-----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, MfYcjoAWxcvyHNNBFcIfqMcDwJ6c4Mn4a21asHeqSjQM8V0F1yXnTYpYwqRclDej yjQogJAkYdP49mRDNZKfKg== 0000950147-99-000872.txt : 19990817 0000950147-99-000872.hdr.sgml : 19990817 ACCESSION NUMBER: 0000950147-99-000872 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990816 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: 99690153 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 QUARTERLY REPORT FOR THE QTR ENDED 6/30/99 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended Commission File Number: June 30, 1999 0-10211 INTER-TEL, INCORPORATED Incorporated in the State of Arizona I.R.S. No. 86-0220994 120 North 44th Street, Suite 200 Phoenix, Arizona 85034-1822 (602) 302-8900 Common Stock (25,841,131 shares outstanding as of June 30, 1999) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] INDEX INTER-TEL, INCORPORATED AND SUBSIDIARIES Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed consolidated balance sheets--June 30, 3 1999 and December 31, 1998 Condensed consolidated statements of operations--three 4 and six months ended June 30, 1999 and June 30, 1998 Condensed consolidated statements of cash flows 5 --three and six months ended June 30, 1999 and June 30, 1998 Notes to condensed consolidated financial 6 statements--June 30, 1999 Item 2. Management's Discussion and Analysis of Financial 7 Condition and Results of Operations PART II. OTHER INFORMATION 20 SIGNATURES 21 2 PART I. FINANCIAL INFORMATION INTER-TEL, INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (In thousands) June 30, December 31, 1999 1998 --------- --------- ASSETS CURRENT ASSETS Cash and equivalents $ 60,313 $ 63,124 Accounts receivable - net 48,338 41,116 Inventories 17,980 19,663 Net investment in sales-leases 13,512 13,979 Prepaid expenses and other assets 3,897 2,781 --------- --------- TOTAL CURRENT ASSETS 144,040 140,663 PROPERTY & EQUIPMENT 26,059 22,198 EQUIPMENT HELD UNDER LEASE, NET 6,477 6,771 OTHER ASSETS 30,272 27,398 --------- --------- $ 206,848 $ 197,030 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 16,819 $ 14,956 Other current liabilities 29,806 29,390 --------- --------- TOTAL CURRENT LIABILITIES 46,625 44,346 DEFERRED TAXES 4,575 5,026 OTHER LIABILITIES 6,418 4,972 SHAREHOLDERS' EQUITY Common stock, no par value-authorized 100,000,000 shares, issued and outstanding - 29,029,987 in 1998 104,539 104,539 Less: shareholder loans (871) -- Retained earnings 63,506 54,194 Accumulated other comprehensive income (226) (196) --------- --------- 166,948 158,537 Less: Treasury stock at cost (17,718) (15,851) TOTAL SHAREHOLDERS' EQUITY 149,230 142,686 --------- --------- $ 206,848 $ 197,030 ========= ========= 3 INTER-TEL, INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except Three Months Six Months per share amounts) Ended June 30, Ended June 30, ---------------------- ---------------------- 1999 1998 1999 1998 --------- --------- --------- --------- NET SALES $ 77,788 $ 68,088 $ 143,313 $ 131,846 Cost of sales 38,269 35,453 72,122 68,070 --------- --------- --------- --------- GROSS PROFIT 39,519 32,635 71,191 63,776 Research & development 3,725 2,828 7,032 5,256 Selling, general and administrative 24,625 22,003 45,204 42,540 Purchased in-process research and development and acquisition related expenses -- 22,755 -- 22,755 --------- --------- --------- --------- 28,350 47,586 52,236 70,551 --------- --------- --------- --------- OPERATING INCOME (LOSS) 11,169 (14,951) 18,955 (6,775) Interest and other income 491 877 925 1,846 Interest expense (13) (30) (25) (39) --------- --------- --------- --------- INCOME (LOSS) BEFORE INCOME TAXES 11,647 (14,104) 19,855 (4,968) Income taxes 4,426 (5,461) 7,542 (1,687) --------- --------- --------- --------- NET INCOME (LOSS) $ 7,221 $ (8,643) $ 12,313 $ (3,281) ========= ========= ========= ========= NET INCOME (LOSS) PER SHARE Basic $ 0.28 $ (0.32) $ 0.47 $ (0.12) ========= ========= ========= ========= Diluted $ 0.27 $ (0.32) $ 0.46 $ (0.12) ========= ========= ========= ========= Average common shares outstanding 25,826 26,877 25,961 26,810 ========= ========= ========= ========= Average common shares outstanding assuming dilution 26,711 26,877 26,994 26,810 ========= ========= ========= =========
4 INTER-TEL, INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands, except Three Months Six Months per share amounts) Ended June 30, Ended June 30, -------------------- -------------------- 1999 1998 1999 1998 -------- -------- -------- -------- OPERATING ACTIVITIES NET INCOME (LOSS) 7,221 $ (8,643) 12,313 $ (3,281) Adjustments to reflect operating activities: Purchased in-process research and development -- 22,755 -- 22,755 Depreciation and amortization 2,201 1,481 4,324 2,733 Changes in operating assets and liabilities (5,704) (3,218) (12,511) (6,746) Other 3,701 (5,317) 6,934 (3,596) -------- -------- -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 7,419 7,058 11,060 11,865 INVESTING ACTIVITIES Proceeds from disposal of property and equipment and operating leases 1,999 -- 1,999 7 Cash used in acquisitions (500) (25,308) (720) (25,308) Additions to property and equipment and operating leases (4,435) (5,287) (9,380) (8,119) -------- -------- -------- -------- NET CASH USED IN INVESTING ACTIVITIES (2,936) (30,595) (8,101) (33,420) FINANCING ACTIVITIES Payments for repurchase of common stock (6,682) -- (6,682) -- Cash dividends paid (262) (270) (522) (537) Proceeds from Stock issued under the ESPP 421 359 421 359 Proceeds from exercise of stock options 160 640 1,013 1,097 -------- -------- -------- -------- NET CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES (6,363) 729 (5,770) 919 DECREASE IN CASH AND EQUIVALENTS (1,880) (22,808) (2,811) (20,636) CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 62,193 90,977 63,124 88,805 -------- -------- -------- -------- CASH AND EQUIVALENTS AT END OF PERIOD $ 60,313 $ 68,169 $ 60,313 $ 68,169 ======== ======== ======== ========
5 INTER-TEL, INCORPORATED AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) June 30, 1999 NOTE A--BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for the interim periods presented have been included. Operating results for the three and six months ended June 30, 1999 are not necessarily indicative of the results that may be expected for the year ending December 31, 1999. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1998. NOTE B--EARNINGS PER SHARE Diluted earnings per share assume that outstanding common shares were increased by shares issuable upon the exercise of all outstanding stock options to which market price exceeds exercise price less shares which could have been purchased with related proceeds, if the effect would not be antidilutive. The following table sets forth the computation of basic and diluted earnings per share: (In thousands, except Three Months Ended Six Months Ended per share amounts) ------------------- ------------------ June 30, June 30, June 30, June 30, 1999 1998 1999 1998 -------- --------- -------- -------- Numerator: Net income (loss) $ 7,221 $ (8,643) $ 12,313 $ (3,281) ======== ========= ======== ======== Denominator: Denominator for basic earnings per share - weighted average shares 25,826 26,877 25,961 26,810 Effect of dilutive securities: Employee and director stock options 885 -- 1,033 -- -------- --------- -------- -------- Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 26,711 26,877 26,994 26,810 ======== ========= ======== ======== Basic earnings (loss) per share $ 0.28 $ (0.32) $ 0.47 $ (0.12) ======== ========= ======== ======== Diluted earnings (loss) per share $ 0.27 $ (0.32) $ 0.46 $ (0.12) ======== ========= ======== ======== NOTE C--ACQUISITIONS Effective June 1998, Inter-Tel acquired certain assets and assumed certain liabilities of Telecom Multimedia Systems, Inc. ("TMSI") for cash. The TMSI acquisition was accounted for using the purchase method of accounting. The aggregate purchase price of approximately $25 million plus related acquisition costs was allocated to the acquired assets and liabilities based on fair values at acquisition, of which $22.8 million ($13.7 million after taxes) was written-off as purchased in-process research and development. 6 NOTE D - SEGMENT INFORMATION The Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131") in the fiscal year ended December 31, 1998. SFAS 131 establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. SFAS 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions how to allocate resources and assess performance. The Company's chief decision maker, as defined under SFAS 131, is the Chief Executive Officer. To date, the Company has viewed its operations as principally one segment: telephone systems, telecommunications software and hardware, and related long distance calling services. These services are provided through the Company's direct sales offices and dealer network to business customers throughout the United States, Europe, Asia and South America. As a result, the financial information disclosed herein materially represents all of the financial information related to the Company's principal operating segment. The Company's revenues are generated predominantly in the United States. Total revenues generated from U.S. customers totaled $76.1 million and $66.3 million of total revenues for the quarters ended June 30, 1999 and 1998, respectively and $140.1 million and $128.0 million of total revenues for the six months ended June 30, 1999 and 1998, respectively. The Company's revenues from international sources were primarily generated from customers located in the United Kingdom, Europe, Asia and South America. In the second quarters of 1999 and 1998, revenues from customers located internationally accounted for 2.2% and 2.6% of total revenues, respectively. In the six months ended June 30, 1999 and 1998, revenues from customers located internationally accounted for 2.2% and 2.9% of total revenues, respectively. PART I. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This interim report on Form 10-Q contains trend analysis and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements include expectations, beliefs, intentions or strategies regarding future operating results, future expenditures, future cash requirements, and future industry conditions and involve risks and uncertainties. The Company's actual results could differ materially from those projected in such forward-looking statements as a result of many risk factors, including without limitation those set forth under this section, under the section entitled "Factors That May Affect Future Results Of Operations" below and elsewhere in this report on Form 10-Q. OVERVIEW Inter-Tel is a single point of contact, full service provider of digital business telephone systems, IP telephony products, CTI applications, voice processing software and long distance calling services. Inter-Tel's award - -winning products and services include the AXXESS and Inter-Tel Axxent digital business communication platforms, the AXXESSORY TALK voice processing platform, the Inter-Tel Vocal'Net IP telephony gateway, the Inter-Tel Vocal'Net Service Provider Software and Centralized Accounting Software, the InterPrise voice and data routers and the Inter-Tel.net private IP long distance network. The Company also provides maintenance, leasing and support services for its products. 7 RESULTS OF OPERATIONS Net sales for the second quarter of 1999 increased 14.2% to $77.8 million, compared to $68.1 million in the second quarter of 1998. Net sales increased 8.7% to $143.3 million in the first six months of 1999, compared to $131.8 million in the first six months of 1998. For the quarter and six months ended June 30, 1999, sales from wholesale distribution and direct sales offices accounted for approximately $7.9 million and $8.1 million, respectively, of the increase in net sales. The increase in net sales was also attributable to increases in long distance sales and sales from leasing operations. The following table sets forth certain statement of operations data of the Company expressed as a percentage of net sales for the periods indicated: Three Months Six Months Ended June 30, Ended June 30, -------------- -------------- 1999 1998 1999 1998 ----- ----- ----- ----- Net Sales 100.0% 100.0% 100.0% 100.0% Cost of Sales 49.2 52.1 50.3 51.6 ----- ----- ----- ----- Gross profit 50.8 47.9 49.7 48.4 Research and development 4.8 4.2 4.9 4.0 Selling, general and administrative 31.6 32.3 31.5 32.3 In-process research and development and related acquisition expenses -- 33.4 -- 17.3 ----- ----- ----- ----- Operating income 14.4 (22.0) 13.3 (5.2) Interest and other income 0.6 1.3 0.6 1.4 Interest expense 0.0 0.0 0.0 0.0 Income taxes 5.7 (8.0) 5.3 (1.3) ----- ----- ----- ----- Net income (loss) 9.3% (12.7)% 8.6% (2.5)% ===== ===== ===== ===== Gross profit for the second quarter of 1999 increased 21.1% to $39.5 million, or 50.8% of net sales, compared to $32.6 million, or 47.9% of net sales, for the second quarter of 1998. Gross profit increased 11.6% to $71.2 million, or 49.7% of net sales, in the first six months of 1999 compared to $63.8 million, or 48.4% of net sales, in the first six months of 1998. Gross margin increased in the second quarter of 1999 primarily as a result of sales channel and product mix. A larger portion of the Company's sales increases were through direct channels, as compared to sales through the dealer channel. In addition, the Company experienced increased sales of its higher margin products such as its AXXESS digital communication platforms, call processing software and voice processing software as a percentage of net sales. Research and development expenses for the second quarter of 1999 increased to $3.7 million, or 4.8% of net sales, compared to $2.8 million, or 4.2% of net sales, for the second quarter of 1998. Research and development expenses increased to $7.0 million, or 4.9% of net sales, in the first six months of 1999 compared to $5.3 million, or 4.0% of net sales, in the first six months of 1998. The increases in absolute dollars and as a percentage of net sales in both periods were primarily attributable to expenses relating to the development and introduction of new products, including the continuing development and improvement of the Company's AXXESS digital communication platforms, call processing and voice processing software, CTI products, unified messaging, and TCP/IP intranet and internet voice solutions (which are branded as the Company's Vocal'Net, InterPrise and Inter-Tel.net products). The Company expects that research and development expenses will continue to increase in absolute dollars as the Company continues to develop new software and to enhance existing technologies and products. These expenses may vary in the future, however, as a percentage of net sales. 8 Selling, general and administrative expenses for the second quarter of 1999 increased in absolute dollars to $24.6 million compared to $22.0 million for the second quarter of 1998. Selling, general and administrative expenses increased to $45.2 million in the first six months of 1999 compared to $42.5 million in the first six months of 1998. The increases in absolute dollars for the quarter and six months ended June 30, 1999, were attributable in part to continued efforts to hire and train additional sales personnel throughout Inter-Tel's direct sales offices; higher sales commissions paid to the Company's sales force; increased write-offs of accounts receivable as a percentage of sales; and providing additional marketing resources for new IP product introductions and network and long distance services. Selling, general and administrative expenses decreased as a percentage of net sales for the quarter to 31.6% from 32.3% for the second quarter of 1998, and also decreased as a percentage of net sales to 31.5% from 32.3% for the six months ended June 30, 1999. These decreases were largely attributable to increased net sales and cost-cutting measures. The Company expects that selling, general and administrative expenses will continue to increase in absolute dollars, but may vary in the future as a percentage of net sales. In June 1998, the Company purchased certain assets and liabilities of Telecom Multimedia Systems, Inc. ("TMSI") for approximately $25 million plus related acquisition costs. The aggregate purchase price was allocated to the fair value of the assets and liabilities acquired, of which $22.8 million, or $13.7 million after taxes, was written-off as purchased in-process research and development. Other income in both periods consisted primarily of interest income and foreign exchange rate gains and losses. Income from interest decreased in both comparable periods of 1999 based on a lower level of invested funds, principally relating to the repurchase of shares of the Company's common stock during the second half of 1998 and in the second quarter of 1999. Other changes in other income primarily reflected differences in net foreign exchange rate gains and losses. Net income for the second quarter was $7.2 million ($0.27 per diluted share), compared to a net loss of $8.6 million ($0.32 per diluted share) for the second quarter of 1998, reflecting the write-off of those in-process research and development costs noted above. Net income for the six months ended June 30, 1999 was $12.3 million, or $0.46 per diluted share, compared to a net loss of $3.3 million, or $0.12 per diluted share, in the first six months of 1998, reflecting the write-off of such in-process research and development costs. Without such write-off, net income for the quarter ended June 30, 1999 would have increased 44.1% compared to 1998. Moreover, without such write-off, net income for the six months ended June 30, 1999 would have increased 18.7% compared to 1998. INFLATION/CURRENCY FLUCTUATION Inflation and currency fluctuations have not previously had a material impact on Inter-Tel's operations. International procurement agreements have traditionally been denominated in U.S. currency. Moreover, a significant amount of contract manufacturing has been moved to domestic sources. The expansion of international operations in the United Kingdom and Europe and increased sales, if any, in Japan and Asia and elsewhere could result in higher international sales as a percentage of total revenues; however, international revenues are currently not a significant component of the Company's consolidated operations. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1999, the Company had $60.3 million in cash and equivalents, which represents a decrease of approximately $2.8 million from December 31, 1998. The Company maintains a $7.0 million, unsecured revolving line of credit with Bank One, Arizona, NA. The credit facility is annually renewable and is available through June 1, 2000. Under this credit facility, the Company has the option to borrow at a prime rate or adjusted LIBOR interest rate. Historically, the credit facility has been used primarily to support international letters of credit to suppliers. The remaining cash balances may be used to further develop and 9 expand Inter-Tel.net and for potential acquisitions, strategic alliances, working capital and general corporate purposes. Net cash provided by operating activities totaled $11.1 for the six months ended June 30, 1999, compared to net cash provided by operating activities of $11.9 million for the same period in 1998. The operating cash flow in the first six months of 1999 was primarily the result of profitable operations including non-cash depreciation and amortization charges. During the first six months of 1999, accounts receivable increased approximately $7.2 million ($2.7 million of which was attributable to an acquisition), while inventories decreased approximately $1.7 million. During the first six months of 1999, increases in accounts receivable and prepaid expenses and other assets were offset in part by reductions in inventories and investment in sales-leases. The Company expects to expand sales through its direct sales office and dealer networks, which is expected to require working capital for increased accounts receivable and inventories. Net cash used in investing activities, primarily in the form of capital expenditures and additions to operating leases offered to customers, less proceeds from the disposal of some operating leases, totaled $8.1 million in the six months ended June 30, 1999, compared to $33.4 million for the same period of 1998. The net cash used in 1998 was primarily the result of the purchase of certain assets of TMSI and related write-off of in-process research and development costs. Cash used in acquisitions totaled approximately $25.3 million in the first six months of 1998. Capital expenditures totaled approximately $9.4 million in 1999 and $8.1 million for 1998. The Company anticipates additional capital expenditures during 1999, principally relating to potential acquisition expenditures and other expenditures for equipment used in operations, facilities expansion and anticipated increased volumes of operating leases offered by the Company to its customers, which must be capitalized as fixed assets by the Company. Net cash used in financing activities totaled $5.8 million in the six months ended June 30, 1999 compared to cash provided by financing activities totaling $919,000 for the same period in 1998. Cash used in 1999 was related primarily to payments for the repurchase of the Company's common stock of $6.7 million, offset by proceeds from the exercise of stock options and stock issued under the Company's Employee Stock Purchase Plan ("ESPP"), less cash dividends paid. During the second quarter of 1999, the Company initiated a stock repurchase program under which the Board of Directors authorized the repurchase of up to 2,500,000 shares of the Company's common stock. The Company stock repurchases in the second quarter of 1999 were funded primarily by existing cash balances. The Company reissued treasury shares with a cost basis of approximately $4.9 million in connection with stock option and ESPP exercises and issuances. The proceeds received for the treasury stock reissued was less than its cost basis. Accordingly, the difference was recorded as a reduction to retained earnings. The Company offers to its customers lease financing and other services, including its Totalease program, through its Inter-Tel Leasing subsidiary. The Company funds its Totalease program in part through the sale to financial institutions of rental income streams under the leases. Resold Totalease rentals totaling $150.1 million and $131.3 remained unbilled at June 30, 1999 and December 31, 1998, respectively. The Company is obligated to repurchase such income streams in the event of defaults by lease customers, and accordingly, maintains reserves based on loss experience and past due accounts. Although the Company to date has been able to resell the rental streams from leases under the Totalease program profitably and on a substantially current basis, the timing and profitability of lease resales could impact the Company's business and operating results, particularly in an environment of fluctuating interest rates and economic uncertainty. If the Company is required to repurchase rental streams and realizes losses thereon in amounts exceeding its reserves, its operating results will be adversely affected. The Company believes that its cash balances, working capital and available credit facilities, together with anticipated ongoing cash generated from operations, will be sufficient to develop and expand its Inter-Tel.net network, to finance acquisitions of additional resellers of telephony products and other strategic acquisitions or corporate alliances, and to provide adequate working capital for at least the next twelve months. However, to the extent that additional funds are required in the future to address 10 working capital needs and to provide funding for capital expenditures, expansion of the business or the Inter-Tel.net network or additional acquisitions, the Company will seek, if at all, additional financing. There can be no assurance that additional financing will be available when required or on acceptable terms. FACTORS THAT MAY AFFECT RESULTS OF FUTURE OPERATIONS This Quarterly Report to Shareholders on Form 10-Q ("10-Q") contains forward-looking statements that involve risks and uncertainties. The statements contained in this 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including without limitation statements regarding the Company's expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this document are based on information available to the Company on the date hereof, and the Company assumes no obligation to update any such forward-looking statements. The cautionary statements made in this 10-Q should be read as being applicable to all related forward-looking statements wherever they appear in this document. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under "Factors That May Affect Results of Future Operations" below and elsewhere in this document. In evaluating the Company's business, shareholders and prospective investors should consider carefully the following factors in addition to the other information set forth in this document. RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON RECENTLY INTRODUCED PRODUCTS The market for the Company's software, products and services is characterized by rapid technological change and continuing demand for new products, features and applications. Current competitors or new market entrants may develop new products or product features that could adversely affect the competitive position of the Company's products. Accordingly, the timely introduction of new products and product features, as well as new telecommunications applications, will be key factors in the Company's future success. During the past few years, the Company introduced unified messaging on its AXXESSORY TALK platform, developed a number of enhancements to its existing AXXESS and AXXESSORY Talk platforms and introduced Inter-Tel Vocal'Net Gateway Server and the Inter-Tel Vocal'Net Service Provider Package. In April 1999, the Company released the InterPrise 400 voice and data router, the first of a family of voice and data convergence products that will be released over the next year. Also, during the second quarter of 1999, the Company introduced AXXESS and AXXESSORY TALK 5.1 software into controlled product introduction. During the past 12 months, sales of the Company's AXXESS digital communications platforms and related software have comprised a substantial portion of the Company's net sales. The Company expects that its future success will continue to depend, in large part, upon the increasing commercial acceptance of the InterPrise products and the AXXESS platform, as well as future upgrades and enhancements to these products and networking platforms. There can be no assurance that any of these introduced products and enhancements will be successful. Due to the complexity of the Company's products, the Company has in the past and expects in the future to experience delays in the development and release of new products or product enhancements. In the event that the Company were to fail to successfully introduce new software, products or services or upgrades to its existing systems or products on a regular and timely basis, demand for the Company's existing software, products and services could decline, which could have a material adverse effect on the Company's business and operating results. Further, if the markets for IP network products or CTI applications fail to develop, or grow more slowly than the Company anticipates, or if the Company is unable for any reason to capitalize on any of these emerging market opportunities, the Company's business, financial condition and results of operations could be materially adversely affected. Occasionally, new products contain undetected program errors or "bugs" when released. Such bugs may result from defects contained in software products offered by the Company's suppliers or other 11 third parties that are intended to be compatible with the Company's products, over which the Company has little or no control. Although the Company seeks to minimize the number of bugs in its products by its test procedures and quality control, there can be no assurance that its new products will be error-free when introduced. Any significant delay in the commercial introduction of the Company's products due to bugs, design modifications required to correct bugs or impairment of customer satisfaction as a result of bugs could have a material adverse effect on the Company's business and operating results. In addition, new products often take several months before their manufacturing costs stabilize, and, accordingly, operating results would be adversely affected for a period of time following introduction. DEVELOPING MARKET FOR IP NETWORK TELEPHONY; UNCERTAIN REGULATORY ENVIRONMENT The market for IP network voice communications products has only recently begun to develop, is rapidly evolving and is characterized by an increasing number of market entrants who have introduced or developed products and services for Internet or other IP network voice communications. As is typical in the case of a new and rapidly evolving industry, the demand for and market acceptance of recently introduced IP network products and services is highly uncertain. There can be no assurance that voice communications over IP networks will become widespread. Further, even if voice communications over IP networks achieve broad market acceptance, in light of the competitive pressures developing in this market, there can be no assurance that the Company's products, and particularly Inter-Tel Vocal'Net and the Inter-Tel InterPrise products, will achieve market acceptance. The adoption of voice communications over IP networks generally requires the acceptance of a new way of exchanging information. In particular, enterprises that have already invested substantial resources in other means of communicating information may be reluctant or slow to adopt a new approach to communications. The lack of control over IP network infrastructure and each user's system configuration may cause users of IP network voice communications delays in the transmission of speech, loss of voice packets and inferior sound quality relative to standard telephony networks. If these factors cause the market for IP network voice communications to fail to develop or to develop more slowly than the Company anticipates, the Company's IP network telephony products could fail to achieve market acceptance, which in turn could have a material adverse effect on the Company's business, financial condition and results of operations. The regulatory environment for IP network telephony is subject to substantial uncertainty. There can be no assurance that the sale and use of IP network telephony products such as Inter-Tel Vocal'Net and the Inter-Tel InterPrise products will comply with telecommunications laws or other regulations in any of the countries in which such products are or will be marketed and used. In the United States, the Company believes that there are currently few laws or regulations directly applicable to voice communications over IP networks or to access to, or commerce on, IP networks generally. However, changes in the regulatory environment, particularly in regulations relating to the telecommunications industry, could have a material adverse effect on the Company's business. The increased commercial acceptance of voice communications over IP networks, as well as other factors, could result in intervention by governmental regulatory agencies in the United States or elsewhere in the world under existing or newly enacted legislation and in the imposition of fees, charges or taxes on users and providers of products and services in this area. There can be no assurance that such intervention or imposition of fees, charges or taxes would not have a material adverse effect upon the acceptance and attractiveness of IP network voice communications. Moreover, legislative proposals from international, federal and state government bodies could impose additional regulations and obligations upon on-line service providers. The growing popularity and use of the Internet has increased public focus and could lead to increased pressure on legislatures to impose such regulations. The Company cannot predict the likelihood that any future legislation or regulation will be enacted, nor the financial impact, if any, of such resulting legislation or regulation. In the future, the Company may also develop and introduce other products with new or additional telecommunications capabilities or services, which could be subject to 12 existing federal government regulations or result in the imposition of new government regulations, either in the United States or elsewhere. RISKS ASSOCIATED WITH INTER-TEL VOCAL'NET AND INTER-TEL INTERPRISE; DEPENDENCE UPON IP NETWORK INFRASTRUCTURES; RISK OF SYSTEM FAILURE; SECURITY RISKS Over the past 24 months, the Company has introduced the Inter-Tel Vocal'Net Server, the Inter-Tel Service Provider Package, and Inter-Tel InterPrise products. The Company has also introduced several new software releases to provide new features and enhancements to the Inter-Tel Vocal'Net product line. There can be no assurance the functionality, scalability, and reliability of the Inter-Tel Vocal'Net, Inter-Tel Service Provider Package and Inter-Tel InterPrise product lines will be accepted in the market. In addition, there can be no assurance that these products and technology will comply with industry standards or that industry standards will not change and render Inter-Tel Vocal'Net or the Company's other IP telephony products obsolete. In the event that these products fail to achieve market acceptance, the Company's business, financial condition and results of operations could be materially and adversely affected. The success of Inter-Tel Vocal'Net and other IP telephony products that the Company acquired through its purchase of assets from Telecom Multimedia Systems, Inc. ("TMSI") in June 1998 will also depend upon, among other things, the continued expansion of the Internet and other IP networks and their network infrastructures. There can be no assurance that the infrastructure or complementary products necessary to make the Internet a viable commercial network will continue to be developed. In addition, there can be no assurance that IP networks will retain their current volume, distance and time-of-day-independent pricing structure, or that the costs of access to IP networks, lack of capacity or poor voice transmission quality of IP networks will not adversely affect the market for IP network products and services. Moreover, critical issues concerning the commercial use of the Internet (including security, reliability, cost, ease of use and access and quality of service) remain unresolved and may affect the growth of IP network use. There can be no assurance that the Internet will be able to meet additional demand or its users' changing requirements on a timely basis, at a commercially reasonable cost, or at all. The Inter-Tel Vocal'Net gateway, the Inter-Tel Vocal'Net Service Provider Package and the Inter-Tel InterPrise products can be vulnerable to computer viruses or similar disruptive problems. Computer viruses or problems caused by third parties could lead to interruptions, delays or cessation of service. Further, inappropriate use of the Internet or other IP networks by third parties could potentially jeopardize the security of confidential information, such as credit card or bank account information or the content of conversations over the IP network, which may deter certain persons from ordering and using the Company's products. Until more comprehensive security technologies are developed, the security and privacy concerns of existing and potential users may inhibit the growth of IP networks in general and the market for the Company's IP network products in particular. DEVELOPMENT AND MAINTENANCE OF INTER-TEL.NET NETWORK The Company is currently utilizing its Inter-Tel Vocal'Net technology and Inter-Tel InterPrise products to develop and expand its own IP network, Inter-Tel.net, to carry voice traffic. The Inter-Tel.net network is in its early stages of deployment and, accordingly, is subject to risks. To date, the Inter-Tel.net network has established points of presence in the San Francisco Bay Area, Washington, D.C., Chicago, New York, Phoenix, Reno, Atlanta, Houston, Los Angeles, Dallas, Ft. Lauderdale and Miami. Certain products that the Company purchased from TMSI have been or are in the process of being tested and deployed in this network. If the domestic or international market for IP network products fails to develop or develops more slowly than the Company anticipates, or should the business experience difficulty in the integration of the TMSI technology, the Company's Inter-Tel.net network could become financially burdensome to maintain or obsolete, which could materially and adversely affect the Company's business, financial condition and results of operations. 13 The Company is dependent on third-party suppliers of telecommunications and Internet network transmission services for implementation of Inter-Tel.net and does not currently have long-term contracts with such suppliers. The Company's ability to expand Inter-Tel.net is dependent upon its ability to obtain services from such suppliers. Certain of these third party suppliers are or may become competitors of the Company, and such suppliers generally are not subject to restrictions upon their ability to compete with the Company. To the extent that these suppliers raise rates or change pricing structures, the Company may be materially adversely affected. Also, the Company faces the risk that there could be a disruption in the service provided by these suppliers, and can give no assurance that there will not be a significant disruption in such service in the future, thereby causing a disruption in the services provided by the Company to its customers. Moreover, although the Company has devoted, and intends to continue to devote, substantial resources to improve the quality of telephone conversations using Inter-Tel Vocal'Net, certain products and Inter-Tel InterPrise products, and the Inter-Tel.net network, there can be no assurance that the problems of voice communications over the Inter-Tel.net network that exist today, including delays in the transmission of speech, loss of voice packets and sound quality inferior to that of standard telephony networks, will be eliminated or reduced. In the event that the Company is unable to improve upon the sound quality and other limitations of voice communications over the Inter-Tel.net network and to offer such improvements to its customers on a cost-effective basis, the Inter-Tel.net network could fail to achieve market acceptance, and the Company's business, financial condition and results of operations could be materially and adversely affected. HIGHLY COMPETITIVE INDUSTRY The market for the Company's core PABX and key systems products is highly competitive and in recent periods has been characterized by pricing pressures and business consolidations. The Company's competitors include Lucent and NorTel, as well as Comdial, Executone, Iwatsu, Mitel, NEC, Nitsuko, Panasonic, Siemens, Toshiba and others. Many of these competitors have significantly greater financial, marketing and technical resources than the Company. The Company also competes against the RBOCs, which offer systems produced by one or more of the aforementioned competitors and also offer Centrex systems in which automatic calling facilities are provided through equipment located in the telephone company's central office. The Company also expects to compete against large data router companies, like Cisco Systems and 3Com, which have acquired telecommunications technology during 1997 through 1999. The Telecommunications Act of 1996 and AT&T's division into three enterprises have impacted competition in the communications industry. The Telecommunications Act opened the market for telephone and cable television services, forcing telephone companies to open their networks to competitors and giving consumers a choice of local phone carriers. Conversely, local phone companies are now able to offer long distance services. In addition, cable companies can offer telephone services and Internet access. These changes have increased competition in the communications industry and have created additional competition and opportunities in customer premise equipment, as these new services and interfaces have become available. In the market for voice processing applications, including voice mail, the Company competes against AVT, Active Voice, Lucent and other competitors, certain of which have significantly greater resources than the Company. In the market for long distance services, the Company competes against AT&T, MCI, Sprint Corporation, Qwest and other competitors, many of which have significantly greater resources than the Company. The Company also competes with RBOCs, cable television companies, satellite and other wireless broadband service providers, and others for long distance business as those companies respond to the Telecommunications Act. Key competitive factors in the sale of telephone systems and related applications include price, performance, features, reliability, service and support, name recognition and distribution capability. The Company believes that it competes favorably in its markets with respect to the price, performance and features of its systems, as well as the level of service 14 and support that the Company provides to its customers. Certain of the Company's competitors have significantly greater name recognition and distribution capabilities than the Company, although the Company believes that it has developed a competitive distribution presence in certain markets, particularly those where the Company has direct sales offices. In the market for IP telephony products, the Company competes against existing IP telephony gateway providers such as Clarent, Lucent, NetSpeak Corporation, VocalTec Communications Ltd., Nokia IP Products and several others. Several of these competitors have been active in developing and marketing IP telephony products for a greater period of time than the Company and have already established relationships with customers within their market. In addition, the Company faces significant competition from vendors such as Cisco Systems, Inc., Nortel, 3Com Corporation, Motorola, Inc. and MICOM Communications Corp., as these established data vendors have entered the market for IP telephony products. Such companies currently produce products that, when equipped with voice capabilities, could represent a considerable threat to the Company within that market. In addition, most of the above data router vendors have greater name recognition, more established positions in the market, and long-standing relationships with data network customers. Moreover, should the market for IP telephony products become fully developed or develop at a rapid rate, large computer companies such as IBM and Microsoft, or large telephone companies such as AT&T, MCI, Sprint Corporation, or Qwest, could choose to develop proprietary software designed to facilitate voice communication over an IP network. As the Company enters the markets for local telephone service and IP network access, it will face additional competition from RBOCs, cable companies and other providers and existing IP carriers like Net2Phone, which have larger marketing and sales organizations, significantly greater financial and technical resources and a larger and more established customer base than the Company. In addition, RBOCs, cable companies and other providers have greater name recognition, more established positions in the market and long standing relationships with customers. Therefore, there can be no assurance that the Company will compete successfully in these markets. Many of the Company's current and potential competitors have longer operating histories, are substantially larger, and have greater financial, manufacturing, marketing, technical and other resources. Competition in the Company's markets may result in significant price reductions. As a result of their greater resources, many current and potential competitors may be better able than the Company to initiate and withstand significant price competition or downturns in the economy. There can be no assurance that the Company will be able to continue to compete effectively, and any failure to do so would have a material adverse effect on the Company's business, financial condition and operating results. The Company expects that competition will continue to be intense in the markets addressed by the Company, and there can be no assurance that the Company will be able to continue to compete successfully. PRODUCT PROTECTION AND INFRINGEMENT The Company's future success will depend in part upon its proprietary technology. The Company currently holds patents for six telecommunication and unified messaging products. The Company has also applied to the U.S. Patent and Trademark Office for a patent related to certain aspects of the Inter-Tel Vocal'Net technology. The Company also relies on copyright and trade secret law and contractual provisions to protect its intellectual property. There can be no assurance that any patent, trademark or copyright owned by or applied for by the Company, will not be invalidated, circumvented or challenged or that the rights granted thereunder will provide meaningful protection or any commercial competitive advantage to the Company. Further, there can be no assurance that others will not develop technologies that are similar or superior to the Company's technology or that duplicate the Company's technology. As the Company expands its international operations, effective intellectual property protection may be unavailable or limited in certain foreign countries. There can be no assurance that the steps taken by the Company will prevent misappropriation of its technology. Litigation may be necessary in 15 the future to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and operating results. From time to time, the Company is subject to proceedings alleging infringement by the Company of intellectual property rights, including patents, trademarks, copyrights, or other intellectual property rights of others. In this regard, the Company recently received a letter from one of its primary competitors alleging that the Company's AXXESS digital communications platform utilizes inventions covered by certain of such competitor's patents. The Company is currently in the process of investigating this matter. When any such claims are asserted against the Company, the Company may seek to purchase a license under the third party's intellectual property rights. Purchasing such licenses can be expensive, and there can be no assurance that a license will be available on prices or other terms acceptable to the Company or at all. In the alternative, the Company could resort to litigation to challenge any such claim. Any such litigation could require the Company to expend significant sums, divert management's attention and require the Company to pay significant damages, develop non-infringing technology or acquire licenses to the technology which is the subject of the asserted infringement, any of which could have a material adverse effect on the Company's business, financial condition and operating results. In the event that the Company is unable or chooses not to license such technology or decides not to challenge such third party's rights, the Company could encounter substantial and costly delays in product introductions while attempting to design around such third party rights, or could find that the development, manufacture or sale of products requiring such licenses could be foreclosed. MANAGEMENT OF GROWTH; IMPLEMENTATION OF NEW MANAGEMENT INFORMATION SYSTEMS The growth in the Company's business has placed, and is expected to continue to place, a significant strain on the Company's personnel, management and other resources. The Company's ability to manage any future growth effectively will require it to attract, train, motivate and manage new employees successfully, to integrate new employees into its overall operations and to continue to improve its operational, financial and management information systems. The Company has substantially implemented various components of the new MIS software beginning in 1998 and completed the deployment of this software in June 1999. Full implementation of this system software and the transition from the old system software has required and will continue to require substantial financial resources, time and personnel. The Company has made strategic acquisitions in the past and expects to continue to do so in the future. Acquisitions require a significant amount of the Company's management attention and financial and operational resources, all of which are limited. The integration of any acquired assets or entities, or prospective acquisition candidates may also result in unexpected costs and disruptions and significant fluctuations in, or reduced predictability of, operating results from period to period. There can be no assurance that an acquisition will have a positive impact on the business relationships of the Company or the acquired entity with its respective suppliers or customers. Further, there can be no assurance that the Company will be able to successfully integrate acquired assets or operations or achieve any of the intended benefits of an acquisition. The Company's failure to manage its growth effectively could have a material adverse effect on its business, financial condition and operating results. DEPENDENCE UPON CONTRACT MANUFACTURERS AND COMPONENT SUPPLIERS The Company currently procures certain components used in its digital communication platforms, including certain microprocessors, integrated circuits, power supplies, voice processing 16 interface cards and IP telephony cards, from a relatively small number of suppliers and manufacturers and, accordingly, product availability could be limited. However, the Company believes that alternate sources of supply are available for virtually every component. All of the Company's proprietary products are manufactured according to specifications and conditions set by the Company. Each manufacturer must meet the Company's specifications relating to the manufacturing process and quality assurance before such manufacturer is selected by the Company. The Company currently manufactures its products through manufacturers located in the United States, the Philippines, the People's Republic of China and Mexico. Foreign manufacturing facilities are subject to changes in governmental policies, imposition of tariffs and import restrictions and other factors beyond the Company's control. Varian currently manufactures a significant portion of the Company's products at Varian's Tempe, Arizona facility, including substantially all of the printed circuit boards used in the AXXESS and Inter-Tel Axxent digital communication platforms. From time to time, the Company has experienced delays in the supply of components and finished goods, and there can be no assurance that the Company will not experience such delays in the future. The Company's reliance on third party manufacturers involves a number of additional risks, including reduced control over delivery schedules, quality assurance and costs. Any delay in delivery or shortage of supply of components or finished goods from any supplier, or the Company's inability to develop in a timely manner alternative or additional sources if and when required, could adversely affect the Company's business, financial condition and operating results. Although the Company does not have long-term supply contracts with any of its contract manufacturers, to date it has been able to obtain supplies of components and products in a timely manner. There can be no assurance that the Company will be able to continue to obtain components or finished goods in sufficient quantities or quality or on favorable pricing and delivery terms in the future. RELIANCE ON DEALER NETWORK A substantial portion of the Company's net sales are made through its network of independent dealers. The Company faces intense competition from other telephone system and voice processing system manufacturers for such dealers' business, as most of the Company's dealers carry products which compete with the Company's products. There can be no assurance that any such dealer will not promote the products of the Company's competitors to the detriment of the Company's products. The loss of any significant dealer or group of dealers, or any event or condition adversely affecting the Company's dealer network, could have a material adverse effect on the Company's business, financial condition and operating results. DEPENDENCE ON KEY PERSONNEL The Company is dependent on the continued service of, and its ability to attract and retain, qualified technical, marketing, sales and managerial personnel. The competition for such personnel is intense, and the loss of any of such persons, as well as the failure to recruit additional key technical and sales personnel in a timely manner, could have a material adverse effect on the Company's business and operating results. There can be no assurance that the Company will be able to continue to attract and retain the qualified personnel necessary for the development of its business. RISKS OF PROVIDING LONG DISTANCE AND NETWORK SERVICES Inter-Tel depends on its supply of telecommunications services and information from several long distance carriers. The Company relies principally on long distance carriers to provide network services to the Company's customers and for billing information. Long distance services are subject to extensive and uncertain governmental regulation on both the federal and state level. There can be no assurance that the promulgation of certain regulations will not materially and adversely affect the Company's business, financial condition and operating results. Contracts with the long distance carriers from which the Company currently resells services typically have multi-year terms in which the Company's prices are relatively fixed and have minimum use requirements. The market for long distance 17 services is currently experiencing and is expected to experience in the future significant price competition, resulting in decreasing end-user rates. There can be no assurance that the Company will meet minimum use commitments, will be able to negotiate lower rates with carriers in the event of any decrease in end user rates or will be able to extend its contracts with long distance carriers at prices favorable to the Company. The Company's ability to continue to expand its long distance services depends upon its ability to continue to secure reliable long distance services from a number of long distance carriers and the willingness of such carriers to continue to provide telecommunications services and billing information to the Company on favorable terms. POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS; EXTENDED SALES CYCLE; LIMITED BACKLOG The Company's quarterly operating results depend upon a variety of factors, including the volume and timing of orders received during the quarter, the mix of products sold, mix of distribution channels, general economic conditions, patterns of capital spending by customers, the timing of new product announcements and releases by the Company and its competitors, pricing pressures, the cost and effect of acquisitions, and the availability and cost of products and components from the Company's suppliers. The Company's customers typically require immediate shipment and installation of platforms and software. As a result, the Company has historically operated with a relatively small backlog, and sales and operating results in any quarter are principally dependent on orders booked and shipped in that quarter. Historically, a substantial portion of the Company's net sales in a given quarter have been recorded in the third month of the quarter, with a concentration of such net sales in the last two weeks of the quarter. Market demand for investment in capital equipment such as digital communication platforms and associated call processing and voice processing software applications is largely dependent on general economic conditions, and can vary significantly as a result of changing conditions in the economy as a whole. In the past 15 months, the Company introduced AXXESS networking systems and software, which are typically sold to larger customers at a higher average selling price. Our AXXESS networking products have a relatively high sales price per unit, and often represent a significant and strategic decision by an enterprise regarding its communications infrastructure. Accordingly, the purchase of our products typically involves significant internal procedures associated with the evaluation, testing, implementation and acceptance of new technologies. This evaluation process frequently results in a lengthy sales process, typically ranging from three months to more than nine months, and subjects the sales cycle associated with the purchase of our products to a number of significant risks, including budgetary constraints and internal acceptance reviews. The length of our sales cycle also may vary substantially from customer to customer. While our customers are evaluating our products and before placing an order with us, we may incur substantial sales and marketing expenses and expend significant management effort. Consequently, if sales forecasted from a specific customer for a particular quarter are not realized in that quarter, the Company's operating results could be materially adversely affected. The Company's expense levels are based in part on expectations of future sales and, if sales levels do not meet expectations, operating results could be adversely affected. Because sales of digital communication platforms through the Company's dealers produce lower gross margins than sales through the Company's direct sales organization, operating results have varied, and will continue to vary based upon the mix of sales through direct and indirect channels. Although the Company to date has been able to resell the rental streams from leases under its Totalease program profitably and on a substantially current basis, the timing and profitability of lease resales from quarter to quarter could impact operating results, particularly in an environment of fluctuating interest rates. Long distance sales, which have lower gross margins than the Company's core business, have grown in recent periods at a faster rate than the Company's overall net sales. As a result, gross margins could be adversely affected in the event that long distance calling services continue to increase as a percentage of net sales. In addition, the Company is subject to seasonality in its operating results, as net sales for the first and third quarters are frequently less than those experienced, in the fourth and second quarters, respectively. As a result of 18 these and other factors, the Company has in the past experienced, and could in the future experience, fluctuations in sales and operating results on a quarterly basis. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." VOLATILITY OF STOCK PRICE The market price for the Company's Common Stock has been highly volatile. The Company believes that factors such as announcements of developments relating to the Company's business, fluctuations in the Company's operating results, shortfalls in revenue or earnings relative to securities analysts' expectations, announcements of technological innovations or new products or enhancements by the Company or its competitors, general conditions in the telecommunications industry, the market for Internet-related products and services or the national or worldwide economy, changes in legislation or regulation affecting the telecommunications industry, an outbreak of hostilities, developments in intellectual property rights and developments in the Company's relationships with its customers and suppliers could cause the price of the Company's Common Stock to fluctuate, perhaps substantially. Many of such factors are beyond the Company's control. In addition, in recent years the stock market in general, and the market for shares of technology stocks in particular, have experienced extreme price fluctuations, which have often been unrelated to the operating performance of affected companies. There can be no assurance that the market price of the Company's Common Stock will not experience significant fluctuations in the future, including fluctuations that are unrelated to the Company's performance. YEAR 2000 READINESS Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. Beginning in the year 2000, these date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists in the software industry concerning the potential effects associated with such readiness. The Company has evaluated its level of exposure to the risks and costs associated with Year 2000 problems and has substantially updated its information systems with systems that are designed to be Year 2000 ready. The Company has upgraded its long distance billing system, which is warranted by the manufacturer to be Year 2000 ready. In addition, the Company has reviewed and tested its lease billing and collections system, which is Year 2000 ready. The Company has contracted outside vendors to perform detailed reviews of the readiness of other information systems devices in use in the Company's business. This assessment has been completed. Anticipated upgrades or remediation performed for devices that are not Year 2000 ready are included in the Company's capital expenditure budget for 1999, and are expected to be either completed before year-end or deemed unnecessary to the continuing operation of the business. The total cost of each system is being or will be capitalized and depreciated in the normal course of business. The Company's critical information systems are believed to be substantially Year 2000 ready and secondary systems and devices deemed necessary for the operation of the business will be completed by the end of the fourth quarter. The Company currently anticipates no material disruptions in the services it provides to its customers as a result of Year 2000 problems. If any of the above systems are not Year 2000 ready, however, the Company's business, financial condition and results of operations could be materially adversely affected. No assurance can be given that the Company's software products, including components manufactured and or developed by the Company's suppliers and vendors, will contain all necessary date code changes necessary to prevent processing errors potentially arising from calculations using the Year 2000 date, or that such updates will be fully completed in a timely manner or that such disruptions will not occur. Products currently manufactured by Inter-Tel are designed to be Year 2000 ready and recent testing of such products by our engineers have indicated that such products are Year 2000 ready, in accordance 19 with our test procedures. Costs to develop and update the Company's products for Year 2000 readiness have been part of the Company's ongoing research and development efforts. Any disruption in manufacturing services provided by the Company as a result of Year 2000 noncompliance could materially adversely affect the Company's business, financial condition and results of operations. If any of the Company's products are not Year 2000 ready, or if certain non-ready products are not replaced or upgraded, the Company's business, financial condition and results of operations could be materially adversely affected. Moreover, the Company could also be materially adversely impacted by Year 2000 issues faced by major distributors, suppliers, customers, vendors and financial service organizations with which the Company interacts. The Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues in a variety of ways. Many companies are expending significant resources to correct or patch their current software systems for Year 2000 readiness. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company. Many of the Company's customers and potential customers are requesting information about Year 2000 readiness of the Company's products. These customers and potential customers may also choose to defer purchasing Year 2000 ready products until they believe it is absolutely necessary, thus resulting in potentially stalled market sales within the industry. Conversely, Year 2000 issues may cause other customers to accelerate purchases with Year 2000 readiness warranties, thereby causing an increase in short-term demand and a consequent decrease in long-term demand for software products. Additionally, Year 2000 issues could cause a significant number of companies, including existing customers of the Company, to reevaluate their current communications platform, IP network telephony or voice processing software needs, and as a result consider switching to other systems or suppliers. Any of the above items for which the Company is unable to provide Year 2000 readiness to these customers could materially adversely affect the Company's business, financial condition and results of operations. Inter-Tel is completing programs and has developed evolution strategies for customers who own non-Year 2000 ready Inter-Tel products. Inter-Tel has begun extensive efforts to alert customers who have such non-Year 2000 ready products, including direct mailings, phone contacts and participation in user and industry groups. Inter-Tel also has a Year 2000 web site that provides Year 2000 product information. Inter-Tel is continuing contingency planning to address potential increases in demand for customer support resulting from the Year 2000 date change. The Plan includes organizing a team of employees dedicated to the specific problems of the Year 2000 change including monitoring key internal systems to insure continuation of operations, and ongoing customer service in the beginning of the new year. CONCENTRATION OF OWNERSHIP As of June 30, 1999, Steven G. Mihaylo, the Company's Chairman of the Board of Directors, Chief Executive Officer and President beneficially owned approximately 21.1% of the outstanding shares of the Common Stock. As a result, he has the ability to exercise significant influence over all matters requiring shareholder approval. In addition, the concentration of ownership could have the effect of delaying or preventing a change in control of the Company. Any of the foregoing could result in a material adverse effect on the Company's business, financial condition and operating results. INTER-TEL, INCORPORATED AND SUBSIDIARIES PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS--NOT APPLICABLE ITEM 2. CHANGES IN SECURITIES--NOT APPLICABLE 20 ITEM 3. DEFAULTS ON SENIOR SECURITIES--NOT APPLICABLE ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS 1. On April 26, 1999, at the Company's annual meeting of shareholders, the shareholders of the Company elected the following directors, each of whom was a nominee of the Company: Name Votes For Votes Withheld ---- --------- -------------- Steven G. Mihaylo 21,352,160 156,725 J. Robert Anderson 21,351,477 157,408 Gary D. Edens 31,352,007 156,878 Maurice H. Esperseth 21,352,007 156,878 C. Roland Haden 21,352,007 156,878 ITEM 5. OTHER INFORMATION Pursuant to Rule 14a-4(c)(1) under the Securities Exchange Act of 1934, in connection with the Company's annual meeting of shareholders, if a stockholder of the Company fails to notify the Company by February 6, 2000, then the proxies of management would be allowed to use their discretionary voting authority when any such proposal is raised at the Company's annual meeting of stockholders, without any discussion of the matter in the proxy statement. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K Exhibits: Exhibit 27.1 - Financial Data Schedule for June 30, 1999 Reports on Form 8-K -- None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INTER-TEL, INCORPORATED Date 8-13-99 /s/ Steven G. Mihaylo ---------------------------------------- Steven G. Mihaylo, Chairman of the Board, Chief Executive Officer and President Date 8-13-99 /s/ Kurt R. Kneip ---------------------------------------- Kurt R. Kneip, Vice President and Chief Financial Officer 21 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE INTER-TEL, INCORPORATED AND SUBSIDIARIES FINANCIAL STATEMENTS FOR THE QUARTER ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 U.S. DOLLARS 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 1 60,313 0 53,688 5,350 17,980 144,040 59,583 27,047 206,848 46,625 0 0 0 104,539 44,691 206,848 143,313 143,313 72,122 72,122 0 4,551 25 19,855 7,542 12,313 0 0 0 12,313 0.47 0.46
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