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:
March 31, 2001 0-10211
INTER-TEL, INCORPORATED
Incorporated in the State of Arizona I.R.S. No. 86-0220994
120 NORTH 44TH STREET, SUITE 200
PHOENIX, ARIZONA 85034-1822
(602) 302-8900
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Title of Class Outstanding as of March 31, 2001
-------------- --------------------------------
Common Stock, no par value 24,556,374
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
INDEX
INTER-TEL, INCORPORATED AND SUBSIDIARIES
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited) 3
Condensed consolidated balance sheets--March 31, 2001
and December 31, 2000 3
Condensed consolidated statements of income--three
months ended March 31, 2001 and March 31, 2000 4
Condensed consolidated statements of cash flows--three
months ended March 31, 2001 and March 31, 2000 5
Notes to condensed consolidated financial Statements--
March 31, 2001 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 23
PART II. OTHER INFORMATION 23
SIGNATURES 25
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands) March 31, December 31,
2001 2000
(Unaudited) (Note A)
----------- --------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 3,114 $ 27,103
Accounts receivable 65,249 61,482
Inventories 35,390 35,060
Net investment in sales-leases 15,655 14,629
Income taxes receivable 7,964 9,157
Deferred income taxes 14,347 13,116
Prepaid expenses and other assets 7,740 7,668
Restricted cash for acquisition 5,496 --
--------- ---------
TOTAL CURRENT ASSETS 154,955 168,215
PROPERTY, PLANT & EQUIPMENT 33,916 32,723
EQUIPMENT HELD UNDER LEASE, NET 342 423
GOODWILL AND OTHER INTANGIBLES 18,976 18,389
NET INVESTMENT IN SALES-LEASES 21,670 22,808
OTHER ASSETS 498 568
--------- ---------
$ 230,357 $ 243,126
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 32,120 $ 35,438
Current maturities of L-T debt 1,952 1,766
Other current liabilities 46,116 45,003
--------- ---------
TOTAL CURRENT LIABILITIES 80,188 82,207
DEFERRED TAX LIABILITY 5,059 5,222
LONG TERM DEBT 4,310 3,720
OTHER LIABILITIES 16,148 15,541
SHAREHOLDERS' EQUITY
Common Stock 109,132 109,132
Less: Shareholder loans (1,018) (1,018)
Retained earnings 46,860 44,099
Accumulated other comprehensive income 62 (280)
--------- ---------
155,036 151,933
Less: Treasury stock at cost (30,384) (15,497)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 124,652 136,436
--------- ---------
$ 230,357 $ 243,126
========= =========
See accompanying notes.
3
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended
(In thousands, except -------------------------------
per share amounts) March 31, 2001 March 31, 2000
- ------------------ -------------- --------------
NET SALES $ 93,703 $ 96,363
Cost of sales 54,055 54,823
-------- --------
GROSS PROFIT 39,648 41,540
Research & development 4,139 5,668
Selling, general, and administrative 32,055 30,911
In-process research and development -- 5,433
-------- --------
36,194 42,012
OPERATING INCOME (LOSS) 3,454 (472)
-------- --------
Equity Share of Cirilium Corp.'s net losses -- (1,699)
Interest and other income 167 342
Loss on foreign translation adjustments (303) (65)
Interest expense (227) (75)
-------- --------
INCOME (LOSS) BEFORE INCOME TAXES 3,091 (1,969)
Income tax provision (benefit) 1,143 (748)
-------- --------
NET INCOME (LOSS) $ 1,948 $ (1,221)
-------- --------
NET INCOME (LOSS) PER SHARE
Basic $ 0.08 $ (0.05)
======== ========
Diluted $ 0.08 $ (0.05)
======== ========
Weighted average basic common shares 25,500 26,249
======== ========
Weighted average diluted common shares 25,843 26,249
======== ========
See accompanying notes.
4
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended
----------------------------------
(In thousands) March 31, 2001 March 31, 2000
- -------------- -------------- --------------
OPERATING ACTIVITIES
Net income (loss) $ 1,948 $ (1,221)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 3,000 3,194
Provision for losses on receivables 2,575 1,993
Provision for inventory valuation 535 3,366
Decrease (Increase) in other liabilities 607 (1,118)
Loss on sale of property and equipment 25 127
Deferred income taxes (1,394) 2,658
Effect of exchange rate changes 342 (260)
Purchased in-process research and development -- 5,433
Changes in operating assets and liabilities (3,725) (15,361)
-------- --------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 3,913 (1,189)
INVESTING ACTIVITIES
Additions to property and equipment (3,088) (2,963)
Additions to operating leases -- (41)
Proceeds from disposal of property and equipment 18 7
Proceeds from disposition of business segment -- 6,602
Cash used in acquisitions (11,520) (1,647)
-------- --------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (14,590) 1,958
-------- --------
FINANCING ACTIVITIES
Cash dividends paid (260) (262)
Treasury stock purchases (14,141) --
Payments on term debt (319) (222)
Proceeds from term debt 1,095 --
Proceeds from exercise of stock options 313 1,257
-------- --------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (13,312) 773
-------- --------
(DECREASE) INCREASE IN CASH AND EQUIVALENTS (23,989) 1,542
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 27,103 19,226
-------- --------
CASH AND EQUIVALENTS AT END OF PERIOD $ 3,114 $ 20,768
======== ========
See accompanying notes.
5
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2001
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation of
the results for the interim periods presented have been included. Operating
results for the three months ending March 31, 2001 are not necessarily
indicative of the results that may be expected for the year ended December 31,
2001. The balance sheet at December 31, 2000 has been derived from the audited
financial statements at that date, but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. 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, 2000.
Certain prior year amounts have been reclassified to conform with the current
period presentation.
From December 1999 to September 2000, the Company owned more than 20% but less
than 50% of Cirilium Corporation ("Cirilium"). Therefore, the Company recorded
the activity of Cirilium using the equity method of accounting during that
period. The Company wrote-off its investment in Cirilium in September 2000, and
reduced its ownership interest below 20%. As a result, since that time, and for
the first quarter ended March 31, 2001, the Company no longer used the equity
method of accounting for the Cirilium investment.
RECENT ACCOUNTING PRONOUNCEMENTS. In June 1998, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet and measure those investments at fair value.
Implementation of this standard has been delayed by the FASB for a twelve-month
period. The Company adopted SFAS 133 in the first quarter of fiscal 2001 with no
effect to the Company's operations or financial position.
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 for which
the 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:
(In thousands, except Three Months Ended
per share amounts) March 31, 2001 March 31, 2000
- ------------------ -------------- --------------
Numerator:
Net Income $ 1,948 $ (1,221)
------- --------
Denominator:
Denominator for basic earnings per
share - weighted average shares 25,500 26,249
6
Effect of dilutive securities:
Employee and director stock options 343 --
------- --------
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 25,843 26,249
------- --------
Basic earnings per share $ 0.08 $ (0.05)
======= ========
Diluted earnings per share $ 0.08 $ (0.05)
======= ========
NOTE C - ACQUISITIONS, DISPOSITIONS AND RESTRUCTURING CHARGES
CONVERGENT. On January 26, 2001, the Company acquired certain assets of
Convergent Technologies, Inc. ("Convergent") for cash plus the assumption of
various specific liabilities and related acquisition costs. Generally, Inter-Tel
acquired segments of the voice customer base, accounts receivable, specified
inventory and fixed assets along with assumption of liabilities for warranty,
maintenance and specified leased premises costs. The Convergent transaction was
accounted for using the purchase method of accounting.
The purchase price paid by the Company in the Convergent transaction is subject
to adjustment based on the final balances of the specified assets and
liabilities, and in particular, actual collected accounts receivable. The
acquisition agreement provides that all accounts receivable not collected within
the 90-day period following the closing of the transaction are guaranteed by
Convergent, and reserves of approximately $7.9 million are held in escrow for
claims relating to uncollected accounts receivable and for breaches of
covenants, representations and warranties contained in the acquisition
agreement. To date, the Company has filed a claim with the escrow agent for
return of $7.8 million of the funds held in escrow, based on uncollected
accounts receivable and adjustments to acquired assets and liabilities.
As of April 2001, Convergent and its parent corporation, Convergent
Communications, Inc. filed for protection under Chapter 11 of the U.S.
Bankruptcy Code. As a result of this bankruptcy filing, Inter-Tel must now
conclude its transactions with Convergent and its representatives, including
matters relating to accounts receivable, inventory, maintenance and customer
relations issues through bankruptcy court petitions and other complex means. In
addition, to the escrow claim, the Company has also filed a petition with the
bankruptcy court to set aside funds of Inter-Tel held by Convergent pursuant to
the terms of the acquisition agreement regarding the collection of accounts
receivable within 90 days of closing. We will be adversely affected to the
extent that the completion of these contractual matters will require increased
time and expense, or result in protracted legal proceedings to conclude the
contractual agreement between the parties.
EXECUTONE. On January 1, 2000 Inter-Tel purchased certain computer telephony
assets and assumed certain liabilities of Executone Information Systems, Inc.
("Executone") for cash plus related acquisition costs. 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 since there was no alternative use. The
Executone transaction was accounted for using the purchase method of accounting.
In connection with the Executone acquisition, the Company sold a portion of the
assets and liabilities at net book value to Varian Associates, Inc. ("Varian")
of Tempe, Arizona in the first quarter of 2000.
During the second quarter of 2000, 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
7
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
Milford facility and consolidate its operations into the Company's
metro-Phoenix, Arizona facilities.
The Company 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.
Accrued costs associated with this plan were estimates. The original estimates
made for the second quarter for reserve balances have not changed significantly
as of March 31, 2001.
Exit costs associated with the closure of the Milford facility also included
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, the Company has entered into sublease
agreements with third parties to sublease portions of the facility and
equipment. The reserve for lease and other contractual obligations is identified
in the table below.
The following table summarizes details of the restructuring charge taken in the
second quarter of 2000 in connection with the Executone acquisition, including
the description of the type and amount of liabilities assumed, and activity in
the reserve balances from the date of the charge through March 31, 2001.
RESERVE
CASH/ RESTRUCTURING BALANCE
DESCRIPTION NONCASH CHARGE ACTIVITY AT 3/31/01
----------- ------- ------ -------- ----------
(In thousands)
PERSONNEL COSTS:
Severance and termination costs Cash $ (1,583) $ 1,583 $ --
Other Plant closure costs Cash (230) 142 (88)
LEASE TERMINATION AND OTHER CONTRACTUAL
OBLIGATIONS (NET OF ANTICIPATED RECOVERY):
Building and equipment leases Cash (7,444) 1,526 (5,918)
Other contractual obligations Cash (1,700) 81 (1,619)
IMPAIRMENT OF ASSETS:
Inventories NonCash (3,454) 1,612 (1,842)
Prepaid inventory and other expenses NonCash (2,485) 2,485 --
Accounts receivable NonCash (1,685) 529 (1,156)
Fixed assets NonCash (3,151) 2,942 (209)
Net intangible assets NonCash (29,184) 29,184 --
-------- ------- --------
TOTAL $(50,916) $40,084 $(10,832)
======== ======= ========
NOTE D - PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE
During the first quarter of 2000, Inter-Tel completed the acquisition of
Executone (refer to NOTE C). 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.
8
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
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 2000, 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 represented substantially all of the financial
information related to the Company's principal operating segment.
During 2000, the operations of Executone were identified separately in the first
and second quarters of 2000. Beginning in the 3rd quarter and directly as a
result of the charge and reorganization associated with the Executone
operations, the Company no longer accounts for or directly reports the Executone
operations on a stand-alone basis. The operations have been integrated with the
Company's existing wholesale and national and government account operations.
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. As of the close
of the third quarter, the Company wrote off its remaining investment in Cirilium
of $2.0 million. This charge includes the write-off of Inter-Tel's remaining
basis in Cirilium Corporation. Total pre-tax losses from Cirilium from all
sources were $8.6 million ($0.21 per diluted share) during 2000. As a result of
the write-off, we do not expect to report the operations of Cirilium as a
separate business segment. Refer to the table below for a summary of the
operations for 2000.
During 2000, the Company determined that the operations of Inter-Tel.NET, the
Company's IP long distance subsidiary, would be separately disclosed as a
business segment. The operations represented a more significant component of the
consolidated operations in 2000 compared to prior years and had a significant
impact on the revenues and net losses.
During the first quarter of 2001, consistent with fiscal year-end 2000
reporting, the Company generated income from business segments, including
charges, as follows:
PRINCIPAL
(in thousands, except per share amounts) SEGMENT INTER-TEL.NET TOTAL
------- ------------- -----
Net sales $ 89,293 $ 4,410 $ 93,703
Gross Profit 43,214 (3,566) 39,648
Operating income (loss) 7,945 (4,491) 3,454
Interest and other income 167 -- 167
Loss of foreign translation adjustments (303) -- (303)
Interest expense (145) (82) (227)
9
Net income (loss) $ 4,828 $(2,881) $ 1,948
======== ======= ========
Net income (loss) per diluted share $ 0.19 $ (0.11) $ 0.08
======== ======= ========
The Company's revenues are generated predominantly in the United States.
Total revenues generated from U.S. customers totaled $90.9 million and $93.8
million of total revenues for the quarters ended March 31, 2001 and 2000,
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 first quarters of 2001 and 2000, revenues from customers located
internationally accounted for 3.0% and 2.6% of total revenues, respectively.
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, incorporated in Arizona in 1969, is a single point of contact,
full service provider of digital business telephone systems, call processing
software, voice processing software, call accounting software, Internet Protocol
("IP") telephony software, computer telephone integration ("CTI") applications,
IP and traditional long distance calling, and other communications services.
Inter-Tel's products and services include the Axxess and Eclipse digital
business communication software platforms, with integrated voice processing and
unified messaging systems, InterPrise voice and data routers, ClearConnect
Talk-to-Agent e-Commerce software, and IP telephony communications services. 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 decreased 2.8% to $93.7 million in the first quarter of 2001 from
$96.4 million in the first quarter of 2000. For the quarter ended March 31,
2001, sales from the Company's direct sales offices and from wholesale
distribution decreased approximately $6.4 million compared to the first quarter
of 2000. This decrease is largely the result of lower sales to the Executone
dealers, and to a lesser extent, of delayed buying decisions from customers
attributable to recent economic conditions and competitive pressures. Sales from
the Company's network services group, including Inter-Tel.NET, NetSolutions and
Network Services agency, increased $1.3 million over the same periods. The
remaining increases were attributable to increases from leasing and foreign
operations. Please refer to Note E for additional segment reporting information.
The following table sets forth selected statements of income data as a
percentage of net sales:
10
Three months
Ended March 31,
-------------------
2001 2000
------ ------
Net sales 100.0% 100.0%
Cost of sales 57.7 56.9
------ ------
Gross Profit 42.3 43.1
Research and development 4.4 5.9
Selling, general and administrative 34.2 32.1
IPRD write-off -- 5.6
------ ------
Operating income (loss) 3.7 (0.5)
Equity share of Cirilium Corp.'s net losses -- (1.8)
Interest and other income (0.1) 0.3
Interest expense (0.2) (0.1)
------ ------
Income (loss) before income taxes (3.3) (2.0)
Income Taxes 1.2 (0.8)
------ ------
Net Income 2.1% (1.3)%
====== ======
Gross profit for the first quarter of 2001 decreased 4.6% to $39.6 million,
or 42.3% of net sales, from $41.5 million, or 43.1% of net sales, in the first
quarter of 2000. The decline in gross profit as a percentage of sales (or gross
margin) was primarily attributable to increases, as a percentage of total sales,
in sales through Inter-Tel.NET operations, which generated negative margins. A
different sales mix of products and services, including more sales of relatively
smaller systems compared to 2000, and sales through different distribution
channels, also contributed to lower gross margins. In addition, competitive
pricing pressures on telephone systems negatively impacted gross margins during
the first quarter of 2001 as net sales from the Company's direct sales offices
and wholesale distribution decreased.
Research and development expenses for the first quarter of 2001 decreased
27.0% to $4.1 million, or 4.4% of net sales, from $5.7 million, or 5.9% of net
sales, for the first quarter of 2000. These decreases were primarily
attributable to the reduction of expenses relating to the former Executone
operations. However, the Company experienced comparable expenses in the
remaining core business operations for the continued development of the Axxess
and Eclipse networking software and systems, and the design and development of
the Company's CTI applications. The Company expects that for the foreseeable
future research and development expenses will increase sequentially in absolute
dollars as the Company continues to enhance existing and develop new
technologies and products. These expenses may vary, however, as a percentage of
net sales.
Selling, general and administrative expenses in the first quarter of 2001
increased 3.7% to $32.1 million, or 34.2% of net sales, from $30.9 million, or
32.1% of net sales, in the first quarter of 2000. The increase in absolute
dollars and as a percentage of net sales was primarily due to integrating the
operations of Convergent, acquired in January 2001. Selling, general and
administrative expenses also increased, as a percentage of net sales, as a
result of lower absorption of fixed costs on lower total net sales. The Company
expects that for the foreseeable future selling, general and administrative
expenses will continue to increase in absolute dollars, but may vary as a
percentage of net sales.
Other income in both periods consisted primarily of interest income and
foreign exchange rate gains and losses. Income from interest decreased in 2001
compared to 2000 based on a lower level of invested funds, principally due to
repurchases of the Company's Common Stock, as well as expenditures relating to
the Convergent acquisition. Other changes in other income primarily reflected
higher net foreign exchange rate losses.
The Company's income tax rate for the first quarter of 2001 decreased to
37% compared to 38% for 2000. The rate decreased as a result of greater
utilization of research tax credits and anticipated lower effective state taxes.
The Company expects the 2001 tax rate to be similar to the tax rate effective
for the quarter ended March 31, 2001.
11
Net income for the first quarter was $1.9 million ($0.08 per diluted
share), compared to a net loss of $1.2 million (loss of $0.05 per diluted share)
reflecting the write-off of in-process research and development costs noted
above. Excluding the write-off of in-process research and development costs, net
income for the quarter ended March 31, 2000 would have been $2.1 million, or
$0.08 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 anticipated
increased sales in Japan and Asia and elsewhere could result in higher
international sales as a percentage of total revenues, but international
revenues are currently not significant.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2001, the Company had $3.1 million in cash and equivalents,
which represented a decrease of approximately $24.0 million from December 31,
2000. During the first quarter of 2001, the Company expended approximately $14.1
million to repurchase shares of the Company's Common Stock. In addition, on
January 26, 2001, the Company paid cash of approximately $10.6 million plus
acquisition and integration costs to purchase certain assets of Convergent. $7.9
million of this total is currently held in escrow, against which Inter-Tel has
made claims of $7.8 million to date. The Company maintains a $25 million
unsecured revolving line of credit with Bank One, Arizona, NA. This credit
facility is annually renewable and is 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. The
remaining cash balances and credit facility may be used to further develop
Inter-Tel.NET and for potential acquisitions, strategic alliances, working
capital, stock repurchases and general corporate purposes.
Net cash provided by operating activities totaled $3.9 million for the three
months ended March 31, 2001, compared to cash used in operating activities of
$1.2 million for the same period in 2000. Cash provided by operating activities
in the first quarter of 2001 was primarily the result of cash generated from
operations including non-cash depreciation and amortization charges, which was
partially offset by increased accounts receivable, inventory, prepaid expenses
and restricted funds associated with the acquisition of Convergent. The Company
expects to expand sales through its direct sales office and dealer networks,
including those acquired in the Convergent acquisition. The Company expects this
sales expansion to require working capital for increased accounts receivable and
inventories.
Net cash used in investing activities totaled $14.6 million for the quarter
ended March 31, 2001, compared to cash provided by investing activities of $2.0
million for the quarter ended March 31, 2000. During the first quarter of 2001,
net cash used in acquisitions totaled approximately $11.5 million, $10.6 of
which was attributable to the Convergent acquisition. Capital expenditures
totaled approximately $3.1 million for the same period. Cash provided by
investing activities in the comparable period of March 31, 2000 benefited from
$6.6 million in cash received from the disposition of the manufacturing
operations of Executone. The Company anticipates additional capital expenditures
during 2001, principally relating to expenditures for equipment and management
information systems used in its operations, for facilities expansion and
Inter-Tel.NET operations.
Net cash used in financing activities totaled $13.3 million in the three
months ended March 31, 2001, compared to net cash provided by financing
activities of $773,000 for the same period in 2000. During the first quarter of
2001, the Company purchased treasury stock using approximately $14.1 million,
which was partially offset by the net proceeds from the issuance of term debt
totaling $1.1 million in connection with the purchase of assets used in the
Inter-Tel.NET network. Net cash used for dividends totaled
12
approximately $260,000 during the first quarter of 2001, which was offset by
cash provided by the exercise of stock options totaling $313,000.
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 $195.2 million and $198.4 million remained unbilled at March 31, 2001
and December 31, 2000, 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 fund the
Company's operations and to provide adequate working capital for the next twelve
months. Provided sufficient resources, the Company may also repurchase shares of
its Common Stock pursuant to board authorization, or finance acquisitions of
additional resellers of telephony products or other strategic acquisitions or
corporate alliances. However, to the extent that additional funds are required
in the future to address working capital needs and to provide funding for
capital expenditures, operation of the business or the Inter-Tel.NET network or
for additional acquisitions or stock repurchases, the Company will seek
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 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 vigorous 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 Internet Protocol, or IP, network products, CTI
applications or related products fail to develop or continue to develop more
slowly than 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.
13
OUR FUTURE SUCCESS LARGELY DEPENDS ON INCREASING COMMERCIAL ACCEPTANCE OF OUR
AXXESS AND ECLIPSE PLATFORMS, INTERPRISE PRODUCTS, AND RELATED COMPUTER
TELEPHONY PRODUCTS.
During the past few years, we have introduced transparent networking and unified
messaging on our Axxess and Eclipse platforms and introduced our InterPrise
family of voice and data convergence products. In 2000, we introduced
ClearConnect, a software-based telephone that runs on a PC, ClearConnect
Talk-to-Agent, an e-commerce "touch-to-talk" web call product, a line of IP
voice terminals that add IP telephony to the Axxess and Eclipse platforms, and
several other telephony-related products. 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 and related Computer Telephony products, the Axxess platform, and
the Eclipse platform, as well as future upgrades and enhancements to these
products and networking platforms. We cannot assure that these products or
platforms will achieve commercial acceptance in the future.
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.
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 IP 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
14
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. Our overall financial condition will be adversely affected if our
Inter-Tel.NET business is unsuccessful.
Moreover, 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. If the market for IP network voice communications fails 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. This
growth may be inhibited by a number of factors, such as quality of
infrastructure; security concerns; equipment, software or other technology
failures; regulatory encroachments; inconsistent quality of service; poor sound
quality over IP networks as compared to circuit-switched networks; and lack of
availability of cost-effective, high-speed network capacity. Moreover, as
IP-based data communications and telephony usage grow, the infrastructure used
to support these IP networks, whether public or private, may not be able to
support the demands placed on them and their performance or reliability may
decline. The technology that allows voice and fax communications over the
Internet, and the delivery of other value-added services, is still in the early
stages of development.
In addition, the development of new services, such as unified communications
services, may require substantial capital expenditures to be made well in
advance of generating any revenue from such services or demonstrating any market
acceptance of such services. If carriers and communications service providers do
not employ our network to offer any new services to their customers, or if their
customers do not subscribe for the services when offered, our own IP telephony
business would not grow as rapidly as we anticipate, which would likely harm our
overall business.
BUSINESS ACQUISITIONS OR JOINT VENTURES 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 assumed certain
liabilities of Executone Information Systems, Inc. We were adversely affected by
several of the factors described above relating to our Executone acquisition,
including the risks related to unanticipated acquisition costs and impairment of
employee and customer relationships, as well as the erosion of gross and
operating margins, which risks substantially harmed our operating results. For
these and other reasons noted in the footnotes to our financial statements and
in the section titled Management's Discussion and Analysis of Financial
Condition and Results of Operations, we wrote-off our investment in Executone
during the second quarter of 2000. In
15
addition to the Executone losses discussed above, for the quarter ended
September 30, 2000, we also recorded a pre-tax loss of $2.0 million related to
our equity share of Cirilium's net losses. As of the close of the third quarter,
the Company wrote off its remaining investment in Cirilium of $2.0 million.
Total pre-tax losses from Cirilium from all sources were $8.6 million for 2000.
In January 2001, we acquired certain assets and assumed certain liabilities of
Convergent. In connection with the Convergent acquisition, we hired
approximately 210 Convergent employees, and opened 8 Inter-Tel branch offices in
previous Convergent locations. In addition to the foregoing risks and
uncertainties we face generally in our acquisitions, we may experience the
following difficulties or risks associated with the Convergent acquisition:
* substantially all of Convergent's sales were of our competitor's
products and services, and these manufacturers may make our service
and maintenance of such products expensive and difficult;
* a large number of Convergent's customers may decline the assignment of
their maintenance contracts to us;
* any number of the approximately 210 employees hired by Inter-Tel may
not integrate successfully or timely into the Inter-Tel business model
and plans; and
* some or all of the independent contractors who performed projects for
Convergent may not assume similar roles with Inter-Tel.
As of April 2001, Convergent and its parent corporation, Convergent
Communications, Inc. filed for protection under Chapter 11 of the U.S.
Bankruptcy Code. As a result of this bankruptcy filing, Inter-Tel must now
conclude its transactions with Convergent and its representatives, including
matters relating to accounts receivable, inventory, maintenance and customer
relations issues through bankruptcy court petitions and other complex means. We
will be adversely affected to the extent that the completion of these
contractual matters will require increased time and expense, or result in
protracted legal proceedings to conclude the contractual agreement between the
parties. To the extent that the bankruptcy filing prohibits or impairs our
ability to make claims against Convergent pursuant to the acquisition agreement,
our results of operations may be adversely affected.
Finally, 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 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 17 telecommunication and unified messaging products and have also applied to
the U.S. Patent and Trademark Office for six 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.
16
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 have viewed presentations from two of our
primary competitors, Lucent and Avaya, a spin-off of 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 alleging that
certain of our IP products infringe upon certain intellectual property protected
by AT&T's patents. Although we have denied AT&T's allegations and intend to
vigorously defend our position, we cannot assure you that we will ultimately
prevail in this dispute. 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, Voice Processing
Software, and Unified Messaging Software 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 THE INTER-TEL.NET NETWORK.
We may be vulnerable to the risk of network failure. Despite the use of security
measures, our network is susceptible to damage or interruption from earthquake,
fire, flood and other natural disasters; and power loss, network failure,
improper operation by employees, physical and electronic break-ins, and similar
events. We presently have no off-site back-up facilities for our Network
Operating Center (NOC), which handles all monitoring of our network, including
trouble reporting, network analysis and network testing. We also use our NOC for
monitoring our partners' networks. Any network interruption that impairs our
ability to transmit and complete calls, as well as conduct adequate monitoring
of our network and our partners' networks could damage our reputations and
reduce demand for our services.
The Inter-Tel.NET network is still in the process of deployment and,
accordingly, is subject to risks and uncertainties. We have replaced some and
expect to replace additional Vocal'Net Servers in the Inter-Tel.NET network with
new technology to improve the reliability, functionality and interoperability of
the network.
17
WE ARE DEPENDENT ON THIRD-PARTY SUPPLIERS OF TELECOMMUNICATIONS AND NETWORK
TRANSMISSION SERVICES.
We rely upon third-party vendors to provide us with the equipment and software
that we use to transfer and translate calls from traditional voice networks to
the IP-based networks, and vice versa. For example, we purchase substantially
all of our IP-based telephony equipment and software from Cisco Systems, Inc.,
Cirilium, Inc., Info Directions, Inc., XACCT Technologies, Inc. and Simplified
Telesys. We cannot assure you that we will be able to continue purchasing such
equipment and software from these vendors on acceptable terms, if at all or that
these vendors will continue to support their products. If we become unable to
purchase from these vendors the equipment needed to maintain and expand our
network as currently configured, or if these vendors discontinue support we may
not be able to maintain or expand our network to accommodate growth and we may
consequently be unable to grow revenues sufficiently to become profitable. Some
of these vendors are smaller companies with limited resources and
capitalization, and may not be able to sustain their business in the future. We
also cannot assure that products developed by our suppliers will not suffer from
speed and scalability problems that could harm our business.
In addition to its own network, Inter-Tel.NET has alliances with other third
party domestic and international IP long distance and local communications
service providers to originate and terminate calls. The successful expansion of
our IP network 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, or experience power or bandwidth outages, our operations and
business may be harmed. There is a risk that the local communications service
providers may be slow, or fail, to provide lines, which would affect our ability
to complete calls to those destinations. We also may not be able to enter into
relationships with enough overseas local service providers to handle increases
in the volume of calls that we receive from our customers. We cannot assure that
there will not be a significant disruption of service provided by these
suppliers, now or in the future. 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 technology, our Inter-Tel.NET
network could become financially burdensome to maintain or obsolete, which could
harm our business.
WE HAVE MANY COMPETITORS AND EXPECT NEW COMPETITORS TO ENTER OUR MARKET, WHICH
COULD PUT PRESSURE 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 in our primary business segments include:
* PABX and core systems providers such as Avaya (formerly part of Lucent),
Nortel, Comdial, Iwatsu, Mitel, NEC, Nitsuko, Panasonic, Siemens, Toshiba,
3Com and Cisco Systems;
* large data routing companies such as Cisco Systems and 3Com;
* voice processing applications providers such as AVT, Active Voice, ADC,
Lucent and Avaya;
* long distance services providers such as AT&T, MCI WorldCom, Sprint and
Qwest Communications;
* IP telephony product and service providers such as Lucent, Nortel, ADC,
3Com, Cisco Systems, iBasis, Concert, DeltaThree, ITXC, deltasix.com,
Net2Phone, Cirilium and others;
* 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.
18
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
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,
the Eclipse, the Inter-Tel Axxent, as well as substantially all of the Executone
Computer Telephony products. 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, voice
processing, and voice/data router system manufacturers for these dealers'
business, as most of our dealers carry products that compete with our products.
Our dealers may choose to promote the products of our competitors to our
detriment. The loss of any
19
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 impaired our
ability to benefit from the Executone business and to grow revenues from the
Executone assets. Moreover, our operating results will be impaired if we lose a
substantial number of Convergent employees in the months to come following the
Convergent acquisition. 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.
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. For example, there is
currently a bill in the U.S. congress to allow the large LECs to provide broader
Internet services that could effect Inter-Tel. This change, as well as 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.
20
The regulatory treatment of IP-based telephony outside of the United States
varies widely from country to country. A number of countries currently prohibit
or limit competition in the provision of traditional voice telephony services.
Some countries prohibit, limit or regulate how companies provide IP-based
telephony. Increased regulation of the Internet and/or IP-based telephony
providers, or the prohibition of IP-based telephony in one or more countries
could limit our ability to provide our services or make them more expensive. If
foreign governments or other bodies begin to regulate or prohibit IP-based
telephony, this regulation could have a material adverse effect on our ability
to attain or maintain profitability.
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 six 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;
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* 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.
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. Also, 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 third 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.
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
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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.
OUR CHAIRMAN OF THE BOARD OF DIRECTORS, CEO AND PRESIDENT CONTROLS 21.5% OF OUR
COMMON STOCK AND BE ABLE TO SIGNIFICANTLY INFLUENCE MATTERS REQUIRING
SHAREHOLDER APPROVAL
As of March 31, 2001 Steven G. Mihaylo, the Company's Chairman of the Board of
Directors, Chief Executive Officer and President beneficially owned
approximately 21.5% 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to the impact of interest rate changes and change in the market
values of our investments.
Interest Rate Risk. We protect and preserve our invested funds with investment
policies and procedures that limit default, market and reinvestment risk. We
have not utilized derivative financial instruments in our investment portfolio.
As of March 31, 2001, we had cash and cash equivalents of $3.1 million,
consisting of cash and highly liquid short-term investments with original
maturities of three months or less at the date of purchase. Declines in interest
rates over time will result in lower interest income.
Foreign Currency Exchange Risk. We generate our revenue primarily from sales in
the United States, however we also sell our products to customers located in the
United Kingdom, Europe, Asia and South America. As a result, our financial
results could be affected by factors such as changes in foreign currency
exchange rates or weak economic conditions in foreign markets. Since our sales
are currently priced in U.S. dollars and translated to local currency amounts, a
strengthening of the dollar could make our products less competitive in foreign
markets. As exchange rates vary, our expenses, when translated, may vary from
expectations and adversely impact overall expected profitability. Our operating
results have not been significantly affected by exchange rate fluctuations in
the first quarter of 2001. If, during the remainder of 2001, the U.S. dollar
uniformly decreases in strength by 10% relative to the currency used in our
foreign sales of our foreign subsidiaries, our operating results for the
remainder of 2001 would likely not be significantly affected.
INTER-TEL, INCORPORATED AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS--NOT APPLICABLE
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS--NOT APPLICABLE
ITEM 3. DEFAULTS ON SENIOR SECURITIES--NOT APPLICABLE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Stockholders was held April 30, 2001 (the Annual Meeting).
On March 28, 2001 we mailed a Proxy Statement, pursuant to Regulation 14A under
the Securities Exchange Act of 1934, to our security holders to solicit their
votes regarding the following matters that were discussed at our Annual Meeting:
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1. Election of Directors: Steven G. Mihaylo, J. Robert Anderson, Jerry W.
Chapman, Gary D. Edens and C. Roland Haden were elected to serve as
directors until the 2002 Annual Meeting of Stockholders. The votes were as
follows:
Nominee For: Against: Abstain: Broker Non-Vote
- ------- ---- -------- -------- ---------------
Steven G. Mihaylo 20,166,675 1,679,289 434,139 0
J. Robert Anderson 21,401,082 444,882 434,139 0
Jerry W. Chapman 21,064,744 781,220 434,139 0
Gary D. Edens 21,403,929 442,035 434,139 0
C. Roland Haden 21,406,148 439,816 434,139 0
2. 1997 Long Term Incentive Plan Amendment: The stockholders voted on and
approved a proposal to approve an amendment to the Company's 1997 Long Term
Incentive Plan to provide for an automatic increase in the number of shares
of Common Stock reserved thereunder on the first day of each fiscal year
equal to the lesser of (a) 2.5% of the outstanding shares on that date, (b)
750,000 shares (subject to appropriate adjustment for all stock splits,
dividends, subdivisions, combinations, recapitalizations and like
transactions) or (c) a lesser amount as determined by the Board of
Directors. The votes were as follows:
For: Against: Abstain: Broker Non-Vote
---- -------- -------- ---------------
7,901,079 7,011,622 24,935 6,908,328
3. The stockholders also voted on and approved a proposal to ratify the
appointment of Ernst & Young LLP to act as the independent auditors to
audit our and our subsidiaries' financial statements for the year 2001. The
votes were as follows:
For: Against: Abstain: Broker Non-Vote
---- -------- -------- ---------------
21,783,982 40,457 21,525 0
ITEM 5. OTHER INFORMATION
Pursuant to Rule 14a-4(c)(1) under the Securities Exchange Act of 1934, in
connection with the Company's annual meeting of shareholders, if a stockholder
of the Company fails to notify the Company at least 45 days prior to the month
and day of mailing of the prior year's proxy statement, then the proxies of
management would be allowed to use their discretionary voting authority when any
such proposal is raised at the Company's annual meeting of stockholders, without
any discussion of the matter in the proxy statement. Since the Company mailed
its proxy statement for the 2001 annual meeting of stockholders on March 28,
2001, the deadline for receipt of any such stockholder proposal for the 2002
annual meeting of stockholders is February 11, 2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
Exhibits: None.
Reports on Form 8-K: None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTER-TEL, INCORPORATED
May 15, 2001 /s/ Steven G. Mihaylo
- ------------ --------------------------------------------
Steven G. Mihaylo
Chairman of the Board, Chief Executive
Officer and President
May 15, 2001 /s/ Kurt R. Kneip
- ------------ --------------------------------------------
Kurt R. Kneip
Vice President and
Chief Financial Officer
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