC> .75
<EPS-DILUTED> .72
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