-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, H6ckjbRWNVkgnJMIosAodv1GZk9wleWQj2aVOXVtf8NyuFM+z27S8HnJJihhhbFH Bp6WWbQ5yTV1XiaJUAmsMg== 0000950147-01-500915.txt : 20010516 0000950147-01-500915.hdr.sgml : 20010516 ACCESSION NUMBER: 0000950147-01-500915 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTER TEL INC CENTRAL INDEX KEY: 0000350066 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 860220994 STATE OF INCORPORATION: AZ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-10211 FILM NUMBER: 1639013 BUSINESS ADDRESS: STREET 1: 120 N 44TH ST STREET 2: STE 200 CITY: PHOENIX STATE: AZ ZIP: 85034-1822 BUSINESS PHONE: 6023028900 MAIL ADDRESS: STREET 1: 120 N 44TH ST STREET 2: STE 200 CITY: PHOENIX STATE: AZ ZIP: 85034-1822 10-Q 1 e-6827.txt QUARTERLY REPORT FOR QTR ENDED 3-31-01 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 ---------- 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; 21 * 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 22 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: 23 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. 24 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 25 -----END PRIVACY-ENHANCED MESSAGE-----