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:
JUNE 30, 2000 0-10211
INTER-TEL, INCORPORATED
Incorporated in the State of Arizona I.R.S. No. 86-0220994
120 NORTH 44TH STREET, SUITE 200
PHOENIX, ARIZONA 85034-1822
(602) 302-8900
Common Stock
(26,424,825 shares outstanding as of June 30, 2000)
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
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) 3
Condensed consolidated balance sheets--June 30,
2000 and December 31, 1999 3
Condensed consolidated statements of operations -- three and six
months ended June 30, 2000 and June 30, 1999 4
Condensed consolidated statements of cash flows -- three and
six months ended June 30, 2000 and June 30, 1999 5
Notes to condensed consolidated financial statements --
June 30, 2000 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
PART II. OTHER INFORMATION 24
SIGNATURES 25
2
<PAGE>
PART I. FINANCIAL INFORMATION
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands) June 30, December 31,
2000 1999
--------- ------------
(Unaudited) (Audited)
ASSETS
CURRENT ASSETS
Cash and equivalents $ 29,170 $ 19,226
Accounts receivable - net 60,225 49,583
Inventories 29,977 18,816
Net investment in sales-leases 13,741 14,466
Restricted cash for acquisition -- 12,097
Deferred income taxes 27,165 --
Prepaid expenses and other assets 7,766 4,926
--------- ---------
TOTAL CURRENT ASSETS 168,044 119,114
PROPERTY, PLANT & EQUIPMENT 29,806 28,706
EQUIPMENT HELD UNDER LEASE, NET 4,520 5,310
GOODWILL AND OTHER INTANGIBLES 16,852 16,452
NET INVESTMENT IN SALES-LEASES 23,639 30,258
RESTRICTED CASH FOR ACQUISITION -- 32,203
OTHER ASSETS 4,745 8,206
--------- ---------
$ 247,606 $ 240,249
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 41,568 $ 20,540
Accrued expenses 29,470 25,937
Restructuring charges 4,825 --
Current maturities of long-term debt 1,040 525
Other current liabilities 11,993 11,187
--------- ---------
TOTAL CURRENT LIABILITIES 88,896 58,189
DEFERRED TAX LIABILITY 7,804 6,278
LONG TERM DEBT 2,954 1,231
OTHER LIABILITIES 13,322 6,430
SHAREHOLDERS' EQUITY
Common Stock 107,280 106,853
Less: shareholder loans (1,018) (1,116)
Retained earnings 38,093 75,835
Accumulated other comprehensive income 56 177
--------- ---------
144,411 181,749
Less: Treasury stock at cost (9,781) (13,628)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 134,630 168,121
--------- ---------
$ 247,606 $ 240,249
========= =========
See accompanying notes.
3
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
(In thousands, except Three Months Six Months
per share amounts) Ended June 30, Ended June 30,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
NET SALES $ 101,089 $ 77,788 $ 197,452 $ 143,313
Cost of sales 63,040 38,269 117,863 72,122
Cost of sales - Executone restructuring 7,639 -- 7,639 --
--------- --------- --------- ---------
Total cost of sales 70,679 38,269 125,502 72,122
GROSS PROFIT 30,410 39,519 71,950 71,191
Research & development 5,431 3,725 11,099 7,032
Selling, general and administrative 32,954 24,625 63,865 45,204
Restructuring charge 45,245 -- 45,245 --
In-process research and development -- -- 5,433 --
--------- --------- --------- ---------
83,630 28,350 125,642 52,236
--------- --------- --------- ---------
OPERATING INCOME (LOSS) (53,220) 11,169 (53,692) 18,955
Equity share of Cirilium Corp.'s net losses (2,215) -- (3,914) --
Interest and other income 396 491 673 925
Interest expense (62) (13) (137) (25)
--------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES (55,101) 11,647 (57,070) 19,855
INCOME TAXES (20,939) 4,426 (21,687) 7,542
--------- --------- --------- ---------
NET INCOME (LOSS) $ (34,162) $ 7,221 $ (35,383) $ 12,313
========= ========= ========= =========
NET INCOME (LOSS) PER SHARE-BASIC $ (1.30) $ 0.28 $ (1.34) $ 0.47
========= ========= ========= =========
NET INCOME (LOSS) PER SHARE-DILUTED $ (1.30) $ 0.27 $ (1.34) $ 0.46
========= ========= ========= =========
Average number of common shares
Outstanding - Basic 26,371 25,826 26,310 25,961
========= ========= ========= =========
Average number of common shares
Outstanding - Diluted 26,371 26,711 26,310 26,994
========= ========= ========= =========
</TABLE>
See accompanying notes.
4
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
(In thousands, except Three Months Six Months
per share amounts) Ended June 30, Ended June 30,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net Income (loss) (34,162) 7,221 (35,383) 12,313
Adjustments to reflect operating activities:
Depreciation and amortization 3,562 2,201 6,756 4,324
Non-cash portion of restructuring charge 41,783 -- 41,783 --
Purchased in-process research and
development -- -- 5,433 --
Changes in operating assets and liabilities (6,397) (5,704) (20,749) (12,511)
Other 6,546 3,701 12,303 6,934
-------- -------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 11,332 7,419 10,143 11,060
INVESTING ACTIVITIES
Additions to property and equipment and
operating leases (3,197) (4,435) (6,201) (9,380)
Proceeds from disposal of property
and equipment 4 1,999 11 1,999
Proceeds from disposition of business segment -- -- 6,602 --
Cash used in acquisitions -- (500) (1,647) (720)
-------- -------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES (3,193) (2,936) (1,235) (8,101)
FINANCING ACTIVITIES
Cash dividends paid (263) (262) (526) (522)
Payments on long-term debt (329) -- (551) --
Treasury stock purchases -- (6,682) -- (6,682)
Proceeds from stock issued under the ESPP 495 421 495 421
Proceeds from exercise of stock options 360 160 1,618 1,013
-------- -------- -------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 263 (6,363) 1,036 (5,770)
INCREASE (DECREASE) IN CASH AND EQUIVALENTS 8,402 (1,880) 9,944 (2,811)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 20,768 62,193 19,226 63,124
-------- -------- -------- --------
CASH AND EQUIVALENTS AT END OF PERIOD $ 29,170 $ 60,313 $ 29,170 $ 60,313
======== ======== ======== ========
</TABLE>
See accompanying notes.
5
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 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 six months ended June 30, 2000 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2000. 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, 1999.
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 Six Months Ended
per share amounts) June 30, 2000 June 30, 1999 June 30, 2000 June 30, 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Numerator:
Net income $(34,162) $ 7,221 $(35,383) $12,313
======== ======= ======== =======
Denominator:
Denominator for basic earnings per
share - weighted average shares 26,371 25,826 26,310 25,961
Effect of dilutive securities:
Employee and director stock options -- 885 -- 1,033
-------- ------- -------- -------
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 26,371 26,711 26,310 26,994
======== ======= ======== =======
Basic earnings per share $ (1.30) $ 0.28 $ (1.34) $ 0.47
======== ======= ======== =======
Diluted earnings per share $ (1.30) $ 0.27 $ (1.34) $ 0.46
======== ======= ======== =======
</TABLE>
NOTE C - ACQUISITIONS, DISPOSITIONS AND RESTRUCTURING CHARGES
EXECUTONE
On January 1, 2000 Inter-Tel purchased certain computer telephony assets
and assumed certain liabilities of Executone Information Systems, Inc.
("Executone") for $44.3 million in cash plus related acquisition costs, subject
to purchase price adjustments as of the closing date. Executone was based in
Milford, CT, with offices located in Poway, California and Oakton, Virginia.
Executone specialized in database design and systems integration for small- to
medium-size businesses that utilize advanced telecommunications products and
services. The
6
<PAGE>
Executone transaction was accounted for using the purchase method of
accounting. The aggregate purchase price was allocated to the fair value of the
assets and liabilities acquired, of which $5.4 million ($3.4 million after
taxes) was written-off as purchased in-process research and development. During
the first quarter of 2000, the Executone division recognized losses of
approximately $2.5 million ($1.5 million after taxes, or $.06 per diluted share)
excluding the charge for in-process research and development.
In connection with the Executone acquisition, the Company sold Executone's
manufacturing assets and liabilities to Varian Associates, Inc. ("Varian") of
Tempe, Arizona at a net book value of $6.6 million.
During the second quarter of 2000, the Executone division continued to
experience significant losses. The Executone division recognized pre-tax losses
during the second quarter and six months ended June 30, 2000 of $3.4 million, or
$2.1 million after-tax ($.08 per diluted share) and $5.9 million, or $3.6
million after-tax ($.14 per diluted share), respectively. As a result of these
losses, together with other considerations noted below, the Company decided to
close the primary Executone facility in Milford, Connecticut and to recognize a
restructuring charge related to the Executone operations. At the time the
original purchase was recorded, the Company had not anticipated closing the
Milford facility. After incurring higher than anticipated losses from Executone
operations and after a deterioration in the Executone business, including loss
of dealers and customers, delays in introduction and acceptance of new products,
the Company's management decided it was in the best interests of the Company and
its shareholders to close the Connecticut facility and consolidate its
operations into the Company's metro-Phoenix, Arizona facilities.
The Company has revised its acquisition plan and, accordingly, has
accounted for the restructuring of the Executone operations, including severance
and related costs, the shut down and consolidation of the Milford facility and
the impairment of assets associated with the restructuring. The Company has
finalized its plan for the exiting of activities and the involuntary termination
or relocation of employees in connection with the integration of Executone
operations. Accrued costs associated with this plan are estimates.
The Company formulated and announced plans during the second quarter for
the closure and consolidation of the Executone Milford facility. On May 22, the
Company announced that it would be closing the Executone facility in Milford and
consolidating the Executone operations into the Company's existing operations in
Arizona. On that date, members of the Company's management notified all of the
Executone employees of the plans to consolidate the facilities and each employee
was offered the opportunity to relocate to Arizona. The costs of employee
termination benefits related to the reduction of approximately 140 positions in
Milford relating to those employees who chose not to move, which represented
substantially all of the employees of that facility.
The Company expects that the consolidation of the Milford, CT facility will
be completed by the end of 2000, except for certain long-term contractual
obligations described below. The Company expects that the operations in Poway,
CA will be consolidated with the Arizona operations on or before the end of
2000. The Executone operation in Oakton, Virginia will remain in operation as a
sales office for Inter-Tel's Government Systems group.
In addition to the personnel severance, termination, plant closure and
other related costs attributable to the plant closing, the Company also recorded
a reserve for costs associated with building, furniture and equipment lease
obligations, as well as write-offs for impairment of assets, including
inventory, accounts and notes receivable, fixed assets and goodwill.
Inventories were impaired based on current sales prices compared to current
costs, the decision by a number of dealers to no longer sell the Executone
product, customer preference for Inter-Tel branded products over Executone
branded products, excess and obsolete inventory, and management's decision not
to pursue continued product development on new or existing product lines. During
the first six months of 2000, various dealers and customers failed to purchase
Executone products for new installations, purchased less products, took on
7
<PAGE>
competitive product lines and/or otherwise gave notice to the Company of the
intent to reduce or minimize further business transactions with the Company for
Executone products.
Exit costs associated with the closure of the Milford facility also include
liabilities for building, furniture and equipment lease, and other contractual
obligations. The Company is liable for the lease on the Milford buildings
through January 2005. Various furniture leases run concurrently through March
2002. Other capital leases for computer and other equipment terminate on varying
dates through September 2002. To date, other than a sublease agreement with
eLOT, Inc. for part of the facility and equipment, the Company has been unable
to sublease a significant portion of the buildings or the related furniture and
equipment. The reserve for lease and other contractual obligations is identified
in the table below.
The Executone business has operated at a cash deficit since the acquisition
date. Pre-tax operating losses for Executone totaled approximately $5.9 million
during the first six months of 2000, and the Company has experienced negative
cash flows during this same period. In addition to incurring ongoing losses from
Executone operations and business deterioration, the Company has experienced
loss of Executone dealers and customers, delays in introduction and acceptance
of new products, a deterioration in the accounts receivable agings, customer
preference for Inter-Tel branded products over the Executone brand and the lack
of continuity of personnel, including loss of key management and product
development personnel. As a result, the Company believes that the Executone
business now offers no value from the Executone business, products and related
trademark, brand and name. Dealer and customer lists have yielded much less
value than originally anticipated from the transaction. Accordingly, the Company
has increased its reserve for accounts receivable.
In addition, as part of the restructuring, the Company has recorded a
charge for impairment to the goodwill. For the six months ended June 30, 2000,
the Company experienced negative cash flows from the Executone division of
approximately $9.8 million. Revenues, customer orders for new installations of
Executone products, customer and employee retention, trade and brand name
recognition, and other reasons for initially purchasing the Executone computer
telephony business have fallen significantly below management expectations.
Accordingly, the Company has determined that no value exists in the goodwill
originally recorded for the Executone operations. Refer to the table below for
more information regarding the details of the charge.
The following tables summarize details of the restructuring charge in
connection with the Executone acquisition, including the description of the type
and amount of liabilities assumed.
RESERVE
CASH/ RESTRUCTURING BALANCE
DESCRIPTION NONCASH CHARGE ACTIVITY AT 6/30/00
----------- ------- ------ -------- ----------
(In thousands)
PERSONNEL COSTS:
Severance and termination costs Cash $(1,583) 134 $(1,449)
Other Plant closure costs Cash (230) 25 (205)
LEASE TERMINATION AND OTHER
CONTRACTUAL OBLIGATIONS (NET OF
ANTICIPATED RECOVERY):
Building and equipment leases Cash (7,444) 173 (7,271)
Other contractual obligations Cash (1,700) -- (1,700)
IMPAIRMENT OF ASSETS:
Inventories NonCash (5,939) 5,939 --
Accounts receivable NonCash (1,685) 1,685 --
Fixed assets NonCash (3,151) 3,151 --
Net intangible assets NonCash (29,184) 29,184 --
-------- --------
TOTAL (50,916) (10,625)
======== ========
Included in the total Executone restructuring costs of $50.9 million is a
$45.2 million restructuring charge for exit costs and asset impairment, and $7.6
million associated with the impairment of inventories, which has accordingly
been recorded as additional costs of sales. Refer to Management's Discussion and
Analysis for additional information.
INTER-TEL.NET
During the second quarter, Inter-Tel recorded a pre-tax charge associated
with Inter-Tel.net operations of $2.0 million ($1.2 million after-tax), related
to the write-down to net realizable value of the Vocal'Net servers in the
division's IP network and lease termination costs of redundant facilities.
Inter-Tel.net is in the process of adding new technology to be implemented
throughout the Inter-Tel.net network. The changes to the Inter-Tel.net network
are designed to improve the voice quality, design and interoperability, and to
allow Inter-Tel to better position itself to sell services to its enterprise
customers.
The pre-tax charge associated with Inter-Tel.net is related to the
write-down to net realizable value of the Vocal'Net servers in the division's IP
network, and lease termination costs of redundant facilities, summarized as
follows:
RESERVE
CASH/ RESTRUCTURING BALANCE
DESCRIPTION NONCASH CHARGE ACTIVITY AT 6/30/00
----------- ------- ------ -------- ----------
(In thousands)
LEASE TERMINATION OBLIGATIONS
(NET OF ANTICIPATED RECOVERY):
Building leases Cash (144) 27 (117)
IMPAIRMENT OF ASSETS:
Fixed assets NonCash (1,824) 1,824 --
------ ----
TOTAL (1,968) (117)
====== ====
NOTE D - PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE
During the first quarter of 2000, Inter-Tel completed the acquisition of
Executone (see NOTE C above). The aggregate purchase price of the Executone
acquisition was allocated to the fair value of the assets and liabilities
acquired, of which $5.4 million ($3.4 million after taxes), or $0.13 per diluted
share, was written-off as purchased in-process research and development.
Including this charge, the Company incurred net losses of $1.2 million ($0.05
per diluted share) for the first quarter ended March 31, 2000.
NOTE E - 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
9
<PAGE>
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.
Prior to this quarter, the Company had 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,
financial information disclosed previously materially represented all of the
financial information related to the Company's principal operating segment.
Although the operations of Executone are identified separately below, the
Executone operations are similar and comparable to the principal segment and
future disclosures will likely reflect the Executone operations combined with
the principal segment.
In the second quarter of 2000, the Company generated income from business
segments, including one-time charges, as follows:
<TABLE>
<CAPTION>
(in thousands, except per share PRINCIPAL INTER-
amounts) SEGMENT EXECUTONE CIRILIUM TEL.NET TOTAL
------- --------- -------- ------- -----
<S> <C> <C> <C> <C> <C>
Net sales $ 80,460 $ 13,638 $ -- $ 6,991 $ 101,089
Operating income (loss) 8,555 (54,218) -- (7,557) $ (53,220)
Equity Share of Cirilium Corp.'s net losses -- -- (2,215) -- (2,215)
Interest and other income 422 (27) -- 1 396
Interest expense (27) (35) -- -- (62)
Net income (loss) 5,549 (33,654) (1,373) (4,684) (34,162)
Net Income (loss) per share--diluted $ 0.21 $ (1.28) $ (0.05) $ (0.18) $ (1.30)
Average number of common
shares outstanding - diluted 27,063 26,371 26,371 26,371 26,371
</TABLE>
In December 1999, Inter-Tel entered into an agreement with Hypercom
Corporation to jointly form Cirilium Corporation ("Cirilium"). Cirilium
comprises parts of Hypercom's data and Inter-Tel's packet telephony products and
services, including Inter-Tel's Vocal'Net gateway products and technology.
The Company's revenues are generated predominantly in the United States.
Total revenues generated from U.S. customers totaled $98.4 million and $76.0
million of total revenues for the quarters ended June 30, 2000 and 1999,
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 second quarters of 2000 and 1999, revenues from customers
located internationally accounted for 2.6% and 2.2% of total revenues,
respectively.
10
<PAGE>
PART I.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report to Shareholders on Form 10-Q ("10-Q") contains
forward-looking statements that involve risks and uncertainties. The statements
contained in this 10-Q that are not purely historical are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
including without limitation statements regarding 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.
OVERVIEW
Inter-Tel is a leading provider of business telephone systems, voice
processing systems and related software applications for the 40+ station
telephone system market in the United Sates. Inter-Tel is also a leading
provider of IP telephony voice and data convergence products. Inter-Tel's
products include the AXXESS business telephone system, AXXESSORY TALK voice mail
system, Executone computer telephony products, and the InterPrise voice and data
routers. Inter-Tel also operates Inter-Tel.net, an IP telephony-based long
distance network. The Company also provides maintenance, leasing and support
services for its products. The Company's Common Stock is quoted on the Nasdaq
National Market System under the symbol INTL.
RESULTS OF OPERATIONS
Net sales for the second quarter of 2000 increased 30.0% to $101.1 million,
compared to $77.8 million in the second quarter of 1999. Net sales increased
37.8% to $197.5 million in the first six months of 2000, compared to $143.3
million in the first six months of 1999. For the quarter and six months ended
June 30, 2000, sales from wholesale distribution and direct sales offices
accounted for approximately $14.5 million and $42.6 million, respectively, of
the increase in net sales. The increase in net sales was also attributable to
increases in sales of network services.
The following table sets forth certain statement of operations data of the
Company expressed as a percentage of net sales for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2000 1999 2000 1999
------ ------ ------ ------
NET SALES 100.0% 100.0% 100.0% 100.0%
Cost of sales 62.4 49.2 59.7 50.3
Cost of sales - Executone
Restructuring 7.6 0.0 3.9 0.0
------ ------ ------ ------
Total cost of sales 69.9 49.2 63.6 50.3
GROSS PROFIT 30.1 50.8 36.4 49.7
Research and development 5.4 4.8 5.6 4.9
Selling, general and
administrative 32.6 31.6 32.3 31.5
Restructuring Charge 44.7 0.0 22.9 0.0
IPRD write-off 0.0 0.0 2.8 0.0
------ ------ ------ ------
11
<PAGE>
OPERATING INCOME (52.6) 14.4 (27.2) 13.3
Equity Share of Cirilium
Corp's net losses (2.2) 0.0 (2.0) 0.0
Interest and other income 0.4 0.6 0.3 0.6
Interest expense (0.1) 0.0 (0.1) 0.0
Income taxes (20.7) 5.7 (11.0) 5.3
------ ------ ------ ------
Net income (loss) (33.8)% 9.3% (17.9)% 8.6%
====== ====== ====== ======
Included in the table above are total Executone restructuring costs of
$50.9 million. The restructuring charge for exit costs and asset impairment
represents $45.2 million, and the remaining $7.6 million is associated with the
impairment of inventories, which has accordingly been recorded as additional
costs of sales. The restructuring costs are the result of management's decision
to close the primary Executone facility in Milford, Connecticut and to recognize
a restructuring charge related to the entire Executone operations. After
incurring higher than anticipated losses from Executone operations and
experiencing a material deterioration in the business, including loss of dealers
and customers, delays in introduction and acceptance of new products, management
decided it was in the best interests of the Company and its shareholders to
close the Connecticut facility, consolidate the operations into the Company's
metro Phoenix, Arizona facilities and record the one-time charge.
Gross profit for the second quarter of 2000 excluding the Executone
restructuring costs was $38.0 million, or 37.6% of net sales, compared to $39.5
million, or 50.8% of net sales, for the second quarter of 1999. Gross profit
increased 11.8% to $79.6 million, or 40.3% of net sales, in the first six months
of 2000 compared to $71.2 million, or 49.7% of net sales, in the first six
months of 1999. Including the Executone restructuring cost of sales, gross
margin was 30.1% and 36.4% for the second quarter and six months ended June 30,
2000, respectively. Gross margins in the second quarter of 2000 excluding the
Executone restructuring costs decreased primarily as a result of lower margins
from Inter-Tel.net and the acquired Executone operations. To a lesser extent,
margins were lower as a result of sales channel and product mix, as well as
competitive pricing pressures. A smaller portion of the Company's sales
increases were through direct channels, where the Company has historically
generated higher margins, as compared to sales through the network services
group, which has generated lower gross margins.
Research and development expenses for the second quarter of 2000 increased
to $5.4 million, or 5.4% of net sales, compared to $3.7 million, or 4.8% of net
sales, for the second quarter of 1999. Research and development expenses
increased to $11.1 million, or 5.6% of net sales, in the first six months of
2000 compared to $7.0 million, or 4.9% of net sales, in the first six months of
1999. 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 platforms, call
processing and voice processing software, CTI products, unified messaging and IP
voice solutions. Costs were also incurred for new and sustaining product
development associated with the Executone operations. With the exception of the
acquired Executone operations, the Company expects that research and development
expenses will continue to increase in absolute dollars as the Company continues
to develop new software and to enhance existing technologies and products. These
expenses may vary in the future, however, as a percentage of net sales.
Selling, general and administrative expenses for the second quarter of 2000
increased in absolute dollars to $32.95 million compared to $24.6 million for
the second quarter of 1999. Selling, general and administrative expenses
increased to $63.9 million in the first six months of 2000 compared to $45.2
million in the first six months of 1999. The increases in absolute dollars and
as a percentage of net sales for the quarter and six months ended June 30, 2000,
were attributable in part to continued efforts to hire and train additional
sales personnel throughout Inter-Tel's direct sales offices. During the second
quarter, the Company analyzed productive and non-productive employees, and
through attrition and layoffs, incurred higher than anticipated costs. The
Company has also incurred additional personnel and marketing costs to support
the operations of Inter-Tel.net. The Company has incurred and will incur
additional costs associated with the closure of the Executone facility in
Milford, CT, including moving and integration costs that were not included in
12
<PAGE>
the one-time charge. With the exception of costs associated with the Executone
operations, 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.
On January 1, 2000 Inter-Tel purchased certain computer telephony assets
and assumed certain liabilities of Executone Information Systems, Inc. for $44.3
million in cash plus related acquisition costs, subject to purchase price
adjustments as of the closing date. Of the total purchase price, $5.4 million,
or $3.4 million after taxes, was written-off as purchased in-process research
and development.
In December 1999, Inter-Tel entered into an agreement with Hypercom
Corporation to jointly form Cirilium Corporation ("Cirilium"). Cirilium
comprises parts of Hypercom's data and Inter-Tel's packet telephony products and
services, including Inter-Tel's Vocal'Net gateway products and technology. The
Company owns approximately 45.25% of the outstanding capital stock of Cirilium.
Accordingly, the Company recorded the net losses of Cirilium as a single line
item below operating income. Pretax losses from Cirilium totaled $2.2 million
and $3.9 million for the quarter and six months ended June 30, 2000,
respectively.
During the second quarter, the Company recorded a one-time after-tax
restructuring charge of $31.6 million associated with the restructuring and
write-off of assets in connection with the acquired Executone operations,
including $4.7 million after-tax for the impairment of inventories included in
cost of sales. Included in the remaining after-tax charge of $26.9 million were
costs for the plant closure, severance and related termination benefits for
terminated employees, lease obligations and other contractual obligations, as
well as the impairment of accounts receivable, fixed assets and intangible
assets. In addition, during the second quarter, Inter-Tel recorded an after-tax
charge associated with Inter-Tel.net operations of $1.2 million, related to the
write-down to net realizable value of the Vocal'Net servers in the division's IP
network and lease termination costs of redundant facilities. The charges,
including the amounts attributable to cost of sales, reduced diluted earnings
per share by $1.24 per share and $1.25 per share for the second quarter and six
months ended June 30, 2000, respectively.
Other income in both periods consisted primarily of interest income and
foreign exchange rate gains and losses. Income from interest decreased in both
comparable periods of 2000 based on a lower level of invested funds. Other
changes in other income primarily reflected differences in net foreign exchange
rate gains and losses.
Net loss for the second quarter was $34.2 million (loss of $1.30 per
diluted share), compared to net income of $7.2 million ($0.27 per diluted share)
for the second quarter of 1999, reflecting the charges (including cost of sales)
associated with the Executone and Inter-Tel.net operations noted above. Net loss
for the six months ended June 30, 1999 was $35.4 million (loss of $1.34 per
diluted share), compared to net income of $12.3 million, or $0.46 per diluted
share, in the first six months of 1999, reflecting again the charges noted
above. Excluding such charges, net loss for the quarter ended June 30, 2000
would have been reduced to $1.4 million (loss of $0.05 per share). Moreover,
excluding the charges, net income for the six months ended June 30, 1999 would
have been $773,000 ($0.03 per diluted share).
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 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.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2000, the Company had $29.2 million in cash and equivalents,
which represented an increase of approximately $9.9 million from December 31,
1999. On June 1, 2000, the Company increased its unsecured revolving line of
credit with Bank One, Arizona, NA to $25 million. This credit facility is
13
<PAGE>
available through June 1, 2002. Under the credit facility, the Company has the
option to borrow at a prime rate or adjusted LIBOR interest rate. Historically,
the Company has used the credit facility primarily to support international
letters of credit to suppliers. On December 31, 1999, the Company paid cash of
approximately $44.3 million plus acquisition costs to purchase certain assets of
Executone. This transaction closed on January 1, 2000. The remaining cash
balances may be used to further 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 $10.1 million for the six
months ended June 30, 2000, compared to $11.1 million for the same period in
1999. The operating cash provided in the six months ended June 30, 2000 was
primarily the result of income from operations after considering the non-cash
portion of restructuring charges and the non-cash depreciation and amortization
charges. Cash used in operating assets and liabilities in the six month period
ended June 30, 2000 was $20.7 million, compared to $12.5 million in the same
period of 1999. During the first six months of 2000, the Company had higher
accounts receivable, inventory, and prepaid expenses and other assets than at
December 31, 1999, attributable primarily to the Executone acquisition. The
Company expects to expand sales through its direct sales office and dealer
networks, which is expected to require working capital for increased accounts
receivable and inventories. During the fist six months of 2000, accounts payable
and other current liabilities increased primarily as a result of the assumption
of liabilities of Executone.
Net cash used in investing activities, primarily in the form of cash used
for acquisitions, capital and operating lease expenditures, offset by cash
received from the disposition of the manufacturing operations of Executone to
Varian of $6.6 million, totaled $1.2 million for the six months ended June 30,
2000, compared to cash used of $8.1 million for the six months ended June 30,
1999. Net cash used in acquisitions totaled approximately $1.6 million in 2000.
Capital expenditures totaled approximately $6.2 million for the same period. The
Company anticipates additional capital expenditures during 2000, principally
relating to expenditures for equipment and management information systems used
in its operations, for facilities expansion and the Inter-Tel.net network and
operations.
Net cash provided by financing activities totaled $1.0 million in the six
months ended June 30, 2000 was primarily attributable to the proceeds from the
stock option and purchase plans, offset by payments for cash dividends and
long-term debt. For the six months ended June 30, 1999, net cash used in
financing activities of $5.8 million related primarily to treasury stock
purchases of $6.7 million and cash dividends paid, less proceeds from the stock
option and purchase plans.
The Company offers to its customers lease financing and other services,
including its Totalease program, through its Inter-Tel Leasing, Inc. 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 $180.2 million and $163.7 million remained unbilled at June 30, 2000
and December 31, 1999, 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 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 working capital and credit facilities,
together with cash generated from operations, will be sufficient to develop and
expand its business operations and the 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
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 additional financing. There
can be no assurance that additional financing will be available when required or
on acceptable terms.
14
<PAGE>
FACTORS THAT MAY AFFECT RESULTS OF FUTURE OPERATIONS
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. 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.
OUR MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND TO COMPETE SUCCESSFULLY,
WE MUST CONTINUALLY INTRODUCE NEW AND ENHANCED PRODUCTS AND SERVICES THAT
ACHIEVE BROAD MARKET ACCEPTANCE.
The market for our products and services is characterized by rapid
technological change, evolving industry standards and persistent customer demand
for new products, applications and services. To compete successfully, we must
continually enhance our existing telecommunications products, related software
and customer services as well as develop new technologies and applications in a
timely and cost-effective manner. If we fail to introduce new products and
services that achieve broad market acceptance, or do not adapt our existing
products and services to customer demands or evolving industry standards, our
business could be significantly harmed. In addition, current competitors or new
market entrants may offer products, applications or services that are better
adapted to changing technology or customer demands and could render our products
and services obsolete.
In addition, if the markets for IP network products or CTI applications
fail to develop as quickly as we anticipate, or if we are unable for any reason
to capitalize on any of these emerging market opportunities, our business,
financial condition and operating results could be significantly harmed.
OUR FUTURE SUCCESS LARGELY DEPENDS ON INCREASING COMMERCIAL ACCEPTANCE OF OUR
INTERPRISE PRODUCTS, AXXESS PLATFORM, AND RELATED COMPUTER TELEPHONY PRODUCTS.
During the past few years, we have introduced unified messaging on our
AXXESSORY TALK platform, developed a number of enhancements to our existing
AXXESS and AXXESSORY Talk platforms, introduced the Inter-Tel Vocal'Net Gateway
Server and the Inter-Tel Vocal'Net Service Provider Package, and in April 1999,
we released the InterPrise 400 voice and data router, our first of a family of
voice and data convergence products. Also, during October 1999, we released
AXXESS 5.1 and AXXESSORY TALK 5.1 software into production. During the past 12
months, sales of our AXXESS digital communications platforms and related
software have comprised a substantial portion of our net sales. We expect that
our 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. We cannot assure that these products or platforms will succeed in the
future. Our future success will also depend upon the market acceptance of our
other new products and enhancements.
WE FACE RISKS ASSOCIATED WITH THE INTER-TEL VOCAL'NET, INTER-TEL SERVICE
PROVIDER PACKAGE AND INTER-TEL INTERPRISE PRODUCTS.
Over the past 2 years, we have introduced the Inter-Tel Vocal'Net Server,
the Inter-Tel Service Provider Package, and Inter-Tel InterPrise products.
Although the Inter-Tel Vocal'Net gateways and Service Provider Package were
transferred to Cirilium in 1999, the products continue to be used in the
Inter-Tel.net network. However, we recently announced that we will replace the
Vocal'Net Servers currently in place in this network, and accordingly, we
wrote-down these assets to net realizable value as of June 30, 2000. We cannot
assure that the functionality, scalability, and reliability of the Inter-Tel
Vocal'Net gateways or its respective replacement technology, Inter-Tel Service
Provider Package and Inter-Tel InterPrise product lines will achieve broad
market acceptance. In addition, we cannot assure that these products will comply
with industry standards or that emerging industry standards will not render our
IP telephony products obsolete. If these products fail to achieve market
acceptance, our business, financial condition and operating results could be
significantly harmed.
15
<PAGE>
THE SUCCESS OF OUR JOINT VENTURE WITH HYPERCOM, AND THE MARKET ACCEPTANCE OF OUR
CIRILIUM VENTURE, AS WELL AS OUR OTHER IP NETWORK TELEPHONY PRODUCT AND SERVICE
OFFERINGS, IS UNCERTAIN AND IS SUBJECT TO RISKS THAT MAY PREVENT US FROM
ACHIEVING OUR OBJECTIVES.
In December 1999, Inter-Tel entered into an agreement with Hypercom
Corporation to jointly form Cirilium. Cirilium comprises parts of Hypercom's
data and Inter-Tel's packet telephony experience, products and services,
including Inter-Tel's Vocal'Net gateway products and technology. The market for
packet switched technology, as well as the market for data telephony products,
services and applications in general, is intensely competitive. Consequently, we
cannot assure that our expectations and objectives for the Cirilium venture with
Hypercom will be successfully attained. For the quarter ended June 30, 2000, we
recorded a pre-tax loss of $2.2 million, or $1.4 million after-tax (loss of
$0.05 per diluted share) related to our interest in Cirilium. In addition,
during the second quarter, we incurred a charge to write-down the Vocal'Net
Servers in the Inter-Tel.net network to net realizable value.
The prospects for market acceptance of the Cirilium venture, and other IP
telephony products acquired through our June 1998 purchase of TMSI assets, must
be considered in light of the uncertainties to which companies and products in
rapidly evolving markets such as IP network telephony are particularly exposed.
These uncertainties include:
* the continued expansion of the Internet and Internet infrastructures;
* the development of complementary products necessary to make the
Internet a viable commercial network;
* the continued expansion of other IP networks and IP network
infrastructures;
* the preservation of current volume, distance and time-of-day pricing
structures by IP networks;
* the successful management of access costs, network capacity and voice
transmission quality relating to IP network products and services;
* the resolution of critical issues concerning commercial use of the
Internet, such as security, reliability, cost, ease of use, access and
quality of service; and
* the ability of the Internet to meet additional demand or its users'
changing requirements on a timely basis and at a commercially
reasonable cost.
OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN ERRORS OR DEFECTS THAT ARE DETECTED
ONLY AFTER THEIR RELEASE, WHICH MAY CAUSE US TO INCUR SIGNIFICANT UNEXPECTED
EXPENSES AND LOST SALES.
Our telecommunications products are highly complex. Although our new
products and upgrades are examined and tested prior to release, they can only be
fully tested when used by a large customer base. Consequently, our customers may
discover program errors or other defects after new products and upgrades have
been released. Some of these errors or "bugs" may result from defects contained
in component parts or software from our suppliers or other third parties that
are intended to be compatible with our products and over which we have little or
no control. Although we have test procedures and quality control standards
designed to minimize the number of errors or other defects in our products, we
cannot assure that our new products and upgrades will be free of bugs when
released. If we are unable to quickly or successfully correct bugs identified
after release, we could experience:
* costs associated with the remediation of any problems;
* costs associated with design modifications;
* loss of or delay in revenues;
* loss of customers;
* failure to achieve market acceptance or loss of market share;
* increased service and warranty costs;
* legal actions by our customers; and
* increased insurance costs.
THE COMPLEXITY OF OUR PRODUCTS COULD CAUSE DELAYS IN THE DEVELOPMENT AND RELEASE
OF NEW PRODUCTS AND SERVICES. AS A RESULT, CUSTOMER DEMAND FOR OUR PRODUCTS
COULD DECLINE, WHICH COULD CAUSE OUR BUSINESS TO BE HARMED.
16
<PAGE>
Due to the complexity of our products, we have in the past and expect in
the future to experience delays in the development and release of new products
or product enhancements. If we fail to introduce new software, products or
services in a timely manner, or fail to release upgrades to our existing systems
or products on a regular and efficient basis, customer demand for our products
could decline and our business would be harmed.
THE EMERGING MARKET FOR INTERNET PROTOCOL NETWORK TELEPHONY IS SUBJECT TO MARKET
RISKS AND UNCERTAINTIES THAT COULD CAUSE SIGNIFICANT DELAYS AND EXPENSES.
The market for IP network voice communications products has begun to
develop only recently, is evolving rapidly and is characterized by an increasing
number of market entrants who have introduced or developed products and services
for Internet or other IP network voice communications. As is typical of a new
and rapidly evolving industry, the demand for and market acceptance of recently
introduced IP network products and services are highly uncertain. We cannot
assure that packet switched technology networks will become widespread. Even if
packet switched technology networks become widespread in the future, we cannot
assure that our products, particularly the Inter-Tel InterPrise product lines,
will successfully compete against other market players and attain broad market
acceptance.
Additional uncertainties involving the development of IP network telephony
could harm our business. The adoption of packet switched technology 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. Due to the lack of user control over network
infrastructure and individual system configuration, users of IP network voice
communications may experience delays in the transmission of speech, loss of
voice packets or 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 we anticipate, our IP network telephony
products could fail to achieve market acceptance, which in turn could
significantly harm our business, financial condition and operating results.
ANY BUSINESS ACQUISITIONS MAY DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE OR
DISTRACT MANAGEMENT ATTENTION.
As part of our business strategy, we consider acquisitions of, or
significant investments in, businesses that offer products, services and
technologies complementary to ours. Such acquisitions could materially adversely
affect our operating results and/or the price of our common stock. Acquisitions
also entail numerous risks, including:
* difficulty of assimilating the operations, products and personnel of
the acquired business;
* potential disruption of our ongoing business;
* unanticipated costs associated with the acquisition;
* inability of management to manage the financial and strategic position
of acquired or developed products, services and technologies;
* the division of management's attention from our core business;
* inability to maintain uniform standards, controls, policies and
procedures; and
* impairment of relationships with employees and customers which may
occur as a result of integration of the acquired business.
In particular, in January 2000, we acquired certain assets and liabilities
of Executone Information Systems, Inc. We were adversely affected by several of
the risks described above relating to our Executone acquisition, including the
risks related to unanticipated acquisition costs and impairment of employee and
customer relationships, which risks substantially harmed our operating results.
Specifically, our gross profit for the quarter ended June 30, 2000 was
negatively affected by Executone operations, which generated significant
operating losses, principally attributable to significant margin erosion in
Executone's system sales and sustained high operating costs. For these and other
reasons noted in the footnotes and in the section above titled Management's
Discussion and Analysis of financial condition and results of operations, we
wrote-off our investment in Executone.
17
<PAGE>
In addition to the risks related to acquisitions mentioned above, to the
extent that shares of our stock or the rights to purchase stock are issued in
connection with any future acquisitions, dilution to our existing shareholders
will result and our earnings per share may suffer. Any future acquisitions may
not generate additional revenue or provide any benefit to our business, and we
may not achieve a satisfactory return on our investment in any acquired
businesses.
WE MAY BECOME SUBJECT TO GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES THAT
COULD HARM OUR BUSINESS.
The regulatory environment for IP network telephony is subject to
substantial uncertainty. In the United States, we believe that there are
currently few laws or regulations directly applicable to packet switched
technology networks or to access to, or commerce on, IP networks generally.
Future changes in the regulatory environment, particularly in regulations
relating to the telecommunications industry, could significantly harm our
business. The increasing commercial acceptance of packet switched technology
networks, as well as other factors, may result in the future application or
adoption of a number of laws and regulations relating to the conduct of our
business as it relates to telecommunications, such as:
* fees or charges on users and providers of products and services;
* pricing;
* characteristics and quality of services;
* taxes;
* copyrights; and
* additional regulations and obligations upon on-line service providers.
Substantial government regulation or government imposition of fees,
charges, taxes or regulation may significantly harm the acceptance and
attractiveness of IP network voice communications. Also, we 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
addition, we may develop and release other products with new telecommunications
capabilities or services which could be subject to existing federal government
regulations or which could trigger the enactment of additional domestic or
foreign government regulations.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGY AND MAY BE
INFRINGING UPON THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS.
Our success depends upon our proprietary technology. We currently hold
patents for 18 telecommunication and unified messaging products and have also
applied to the U.S. Patent and Trademark Office for seven additional patents. We
also rely on copyright and trade secret law and contractual provisions to
protect our intellectual property. Despite these precautions, third parties
could copy or otherwise obtain and use our technology without authorization, or
develop similar technology independently.
We cannot assure that any patent, trademark or copyright that we own or
have applied to own, will not be invalidated, circumvented or challenged by a
third party. Effective protection of intellectual property rights may be
unavailable or limited in foreign countries. We cannot assure that the
protection of our proprietary rights will be adequate or that competitors will
not independently develop similar technology, duplicate our services or design
around any patents or other intellectual property rights we hold. Litigation may
be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Litigation could be costly, absorb significant management time and
harm our business.
We also cannot assure that third parties will not claim our current or
future products or services infringe upon their rights. Occasionally, we are
subject to proceedings alleging that certain of our key products infringed upon
third party intellectual property rights, including patents, trademarks,
copyrights, or other intellectual property rights. We recently received a letter
and viewed a presentation from one of our primary competitors, Lucent, alleging
that our AXXESS digital communications platform utilizes inventions covered by
certain of such competitor's patents. We are continuing the process of
investigating this matter. Additionally, we recently received a letter from AT&T
18
<PAGE>
alleging that certain of our IP products infringe upon certain intellectual
property protected by AT&T's patents. This matter is also being investigated.
When any such claims are asserted against us, we may seek to license the third
party's intellectual property rights. Purchasing such licenses can be expensive,
and we cannot assure that a license will be available on prices or other terms
acceptable to us, if at all. Alternatively, we could resort to litigation to
challenge such a claim. Litigation could require us to expend significant sums
of cash and divert our management's attention. In the event that a court renders
an enforceable decision with respect to our intellectual property, we may be
required to pay significant damages, develop non-infringing technology or
acquire licenses to the technology that is the subject of the infringement. Any
of these actions or outcomes could harm our business, financial condition and
operating results. If we are unable or choose not to license technology, or
decide not to challenge a third party's rights, we could encounter substantial
and costly delays in product introductions. These delays could result from
efforts to design around asserted third party rights or our discovery that the
development, manufacture or sale of products requiring these licenses could be
foreclosed.
OUR IP NETWORK PRODUCTS MAY BE VULNERABLE TO VIRUSES, OTHER SYSTEM FAILURE RISKS
AND SECURITY CONCERNS.
The Inter-Tel InterPrise, ClearConnect, AXXESS NT-CPU, and AXXESSORY Talk
products may be vulnerable to computer viruses or similar disruptive problems.
Computer viruses or problems caused by third parties could lead to
interruptions, delays or cessation of service that could harm our operations and
revenues. In addition, we may lose customers if inappropriate use of the
Internet or other IP networks by third parties jeopardized the security of
confidential information, such as credit card or bank account information or the
content of conversations over the IP network. User concerns about privacy and
security may cause IP networks in general to grow more slowly, and impair market
acceptance of our IP network products in particular, until more comprehensive
security technologies are developed.
WE MAY EXPERIENCE DIFFICULTIES DEVELOPING, MAINTAINING AND IMPROVING THE QUALITY
OF INTER-TEL.NET, OUR INTERNAL IP NETWORK, AND REQUIRE MORE DEPENDENCE ON
THIRD-PARTY SUPPLIERS OF TELECOMMUNICATIONS AND NETWORK TRANSMISSION SERVICES.
The Company is currently utilizing Cirilium's Inter-Tel Vocal'Net
technology until the new replacement technology is installed, and utilizing
Inter-Tel InterPrise products to develop and expand our own IP long-distance
network, Inter-Tel.net, to carry voice and data traffic. The Inter-Tel.net
network is currently in the process of deployment and, accordingly, is subject
to risks and uncertainties. As noted earlier, we will replace the Vocal'Net
Servers in the Inter-Tel.net network to allow for deployment of new technology
and greater interoperability of the network. To date, the Inter-Tel.net network
has established domestic 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, and international points of presence
in Hong Kong, Monterey, Puebla, Mexico City and Guadalajara. In addition,
Inter-Tel.net has alliances with other third party domestic and international IP
long distance providers to originate and terminate calls. If the domestic or
international market for IP network products fails to develop or develops more
slowly than we anticipate, or if we experience difficulty in the integration of
the TMSI technology, our Inter-Tel.net network could become financially
burdensome to maintain or obsolete, which could harm our business.
In addition, we are dependent on third-party or affiliate suppliers of
telecommunications and Internet network transmission services for implementation
of Inter-Tel.net, and we currently do not have long-term contracts with these
suppliers. The successful expansion of Inter-Tel.net depends on our ability to
obtain services from these suppliers. Some of these suppliers are or may become
our competitors and have not agreed to restrict competition against us. If these
suppliers raise rates, change pricing structures, experience power or bandwidth
outages, or suffer delays in provision of local circuits, our operations and
business may be harmed. We cannot assure that there will not be a significant
disruption of service provided by these suppliers, now or in the future, that
would harm our ability to provide undisrupted services to our customers. We also
cannot assure that products developed by our suppliers will not suffer from
speed and scalability problems that could harm our business.
19
<PAGE>
Moreover, although we have devoted and intend to continue devoting
substantial resources to improving the quality of telephone conversations using
technology that will replace Cirilium's Inter-Tel Vocal'Net, Inter-Tel
InterPrise products, and the Inter-Tel.net network, we cannot assure that we
will be able to eliminate or reduce the problems of voice communications over
the Inter-Tel.net network, such as delays in the speech transmission, loss of
voice packets and poor sound quality. If we fail to improve the sound quality
and other limitations of voice communications over the Inter-Tel.net network and
to offer such improvements to our customers on a cost-effective basis, the
Inter-Tel.net network could fail to achieve market acceptance and our business,
financial condition and operating results would suffer.
WE HAVE MANY COMPETITORS AND EXPECT NEW COMPETITORS TO ENTER OUR MARKET, WHICH
COULD PUT PRESSURES ON US.
The markets for our products and services are extremely competitive and we
expect competition to increase in the future. Our current and potential
competitors primarily include:
* PABX and core systems providers such as Lucent, Nortel, Comdial,
Iwatsu, Mitel, NEC, Nitsuko, Panasonic, Siemens and Toshiba;
* large data routing companies such as Cisco Systems and 3Com;
* voice processing applications providers such as AVT, Active Voice,
Centigram and Lucent;
* long distance services providers such as AT&T, MCI WorldCom, Sprint
and Qwest Communications;
* IP telephony product and service providers such as Clarent, Lucent,
NetSpeak, Nortel, VocalTec, Nokia, ITXC, deltathree.com, Net2Phone,
Cirilium and others;
* our current vendors, such as Cisco Systems, Nortel, 3Com, Motorola and
MICOM;
* large computer corporations such as Microsoft and IBM; and
* regional Bell operating companies, or RBOCs, cable television
companies and satellite and other wireless broadband service
providers.
These and other companies may form strategic relationships with each other
to compete with us. These relationships may take the form of strategic
investments, joint-marketing agreements, licenses or other contractual
arrangements, which arrangements increase our competitors' ability to address
customer needs with their product and service offerings.
Many of our competitors and potential competitors have substantially
greater financial, customer support, technical and marketing resources, larger
customer bases, longer operating histories, greater name recognition and more
established relationships in the industry than we do. We cannot be sure that we
will have the resources or expertise to compete successfully in the future. Our
competitors may be able to:
* develop and expand their product and service offerings more quickly;
* adapt to new or emerging technologies and changing customer needs
faster;
* take advantage of acquisitions and other opportunities more readily;
* negotiate more favorable licensing agreements with vendors;
* devote greater resources to the marketing and sale of their products;
and
* address customers' service-related issues better.
Some of our competitors may also be able to provide customers with
additional benefits at lower overall costs or to reduce their application
service charges aggressively in an effort to increase market share. We cannot be
sure that we will be able to match cost reductions by our competitors. In
addition, we believe that there is likely to be consolidation in our markets,
which could lead to increased price competition and other forms of competition
that could cause our business to suffer.
OUR RELIANCE ON A LIMITED NUMBER OF SUPPLIERS FOR KEY COMPONENTS AND OUR
INCREASING DEPENDENCE ON CONTRACT MANUFACTURERS COULD IMPAIR OUR ABILITY TO
MANUFACTURE AND DELIVER OUR PRODUCTS AND SERVICES IN A TIMELY MANNER.
We currently obtain certain key components for our digital communication
platforms, including certain microprocessors, integrated circuits, power
supplies, voice processing interface cards and IP telephony cards, from a
20
<PAGE>
limited number of suppliers and manufacturers. Our reliance on these limited
suppliers and contract manufacturers involves certain risks and uncertainties,
including the possibility of a shortage or delivery delay for certain key
components, although we believe that alternate sources are available for most
key components. We currently manufacture our 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 our control. Varian currently manufactures a significant portion
of our products at Varian's Tempe, Arizona and Poway, California facilities,
including substantially all of the printed circuit boards used in the AXXESS and
Inter-Tel Axxent digital communication platforms as well as substantially all of
the Executone Computer Telephony products. Although we set manufacturing
specifications and conditions for our products, and all of our contract
manufacturers must meet our requirements for manufacturing process and quality
assurance before we enter into manufacturing agreements, we have occasionally
experienced delays in the supply of components and finished goods. We cannot
assure that we will not experience similar delays in the future.
Our reliance on third party manufacturers involves a number of additional
risks, including reduced control over delivery schedules, quality assurance and
costs. Our business may be harmed by any delay in delivery or any shortage of
supply of components or finished goods from a supplier. Our business may also be
harmed if we cannot efficiently develop alternative or additional sources if
necessary. To date, we have been able to obtain supplies of components and
products in a timely manner even though we do not have long-term supply
contracts with any of our contract manufacturers. However, we cannot assure that
we 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.
WE RELY ON OUR DEALER NETWORK FOR A SUBSTANTIAL PORTION OF OUR NET SALES AND IF
THESE DEALERS DO NOT EFFECTIVELY PROMOTE AND SELL OUR PRODUCTS, OUR BUSINESS AND
OPERATING RESULTS COULD BE HARMED.
A substantial portion of our net sales is made through our network of
independent dealers. We face intense competition from other telephone system and
voice processing system manufacturers for these dealers' business, as most of
our dealers carry products that compete with our products. We cannot assure that
any of our dealers will not promote the products of our competitors to our
detriment. The loss of any significant dealer or group of dealers, or any event
or condition harming our dealer network, could harm our business, financial
condition and operating results.
IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL AS
NECESSARY, WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE GROWTH IN OUR BUSINESS OR
ACHIEVE OUR OBJECTIVES.
We depend on the continued service of, and our ability to attract and
retain, qualified technical, marketing, sales and managerial personnel, many of
whom would be difficult to replace. Competition for qualified personnel is
intense, and we have had difficulty hiring employees in the timeframe that we
desire, particularly skilled engineers. Our loss of any key personnel or our
failure to effectively recruit additional key personnel could make it difficult
for us to manage our business, make timely product introductions and meet other
key objectives and therefore harm our business. For example, our inability to
retain key executives of Executone following our Executone acquisition has
impaired our ability to benefit from the Executone business and to grow revenues
from the Executone assets. We cannot assure that we will be able to continue
attracting and retaining the qualified personnel necessary for the development
of our business.
Moreover, the growth in our business has placed, and is expected to
continue to place, a significant strain on our personnel, management and other
resources. Our ability to manage any future growth effectively will require us
to successfully attract, train, motivate and manage new employees, to integrate
new employees into our overall operations and to continue to improve our
operational, financial and management information systems.
21
<PAGE>
GOVERNMENT REGULATION OF THIRD PARTY LONG DISTANCE AND NETWORK SERVICE ENTITIES
ON WHICH WE RELY MAY HARM OUR BUSINESS
Our supply of telecommunications services and information depends on
several long distance carriers, RBOCs, local exchange carriers, or LECs, and
competitive local exchange carriers, or CLECs. We rely on these carriers to
provide network services to our customers and to provide us with billing
information. Long distance services are subject to extensive and uncertain
governmental regulation on both the federal and state level. We cannot assure
that the increase in regulations will not harm our business. Our current
contracts for the resale of services through long distance carriers include
multi-year periods during which we have minimum use requirements and/or costs.
The market for long distance services is experiencing, and is expected to
continue experiencing significant price competition, and this may cause a
decrease in end-user rates. We cannot assure that we will meet minimum use
commitments, that we will be able to negotiate lower rates with carriers if
end-user rates decrease or that we will be able to extend our contracts with
carriers at favorable prices. If we are unable to secure reliable long distance
and network services from certain long distance carriers, RBOCs, LECs and CLECs,
or if these entities are unwilling to provide telecommunications services and
billing information to us on favorable terms, our ability to expand our own long
distance and network services will be harmed.
THE INTRODUCTION OF NEW PRODUCTS AND SERVICES HAS RESULTED IN CHANGES TO OUR
SALES CYCLES AND BACKLOG WHICH MAY CAUSE FLUCTUATIONS IN OUR QUARTERLY RESULTS.
In the past few years, we 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
our 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, our operating results
could be materially adversely affected.
Our quarterly operating results have historically depended on, and may
fluctuate in the future as a result of, many factors including:
* volume and timing of orders received during the quarter;
* the mix of products sold;
* the mix of distribution channels;
* general economic conditions;
* patterns of capital spending by customers;
* the timing of new product announcements and releases by us and our
competitors;
* the operating results of Cirilium, which are largely beyond our
ability to control;
* pricing pressures, the cost and effect of acquisitions, in particular
the Executone acquisition; and
* the availability and cost of products and components from our
suppliers.
In addition, we have historically operated with a relatively small backlog,
with sales and operating results in any quarter principally dependent on orders
booked and shipped in that quarter. This results primarily from our customers'
desire for immediate shipment and installation of platforms and software. In the
past, we have recorded a substantial portion of our net sales for a given
quarter in the third month of that quarter, with a concentration of such net
sales in the last two weeks of the quarter. Market demand for investment in
capital equipment such as 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. We cannot assure that historical trends
for small backlog will continue in the future.
22
<PAGE>
Our expense levels are based in part on expectations of future sales and,
if sales levels do not meet expectations, operating results could be harmed.
Because sales of digital communication platforms through our dealers produce
lower gross margins than sales through our direct sales organization, operating
results have varied, and will continue to vary based upon the mix of sales
through direct and indirect channels. Although to date we have been able to
resell the rental streams from leases under our 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 our core business, have grown in recent periods at a faster
rate than our overall net sales. As a result, gross margins could be harmed if
long distance calling services continue to increase as a percentage of net
sales. In addition, we experience seasonal fluctuations in our 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, we have historically experienced, and could continue
to experience in the future, fluctuations in sales and operating results on a
quarterly basis. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, IMPAIRING YOUR ABILITY
TO SELL YOUR SHARES AT OR ABOVE PURCHASE PRICE.
The market price for our Common Stock has been highly volatile. We cannot
assure that you will be able to sell your shares at or above purchase price. The
volatility of our stock could be subject to continued wide fluctuations in
response to many risk factors listed in this section, and others beyond our
control, including:
* announcements of developments relating to our business;
* fluctuations in our operating results;
* shortfalls in revenue or earnings relative to securities analysts'
expectations;
* announcements of technological innovations or new products or
enhancements by us or our competitors;
* announcements of acquisitions or planned acquisitions of other
companies or businesses;
* investors' reactions to acquisition announcements;
* general conditions in the telecommunications industry;
* the market for Internet-related products and services
* changes in the national or worldwide economy;
* changes in legislation or regulation affecting the telecommunications
industry;
* an outbreak of hostilities;
* developments relating to our and third party intellectual property
rights; and
* changes in our relationships with our customers and suppliers.
In addition, 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 in recent years which
have often been unrelated to the operating performance of affected companies. We
cannot assure that the market price of our Common Stock will not experience
significant fluctuations in the future, including fluctuations that are
unrelated to our performance.
YEAR 2000 COMPLICATIONS MAY DISRUPT OUR OPERATIONS AND HARM OUR BUSINESS.
The date fields coded in many software products and computer systems need
to be able to distinguish 21st century dates from the 20th century dates,
including leap year calculations. The failure to be able to accurately
distinguish these dates is commonly known as the year 2000 problem. While we
have yet to experience any material year 2000 problems, the computer software
programs and operating systems used in our internal operations, including our
financial, product development, order management and manufacturing systems,
could experience errors or interruptions due to the year 2000 problem. In
addition, it is possible that our suppliers' and service providers' failure to
adequately address the year 2000 problem could have an adverse effect on their
operations, which, in turn, could have an adverse impact on us.
23
<PAGE>
OUR CHAIRMAN OF THE BOARD OF DIRECTORS, CEO AND PRESIDENT WILL CONTROL 20.5% OF
OUR COMMON STOCK AND BE ABLE TO SIGNIFICANTLY INFLUENCE MATTERS REQUIRING
SHAREHOLDER APPROVAL
As of June 30, 2000, Steven G. Mihaylo, the Company's Chairman of the Board
of Directors, Chief Executive Officer and President beneficially owned
approximately 20.5% of the outstanding shares of the Common Stock. As a result,
he has the ability to exercise significant influence over all matters requiring
shareholder approval. In addition, the concentration of ownership could have the
effect of delaying or preventing a change in control of the Company.
Any of the foregoing could result in a material adverse effect on the
Company's business, financial condition and operating results.
INTER-TEL, INCORPORATED AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS--NOT APPLICABLE
ITEM 2. CHANGES IN SECURITIES--NOT APPLICABLE
ITEM 3. DEFAULTS ON SENIOR SECURITIES--NOT APPLICABLE
24
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
1. On May 3, 2000, 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 16,237,162 375,896
J. Robert Anderson 16,235,862 377,196
Jerry W. Chapman 16,233,722 379,336
Gary D. Edens 16,236,072 376,986
C. Roland Haden 16,236,384 376,674
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 January 3, 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 June 30, 2000
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: August 14, 2000 /s/ Steven G. Mihaylo
----------------------------------------
Steven G. Mihaylo,
Chairman of the Board,
Chief Executive Officer and President
Date: August 14, 2000 /s/ Kurt R. Kneip
----------------------------------------
Kurt R. Kneip,
Vice President
and Chief Financial Officer
24
