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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission File Number:
December 31, 1998 0-10211
INTER-TEL, INCORPORATED
Incorporated in the State of Arizona I.R.S. No. 86-0220994
120 North 44Th Street, Suite 200
Phoenix, Arizona 85034-1822
(602) 302-8900
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock
(26,157,657 shares outstanding as of March 12, 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 period 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (S 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K - [ ].
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the last reported sales price of the Company's
Common Stock reported on the Nasdaq National Market System on March 12, 1999 was
approximately $340,486,509. Shares of Common Stock held by each executive
officer and director have been excluded in that such persons may be deemed to be
affiliates.
Sections from the following documents have been incorporated by reference into
this Report where indicated below: (1) the Registrant's Proxy Statement relating
to its 1998 Annual Meeting of Shareholders have been incorporated by reference
into Part III and Part IV of this report and (2) the Registrant's Form S-1
Registration Statements (Nos. 2-70437 and 33-70054), Form S-3 Registration
Statements (Nos. 33-58161, 33-61437, 333-01735, 333-12433 and 333-39221), Form
S-8 Registration Statements (Nos. 2-94805, 33-40353, 33-73620, 333-41197 and
333-67261), Annual Reports on Form 10-K for the years ended December 31, 1984,
1988 and 1994, and Reports on Form 8-K dated July 17, 1987 and August 3, 1988
have been incorporated by reference into Part IV, Item 14. Portions of the
Annual Report to Shareholders for the year ended December 31, 1996 are
incorporated by reference into Part II.
INTER-TEL, INCORPORATED
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Page
Item 1 Business 3
Item 2 Properties 26
Item 3 Legal Proceedings 26
Item 4 Submission of Matters to a Vote of Security Holders 26
PART II
Item 5 Market for the Registrant's Common Stock
and Related Stockholder Matters 27
Item 6 Selected Financial Data 27
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations 27
Item 7A Quantitative and Qualitative Disclosures About Market Risk 27
Item 8 Financial Statements and Supplementary Data 28
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 28
PART III
Item 10 Directors and Executive Officers of the Registrant 28
Item 11 Executive Compensation 28
Item 12 Security Ownership of Certain Beneficial Owners and Management 28
Item 13 Certain Relationships and Related Transactions 28
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 28
2
PART I
ITEM 1. BUSINESS
THE COMPANY
THIS ANNUAL REPORT TO SHAREHOLDERS ON FORM 10-K ("10-K") CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS
CONTAINED IN THIS 10-K 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-K
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.
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 and long distance calling services. Inter-Tel's products
and services include the AXXESS and Inter-Tel Axxent digital business
communication software platforms, the AXXESSORY TALK voice processing platform,
the Inter-Tel Vocal'Net IP telephony gateway, InterPrise gateway, the Inter-Tel
Vocal'Net Service Provider Software and Centralized Accounting Software and
Inter-Tel.net, an IP telephony packet switched long distance service. 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.
The Company has developed a distribution network of direct sales
offices, dealers and value added resellers (VARs) which sell the Company's
products to small-to-medium-size organizations and to divisions or departments
of larger organizations, including Fortune 500 companies, large service
organizations and governmental agencies. The Company has 37 direct sales offices
in the United States, one in the United Kingdom, one in Japan, one in Singapore
and a network of hundreds of dealers and VARs around the world who purchase
directly from the Company.
INDUSTRY BACKGROUND
In recent years, advances in telecommunications technologies have
enabled the development of increasingly sophisticated telephone systems and
applications. Users rely upon a variety of applications, including conference
calling, speaker phones, automated attendant, voice processing and unified
messaging (the integration of voice mail, facsimile and electronic mail), to
improve communications within their organizations and with customers and
vendors. Digital technology has facilitated the integration of computing and
telecommunications technologies, which has made possible a number of new
applications that further enhance productivity. Examples of these applications
include automatic call distribution (which provides for queuing and
prioritization of incoming calls), call accounting (which permits accounting for
telephone usage and toll calls), unified messaging, electronic data interchange
between customers and vendors and the use of automatic number identification
coupled with database look-up (where customer information is retrieved
automatically from a computerized database when the customer calls).
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The emergence of high-performance computers and the growth of the
Internet and other digital IP networks have enabled real-time voice
communications to be transmitted on digital packet switched networks rather than
over traditional circuit switched telephone networks. This development of voice
applications for the Internet and other IP networks reflects a broader
convergence of standard voice communications and data networks. Because IP
network telephony converts all transmissions to the same type of packets, both
voice and data can use the same data circuits, thereby increasing efficiency and
maximizing the use of available bandwidth. The lowering of federal regulatory
barriers to competition across traditionally distinct sectors of the
telecommunications industry has opened new markets for and increased competitive
pressures on telecommunications companies. In response to these factors,
telecommunications companies have begun to establish a presence in Internet and
other IP network voice communications services.
Following the breakup of the Bell system in 1984, which removed
restrictions on the ability of the regional Bell operating companies ("RBOCs")
to purchase telecommunications equipment from independent suppliers and to
resell such equipment to end users, the market for telecommunications systems
and applications became increasingly fragmented. The number of independent
suppliers and distributors of telecommunications equipment initially increased,
but increased levels of competition subsequently led to consolidation among
suppliers and distributors. In addition, different telecommunications systems
and applications were often available from only one or a limited number of
suppliers, which required businesses seeking complete systems to work with a
number of different suppliers. A business seeking a telephone system, voice mail
and long distance services would most likely purchase the products and services
from three separate vendors. As business telecommunications requirements have
become more advanced, the integration of different systems has become
increasingly difficult.
STRATEGY
Inter-Tel's objective is to continue to strengthen its position as a
leading single-source provider of telecommunications equipment, software
applications and network services. The Company's strategy incorporates the
following key elements:
OFFER TOTAL TELEPHONY SOLUTION
The Company intends to continue to offer a broad range of products and
services that incorporates advanced technologies and provides customers with a
single source to fulfill their telecommunications needs on a cost-effective
basis. Inter-Tel combines this solution-oriented approach with a high level of
customer service and support and a commitment to quality throughout the
Company's operations. The Company's telephone systems are integrated with the
Company's long distance calling services, voice mail, automated attendant, Voice
Over Internet Protocol (VoIP) services and other telecommunications
applications, and support for interactive voice response. Because of the modular
design of the Company's systems and the high level of software content in its
products, customers can readily increase the size and functionality of their
systems as their needs change by adding software and hardware applications or
services or by upgrading to new systems or advanced versions of existing
systems. The Company believes that its customers prefer to purchase
telecommunications equipment and services from a single source because of the
convenience, consistency of service, ease of upgrade, availability of financing
alternatives and confidence in the performance of integrated systems and
services.
ACCELERATE ADOPTION OF INTERNET PROTOCOL (IP) TELEPHONY TECHNOLOGY
The Company markets its Inter-Tel Vocal'Net Server, InterPrise gateway
and several IP telephony software products to telephone companies, service
providers and businesses worldwide. This suite of products can be used by
telephone companies to offer new services to their customers and expand to new
markets. The products can be used by service providers (ISPs, cable television
companies, etc.) to quickly become telephone companies. The products can be used
by a business to reduce its communications costs through more effective use of
its data network and reduced use of
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traditional long distance services. The Company is focused on expanding current
relationships and pursuing new ones with major telephone companies, service
providers and businesses worldwide.
EXPAND INTER-TEL.NET NETWORK; EXPAND GLOBAL ALLIANCE AND OTHER THIRD
PARTY ALLIANCES
The Company is expanding its customer base on its own private IP
telephony network, Inter-Tel.net, which carries voice and facsimile traffic at
rates typically lower than those of standard telephone networks. To date, the
Inter-Tel.net network has established points of presence in the San Francisco
Bay Area, Washington, D.C., Chicago, Reno, New York, Phoenix and Los Angeles, as
well as a network operations center (NOC) in Reno. The Company intends to expand
the number of points of presence, both domestically and internationally, as well
as increase capacity in existing cities. Through a global alliance,
Inter-Tel.net is participating with businesses in Japan, Europe and South
America to provide international IP telephony service. Through other third party
arrangements, the network is expanding points of presence domestically.
Inter-Tel.net is designed to carry long distance traffic originated from
Inter-Tel's customer base, to generate sales of pre-paid calling cards and
provide other exchange carriers, individuals, and enterprises a cost-effective
alternative to current offerings of the conventional circuit switched long
distance carriers.
CONTINUE TO DEVELOP ADVANCED COMMUNICATIONS PRODUCTS
The Company commits substantial research and development resources to
provide its customers with advanced telecommunications technologies on a
cost-effective basis. The Company has developed an extensive C++ library and
significant telecommunications expertise. In many cases, the Company develops
new technologies as software upgrades or add-ons to existing products. For
example, the AXXESS 5.0 platform provides an extensive enhancement to previous
versions of AXXESS, the Company's primary product. Ongoing research and
development efforts are directed to the development of new products,
applications and services for sale into the Company's existing customer base and
to new customers. Through CTI applications and advanced network services,
Inter-Tel provides technology that is designed to enable its customers to
enhance their efficiency and competitiveness.
EXPAND DISTRIBUTION CHANNELS
The Company continues to expand its distribution channels through a
growing network of direct dealers, as well as the Company's direct sales
presence, and to hire additional direct sales personnel for expansion into
international markets. The Company has established sales relationships with
hundreds of direct dealers and continues to expand this network. The Company is
in the process of establishing dealer networks in Japan and other parts of Asia
and is expanding its dealer network in the United Kingdom and Europe. The
Company has expanded its direct sales activity in recent periods through
strategic acquisitions of resellers of telephony products and services in
strategic markets, and considers additional acquisition opportunities on an
ongoing basis. The Company also is expanding its distribution into other
channels such as computer equipment dealers, resellers of data communications
equipment and software resellers.
PRODUCTS AND SERVICES
The Company offers a broad range of products and services designed to
support the needs of businesses and other organizations requiring voice and data
communications systems. The Company's principal products are digital telephone
systems which support networked installations up to 5,000 ports, IP telephony
products and services, CTI applications, unified messaging software and voice
processing software. The Company's principal system sales consist of systems
supporting 10 to 4,000 telephones with suggested retail prices of larger systems
in excess of $1,000,000 per system, depending on configuration. The Company also
offers long distance calling services, network design and implementation
services, maintenance, leasing and support services, and resells other
telecommunications products.
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DIGITAL COMMUNICATION PLATFORMS
Inter-Tel offers an extensive line of digital communication systems,
including hardware platforms and C++ software applications. Because these
platforms are based upon open architecture and conform to established computer
and telephone industry standard programming interfaces and protocols (such as
TAPI, TSAPI and TCP/IP), customers can choose from a variety of either server
level or desktop applications.
AXXESS. Inter-Tel's primary product, the AXXESS platform, incorporates
advanced technology for computer and telephone integration. The AXXESS platform
is designed to provide businesses with the ability to customize applications to
enhance their operations and increase productivity. The current AXXESS system
release supports up to 5,000 ports and includes such advanced capabilities as
primary rate ISDN, integrated call recording, voice prompts in different
languages, transparent networking and a Windows-based attendant's console. The
AXXESS 5.1 platform, which is currently scheduled for release in the third
quarter of 1999, is being designed to allow, through fully transparent digital
networking, two or more systems to operate as one, and to increase capacity to
20,000 ports. AXXESS 5.2, currently scheduled for release in the fourth quarter
of 1999, is being designed to add the support of ISDN basic rate interfaces.
The AXXESS system incorporates fully-digital processing and
transmission to the desktop and open architecture interfaces, which allow the
system to be integrated with and controlled by attached computers such as PCs
and workstations. The system incorporates object-oriented C++ software developed
by the Company, which facilitates upgrades and the incorporation of additional
features and functionality.
AXXESS system telephones feature user-friendly, 6-by-16 character LCD
displays with menu keys that permit the user to select from multiple menu
choices or access additional menu screens. AXXESSORY TALK permits push-button
selection of voice processing commands to appear on the telephone's LCD display,
as well as voice-prompted selections through the telephone keypad. The AXXESS
system currently offers English or Japanese voice prompts and LCD displays and
allows the user to switch from one language to the other. Spanish has been in
controlled product introduction since the fourth quarter of 1998, and is
scheduled for commercial release in the first half of 1999. The AXXESS system
can support the addition of other languages that the Company expects to add in
the future.
The AXXESS system's open architecture interface permits tight
integration with a PC or workstation system bus, using several industry-standard
interfaces to provide efficient access to voice processing and other
applications on the PC or workstation. Applications include database look-up
(which utilizes Caller-ID information to retrieve customer information
automatically from a computerized database), automated attendant, interactive
voice response, automatic call distribution (which queues and prioritizes
incoming calls), and call accounting (which permits the monitoring of telephone
usage and toll cost). The AXXESS system is managed through a Microsoft
Windows-based graphical user interface on a PC.
The AXXESS system utilizes advanced software to configure and utilize
real-time digital signal processor semiconductor components ("DSPs")
incorporated into the system hardware. The use of DSPs and related software
lowers system costs, permits higher functionality and increases system
flexibility. For example, DSPs can be configured by the system manager for
different combinations of speakerphones, conference capabilities and other
DSP-based facilities. The system's speakerphones incorporate full-duplex
technology, which permits speakerphones to transmit in both directions at the
same time without the need to override one speaker's voice to prevent feedback
interference.
The AXXESS software is written in an object-oriented language which can
operate on many commonly used processors. Accordingly, the software can be
readily ported to other hardware platforms. The Company intends to port the
AXXESS software to faster microprocessors which will
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permit the AXXESS to grow to a much larger size, in order to enhance the
functionality and performance of these larger systems and to permit a migration
path from the smaller AXXESS system as a customer's system requirements
increase.
Inter-Tel is evolving the AXXESS to a server-based communication system
by developing a Windows-NT server-based Central Processing Unit (CPU) for
Inter-Tel's AXXESS system. In its initial release planned for the second quarter
of 1999, this CPU will be designed to handle call processing with greater speed
and efficiency. By combining server-based technology and Inter-Tel AXXESS
technology, Inter-Tel leverages the benefits of a Win-Tel server and the
benefits of a PBX-like hot card insertion of telephony cards. The Company
expects that future upgrades to the AXXESS system will permit it to power
LAN-based computer telephone integration applications, unified messaging
applications, and Internet Protocol (IP) telephony solutions. Because this
server-based CPU will integrate with the AXXESS system, current customers can
benefit from the new functionality, while retaining their current system
investment.
INTER-TEL AXXENT. Small businesses are demanding advanced telephony
applications formerly within reach of only large corporations. The Inter-Tel
Axxent is designed to bring many of the advanced features and functionality of
the AXXESS system to smaller installations on a cost-effective basis while
enabling users to migrate to an AXXESS system as their telecommunications needs
evolve. The Inter-Tel Axxent supports 24 lines and 12 trunks and provides
capabilities such as computer telephone integration, DSP technology, real-time
ACD reporting, and integrated voice processing. Housed in a compact, PC-type
mid-tower chassis, the Inter-Tel Axxent platform also offers the convenience of
a default database, allowing the system to be fully operational as soon as it is
plugged in. Basic database programming can also be performed through the digital
telephone terminals.
IP TELEPHONY PRODUCTS AND INTER-TEL.NET NETWORK
IP TELEPHONY GATEWAYS. Gateways are transition points between two
different network types, such as between the public circuit switched telephone
network and a packet switched IP network such as the Internet. Gateway products
convert regular voice and facsimile transmissions to or from the compressed data
packets that travel over packetized networks.
The Company markets two gateway product lines - the Inter-Tel Vocal'Net
and InterPrise products.
INTER-TEL VOCAL'NET 3200S. The Inter-Tel Vocal'Net 3200S, a Windows NT,
server-based IP telephony solution is designed for carriers and service
providers to bridge the traditional telephone network and an IP network. Using
this technology, the customers of carriers and service providers can conduct
real-time, two-way voice communications over the Internet and realize potential
savings compared to standard long distance telephone service.
The Inter-Tel Vocal'Net 3200S allows phone to phone communication using
high speed DSP technology which connects the call from the circuit switched
telephone network, converts it into the compressed or uncompressed, digitized
data packets used by an IP network, and routes the call via the IP network to
another Inter-Tel Vocal'Net 3200S gateway. The second gateway connects with the
traditional telephone network and dials the final destination.
Although the Inter-Tel Vocal'Net 3200S scales from eight analog to
thirty digital PSTN access ports per server, the Company's software architecture
allows multiple Inter-Tel Vocal'Net servers to be networked together, resulting
in seamless configurations consisting of thousands of ports. The interface to
the Inter-Tel Vocal'Net 3200S access ports are approved for connection to a
large number of foreign telephone companies. This allows the Company to market
and install Inter-Tel Vocal'Net 3200S gateways internationally.
INTER-TEL INTERPRISE PRODUCT LINE. This product line consists of the
InterPrise 400 (four analog PSTN access ports), the InterPrise 2400S (up to
twenty-four analog PSTN access ports) and the
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InterPrise 3200D (up to thirty-two digital PSTN access ports). These products
incorporate high speed embedded DSP technology and a proprietary Inter-Tel
operating system, and are used primarily by business customers, carriers and
service providers. Like the Inter-Tel Vocal'Net 3200S, the InterPrise gateways
enable phone-to-phone calling over IP networks.
INTERPRISE 400. The InterPrise 400 is designed for corporate use over a
wide area network ("WAN"). The InterPrise 400 can be attached to an analog trunk
interface on the PBX, and the PBX's Automatic Route Selection or Least Cost
Routing features will be programmed to automatically route calls for other
locations that also have InterPrise gateways through that trunk interface. When
phone users wish to place a call, they simply dial the desired telephone number
like any other call. The PBX will route the call to the InterPrise 400, which
converts it into the compressed or uncompressed, digitized data packets used by
the corporate WAN, and routes the call via the WAN to another InterPrise
gateway. The second gateway connects with the far-end PBX and dials either the
extension number of the desired party or accesses a trunk on the PBX and makes a
call into the switched network.
Because IP telephony converts all transmissions to the same type of
packets, both voice and data information can be transmitted using the same data
circuits, thereby increasing efficiency and maximizing the use of bandwidth.
Bandwidth utilization can be maximized to a point that some users may be able to
reduce the overall number of circuits needed.
INTERPRISE 2400S. The InterPrise 2400S is designed for corporate,
carrier and service provider use and can be configured in eight, sixteen and
twenty-four analog PSTN access ports.
INTERPRISE 3200D. The InterPrise 3200D is designed for corporate, as
well as medium- to high-density carrier and service provider use.
INTERPRISE 128D. The company is currently developing the InterPrise
128D for higher density carrier and service provider applications.
INTERPRISE SOFTPHONE. The InterPrise SoftPhone is a PC-client software
that acts as a single port IP telephony gateway and allows callers the ability
to make real-time, two-way voice communications over IP networks and realize
potential savings compared to standard long distance telephone service.
Callers connected to an IP network on their PC dial the destination
phone number from a familiar Windows graphical user interface ("GUI"). Using the
PC's microprocessor and multimedia capabilities, the PC-client software converts
the caller's voice into compressed, digitized data packets and routes the call
via the IP network to an Inter-Tel InterPrise gateway. The second gateway
connects with the traditional telephone network and dials the final destination.
Possible applications for the InterPrise SoftPhone are for potential
telecommunications savings for mobile employees and for use as on-ramps for long
distance minutes to Inter-Tel.net.
The Company believes that the opportunity to leverage the potential for
reduced cost phone calls is only one of the many opportunities for IP telephony.
For this reason, the Company continues to enhance its product line. The Company
is currently developing industry standard H.323 functionality, which allows the
Company's IP telephony gateways to integrate with non-Inter-Tel IP telephony
gateways.
The Company plans other enhancements to its IP telephony product line,
such as "Touch-To-Talk" telephony-enabled web pages, which is being designed to
allow users to press a link on a web page and to automatically connect over an
IP network to talk to customer service agents.
INTER-TEL SERVICE PROVIDER PACKAGE AND CENTRALIZED ACCOUNTING SYSTEM.
This product provides a turnkey solution for IP long distance providers for
pre-paid and post-paid billing, back office
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support and customer care. Planned enhancements to the Service Provider Package
and Centralized Accounting System include the integration of H.323 Gatekeeper
functionality, which allows traffic control among multiple IP telephony long
distance networks and compatibility with IP telephony long distance networks
using non-Inter-Tel gateways.
INTER-TEL.NET. Inter-Tel.net is an IP long distance network that
utilizes the Inter-Tel IP telephony gateways and Service Provider Package and
Centralized Accounting System. Inter-Tel.net's points of presence ("POP")
include the San Francisco Bay Area, Washington D.C., Chicago, Reno, New York,
Phoenix and Los Angeles. Utilizing Inter-Tel Vocal'Net technology, Inter-Tel
continues to develop and expand Inter-Tel.net, a private IP network designed to
carry long distance telephone traffic at rates typically lower than traditional
long distance providers. Commercial traffic is being sold to Inter-Tel's base
customers in certain markets, and pre-paid calling cards are being sold through
Inter-Tel's branches, certain agents and resellers. Where Inter-Tel.net or one
of it's network partners does not have a POP, Inter-Tel.net utilizes traditional
Long Distance Carriers to complete the call. See "Factors That May Affect Future
Operating Results--Developing Market for IP Network Telephony; Uncertain
Regulatory Environment," "--Risks Associated with Inter-Tel Vocal'Net;
Dependence upon IP Network Infrastructures; Risk of System Failure; Security
Risks" and "--Development and Maintenance of Inter-Tel.net Network."
COMPUTER-TELEPHONE INTEGRATION
Through CTI, the computer and the telephone are linked into one
environment. Inter-Tel's AXXESSORY Connect software for the AXXESS system
enables users to receive phone calls through their desktop PC. Using Caller
I.D., a caller's information can be retrieved from the company's database even
before the call is accepted. On an individual desktop or a company-wide network
basis, Inter-Tel offers a variety of products, such as AXXESSORY ACD, that can
manage automatic call distribution at peak efficiency or route incoming
telephone calls, based on various parameters, to a specific person. It can also
collect, analyze and report real-time call processing information for staff
forecasting and analysis.
Through the use of Novell's TSAPI and Microsoft's TAPI standard
interfaces, Inter-Tel's software applications integrate with other
"off-the-shelf" Windows applications such as personal information managers, call
routing or call management. Inter-Tel has formed relationships with a number of
third party software developers to integrate with their existing applications to
create a working environment for database, personal organizer, or terminal
emulation programs.
If these "off-the-shelf" applications do not adequately meet the needs
of a customer, the open design of Inter-Tel's software enables independent
software developers to write custom applications through Inter-Tel's Developer
Program. Alternatively, Inter-Tel's CTI Solutions Group can provide professional
consulting services or can develop individual customer applications, for either
desktop or local area network ("LAN")-based applications.
UNIFIED MESSAGING AND VOICE PROCESSING SOFTWARE
Inter-Tel's unified messaging software, AXXESSORY Talk Central, works
in conjunction with a variety of messaging platforms, including the Microsoft
Exchange messaging application, Lotus Notes, Lotus cc:Mail, Novell's GroupWise
and Internet mail applications such as Qualcomm's Eudora. Visual Mail integrates
all types of messages into a single-user interface on a PC, supports both voice
mail and facsimile mail and provides another means for improving workplace
productivity and retrieving messages from a PC connected to a modem.
Inter-Tel's AXXESSORY Talk, Axxent Talk and IVX500 are voice processing
platforms that work with Inter-Tel's communication platforms. All three
applications use the Multi-Vendor Interface Protocol ("MVIP"), an industry
standard for connecting multi-vendor PC-based boards in voice processing, data
switching and video systems.
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OTHER SERVICES AND PRODUCTS
NETWORKING TECHNOLOGIES INTEGRATION. To develop a solid foundation for
state-of-the-art data and telecommunications networking, customers require
strategic network expertise from their networking provider. Inter-Tel designs,
installs and supports the complete integration of a customer's complex data and
telecommunications network, from land-based LANs to geographically dispersed
WANs.
By forming relationships with major manufacturers of hardware and
software technologies, Inter-Tel provides the routers, ATM, LAN and WAN
switches, file servers, intelligent hubs and any other device required for the
customer's intranet or for usage of the Internet. Pre-sale design support,
project coordination for implementation, and installation support are offered on
the full line of Inter-Tel server-based telephony products, InterPrise products,
and services.
NETWORK AND LONG DISTANCE SERVICES. The Company, through its Inter-Tel
NetSolutions, Inc. subsidiary, resells a variety of long distance calling
services, including domestic and international calling services, 800 calling
services, dedicated services, voice and video conferencing, customized billing
and a variety of other telecommunication services. The Company believes that
certain of its customers desire the convenience of acquiring long distance
calling services through the same vendor that the customer uses to purchase its
other telephony equipment and services. The Company currently resells long
distance services pursuant to contracts with major U.S. long distance carriers.
See "Factors That May Affect Future Operating Results--Risks of Providing Long
Distance and Network Services."
Examples of the applications currently supported by Inter-Tel
NetSolutions include call centers using T-1 access for incoming toll-free
traffic, sales offices using NetSolutions' switched long distance and companies
linking multiple offices throughout the country on a frame relay network.
LEASING SERVICES. The Company offers its Totalease program through its
Inter-Tel Leasing, Inc. subsidiary. Totalease enables an end user to acquire a
full range of telephony systems, applications, maintenance and support services,
as well as lease financing, from a single vendor. The Totalease contract
provides a total system solution to the customer at a set monthly cost, with
system expansion available at predictable additional fees. The typical Totalease
contract has a term of 60 months, with the customer entitled to renew the
contract at a specified price for up to an additional 36 months.
Inter-Tel also offers a line of low-cost lease purchase financing.
Lease terms range from 24 to 84 months with $1.00, fixed and fair market value
purchase options. Inter-Tel can also customize financing packages to suit
customers with special financial needs. By offering this type of financing to
acquire Inter-Tel products and services, the customer is able to lease directly
from an affiliate of the manufacturer, thereby allowing Inter-Tel, or the
Inter-Tel dealer, to maintain a direct relationship with customers.
OTHER PRODUCTS. Inter-Tel also distributes other leading
telecommunications products from its Factored Products Division through its
direct sales offices, dealers and VARs. The Factored Products Division
represents products that Inter-Tel has endorsed as leading communications
peripherals utilized in many day-to-day functions. Businesses require
telecommunications products to provide increased productivity, ease of
operations and reliability. Many of these products interface with Inter-Tel
telephone systems. Inter-Tel's product selection consists of videoconferencing,
battery backup, headsets, surge protection, paging equipment, wireless
communications and data multiplexers.
SALES AND DISTRIBUTION
The Company has developed a distribution network of direct sales
offices, dealers and VARs which market the Company's products to small to medium
size organizations and divisions or
10
departments of larger organizations. In the United States, the Company has 37
direct sales offices and a network of hundreds of dealers who purchase systems
directly from the Company. These resellers have traditionally sold complex data
solutions to customers, and the Company is seeking to leverage this distribution
network to capitalize on the merging of the computer and telephony industries.
The Company maintains a dealer support office and direct sales office in the
United Kingdom and has a network of dealers in the United Kingdom and Europe. In
addition, the Company maintains a direct sales office in both Japan and
Singapore.
The Company believes that its success depends in part upon the strength
of its distribution channels and the ability of the Company to maintain close
access to its end user customers. In recent periods, the Company has sought to
improve its access to end user customers by effecting strategic acquisitions of
resellers of telephony products and services in markets in which the Company has
existing direct sales offices and in other strategic markets. The Company has
expanded its direct sales office personnel from a total of 473 persons at
December 31, 1994 to a total of 921 at December 31, 1998.
The Company's sales through its direct sales offices as a percentage of
total sales have decreased from 60.4% of net sales in 1994 to 54.7% of net sales
in 1998. Sales to distributors, dealers, and VARs have increased from 46.6% of
net sales in 1995 to 47.8% of net sales in 1998. Sales through the Company's
long distance, IP and network services operations have increased from 5.0% of
net sales in 1995 to 9.9% of net sales in 1998.
Direct dealers and VARs typically enter into non-exclusive reseller
contracts for a term of one or more years. The Company generally provides
support and other services to the reseller pursuant to the terms of the
agreement. The agreements often include requirements that the reseller meet or
use its best efforts to meet minimum annual purchase quotas. The Company faces
intense competition from other telephone system and voice processing system
manufacturers for its dealers' attention, as most of the Company's dealers carry
products which compete with the Company's products. See "Factors That May Affect
Future Operating Results--Reliance on Dealer Network."
International sales, which includes digital communications platforms
and IP telephony products, accounted for approximately 2.7%, of net sales in
1998 compared to 2.3% in 1997. In order to sell its products to customers in
other countries, the Company must comply with local telecommunications
standards. The Company's AXXESS system and IP telephony products can be readily
altered through software modifications, which the Company believes will
facilitate compliance with these local regulations. In addition, the AXXESS
system has been designed to support multi-lingual functionality, and currently
supports English and Japanese. The Company is presently establishing dealer
networks in Japan, other parts of Asia and Latin America and is working to
expand its dealer network in the United Kingdom and Europe. International sales
are subject to a number of risks, including changes in foreign government
regulations and telecommunications standards, export license requirements,
tariffs and taxes, other trade barriers, difficulties in protecting intellectual
property, fluctuations in currency exchange rates, difficulty in collecting
accounts receivable, difficulty in staffing and managing foreign operations and
political and economic instability. Fluctuations in currency exchange rates
could cause the Company's products to become relatively more expensive to
customers in a particular country, leading to a reduction in sales or
profitability in that country. In addition, the costs associated with developing
international sales may not be offset by increased sales in the short term, or
at all.
CUSTOMER SERVICE AND SUPPORT
The Company believes that customer service and support are critical
components of customer satisfaction and the success of the Company's business.
The Company operates a technical support hotline to provide a range of telephone
support to its distributors, dealers and end user customers through a toll-free
number. The Company also provides on-site customer support and,
11
through remote diagnostic procedures, has the ability to detect and correct
system problems from its technical support facilities.
Information taken from customer service call records allows feedback
into Inter-Tel's Quality First continuous improvement process, thus providing
direction for product and service enhancements. Each direct sales office is
given a periodic service activity report summarizing the reasons that
technicians are asking for assistance and common issues that give rise to
technical inquiries. This allows them to analyze trends in their service
operations and provide better customer service.
RESEARCH AND DEVELOPMENT
The Company believes that its ability to enhance its current products,
develop and introduce new products on a timely basis, maintain technological
competitiveness and meet customer requirements are essential to the Company's
success. The Company's research and development efforts over the last several
years have been focused primarily on development of and enhancements to the
existing AXXESS and AXXESSORY TALK systems with additional applications,
capacity and features; development of a unified messaging software application,
a telecommunications networking package, and new products such as the Inter-Tel
Vocal'Net Server. Over the last several years, the research and development
efforts of the acquired TMSI organization have focused on the development of the
InterPrise IP product line and the InterPrise software phone. The Company's
current efforts are focused on the development and enhancement of IP telephony
products such as the Inter-Tel Vocal'Net Gateway Server, the InterPrise product
line, the Inter-Tel Vocal'Net Service Provider Package, the support of H.323 on
both the gateway and service provider products, the development of additional
applications and features of the AXXESS and AXXESSORY Talk communications
products, and the development of a server-based PBX product. The software-based
architecture of the AXXESS system facilitates maintenance and support, upgrades,
and incorporation of additional features and functionality.
The Company had a total of 120 personnel engaged in research and
development as of December 31, 1998. Research and development expenses were
$11,373,000; $7,998,000 and $6,581,000 for 1998, 1997, and 1996, respectively.
MANUFACTURING
The Company manufactures substantially all of its systems through third
party subcontractors located in the United States, the Philippines, the People's
Republic of China and Mexico. These subcontractors use both standard and
proprietary integrated circuits and other electronic devices and components to
produce telephone switches, telephones and printed circuit boards to the
Company's engineering specifications and designs. The suppliers also inspect and
test the equipment before delivering them to the Company, which in some cases
then performs systems integration, software loading, final testing and shipment.
Varian Associates, Inc. ("Varian"), a multinational electronic company,
currently manufacturers a significant portion of the Company's products,
including substantially all of the printed circuit boards used in the AXXESS and
Inter-Tel Axxent systems, at Varian's Tempe, Arizona facility. The Company
maintains written agreements with its principal suppliers. The Company provides
a forecast schedule to its suppliers and revises the forecast on a periodic
basis. See "Factors That May Effect Future Operating Results--Dependence on
Contract Manufacturers and Component Suppliers."
QUALITY
The Company believes that the quality of its systems, customer service
and support, and other aspects of its organization is a critical element of
meeting the needs of its customers. Through its Quality First continuous
improvement process initiated in 1991, Inter-Tel implements quality processes
throughout its business operations. The Company has established formal
procedures to ensure responsiveness to customer requests, monitor response times
and measure customer satisfaction.
12
The Company has also established means by which all end users, including
customers of the Company's resellers, can make product enhancement requests
directly to the Company. The Company supports its dealers and VARs through an
extensive training program at the Company's facility and at dealer sites, a
toll-free telephone number for sales and technical support, and the provision of
end user marketing materials. The Company typically provides a one year warranty
on its systems to end users. In manufacturing, the Company continuously monitors
the quality of the products produced on its behalf by the Company's
manufacturing subcontractors, and is extending the Company's Quality First
continuous improvement process to its suppliers.
COMPETITION
The market for the Company's products is highly competitive and in
recent periods has been characterized by pricing pressures and business
consolidations. The Company's PABX and key systems products competitors include
Lucent Technologies, Inc. ("Lucent") and Northern Telecom Limited ("NorTel"), as
well as Comdial Corporation ("Comdial"), EXECUTONE Information Systems, Inc.
("Executone"), Iwatsu America, Inc. ("Iwatsu"), Mitel Corporation ("Mitel"), NEC
Corporation ("NEC"), Nitsuko Corporation ("Nitsuko"), Matsushita Electric
Industrial Co., Ltd. ("Panasonic"), Siemens Rolm Communications, Inc.
("Siemens"), Toshiba America, Inc. ("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 Telecommunications Act of 1996 (the "Telecommunications Act") and
the division of AT&T Corporation ("AT&T") into three enterprises has had an
impact on 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 television 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 Applied Voice Technology, Inc. ("AVT"), Active
Voice Corporation ("Active Voice"), Centigram Communications Corporation
("Centigram"), 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 WorldCom, Inc. ("MCI"), Sprint
Corporation, Qwest Communications Corporation ("Qwest") and other competitors,
many of which have significantly greater resources than the Company. The Company
also expects to compete with RBOCs, cable television companies, satellite and
other wireless broadband service providers and others for long distance business
as those companies gradually respond to the Telecommunications Act. Key
competitive factors in the sale of telephone systems and related applications
include price, performance, features, reliability, service and support, name
recognition and distribution capability. The Company believes that it competes
favorably in its markets with respect to the price, performance and features of
its systems, as well as the level of service and support that the Company
provides to its customers. Certain of the Company's competitors have
significantly greater name recognition and distribution capabilities than the
Company.
In the market for IP telephony products, the Company competes against
existing IP telephony gateway providers such as Lucent, NorTel, NetSpeak
Corporation, VocalTec Communications Ltd., Nokia IP Products (formerly Vienna
Systems Corporation), CISCO Systems, Bay Networks, 3Com, Motorola, Ascend and
others. The Company competes against existing IP long distance service providers
such as IDT, Delta Three, ITCX, AT&T and others. Several of these competitors
have been active in developing and marketing IP telephony products and have
13
established relationships with customers within their market. Should the market
for IP telephony products become fully developed or develop at a rapid rate,
large computer companies such as IBM Corporation ("IBM") and Microsoft
Corporation ("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 competes for local telephone service, Long Distance
Service and IP network access, it faces additional competition from established
foreign and domestic Long Distance Carriers, RBOCs and other providers. Many
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 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.
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.
INTELLECTUAL PROPERTY RIGHTS
The Company's future success will depend in part upon its proprietary
technology. The Company currently hold patents for six telecommunications and
unified messaging products. The remaining life of these patents ranges from 5 to
14 years in duration. 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. See "Factors
That May Effect Future Operating Results--Product Protection and Infringement."
EMPLOYEES
As of December 31, 1998, the Company had a total of 1,386 employees, of
whom 1,146 were engaged in sales, marketing and customer support, 46 in quality,
manufacturing and related operations, 120 in research and development, and 74 in
finance and administration. The Company's future success will depend upon its
ability to attract, retain and motivate highly qualified employees, who are in
great demand. The Company believes that its employee relations are good.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
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 twenty-four months, 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 July 1998, the Company also released the AXXESS 5.0 platform, which is a
significant software upgrade and enhancement to its AXXESS and AXXESSORY TALK
platforms. The Company's future success will depend, in large part, upon the
commercial acceptance of the AXXESS 5.0 platform, as well as future upgrades and
enhancements to this networking platform. The Company's future success will also
depend upon market acceptance of the Company's other new products or
enhancements, including Inter-Tel Vocal'Net and the Inter-Tel
14
InterPrise products. There can be no assurance that any of these introduced
products and enhancements will be successful. 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 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
15
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 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 the 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-
16
Tel.net network is in its initial stages of deployment and, accordingly, is
subject to a high degree of risk. 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 and Los Angeles. Certain products that the
Company purchased from TMSI are also in the process of being tested and deployed
in this network. If the domestic or international market for IP network products
fails to develop or develops more slowly than the Company anticipates, or should
the business experience difficulty in the integration of the TMSI technology,
the Company's Inter-Tel.net network could become financially burdensome to
maintain or obsolete, which could materially and adversely affect the Company's
business, financial condition and results of operations.
The Company is dependent on third-party 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 any of these suppliers raise their rates or change their pricing
structure, the Company may be materially adversely affected. Also, the Company
faces the risk that there will 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 and 1998.
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
17
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 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 Lucent, NetSpeak Corporation,
VocalTec Communications Ltd., Nokia IP Products (formerly Vienna Systems
Corporation) 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 likely faces significant
competition from vendors such as Cisco Systems, Inc., Nortel, 3Com Corporation,
Motorola, Inc. and MICOM Communications Corp., as these established data vendors
choose to enter 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 IDC, 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.
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
18
manage new employees successfully, to integrate new employees into its overall
operations and to continue to improve its operational, financial and management
information systems.
During the fourth quarter of 1996, the Company determined that the
limitations of the existing system software would prevent Inter-Tel from
establishing an integrated and centralized dispatch and telemarketing center. As
a result, the Company signed an agreement with a large, established software and
database vendor to replace its existing MIS software and implement, maintain and
support the alternate MIS software to be utilized throughout the Company.
Accordingly, during the fourth quarter of 1996, the Company wrote off the
software license and implementation costs relating to the system software being
replaced. The Company implemented various components of the new MIS software
during 1998 and plan to roll out additional components of the software during
1999.
The actions to replace the MIS software could result in additional
costs and delays associated with obtaining a fully functional MIS system,
including but not limited to the costs of procuring additional or alternate
hardware and software required but not available in the current system
configuration, and additional personnel. Any such cost or delay could have a
material adverse effect on the Company's business, financial condition and
operating results. In addition, implementation of this system software and the
transition from the current system software to the new information 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. In June 1998, the Company purchased certain
assets of TMSI for cash of approximately $25 million plus the assumption of
certain liabilities and acquisition costs. In the second quarter of 1998, the
Company also acquired Integrated Telecom Services Corporation ("ITS"), pursuant
to which the Company issued approximately 140,000 shares of common stock,
accounted for as a purchase transaction. In addition, in December 1998, the
Company acquired certain assets of Central Florida Communications, Inc.
("Southcom") for approximately $2.3 million. This asset acquisition was
accounted for using purchase accounting. In November 1998, the Company also
acquired certain assets of Telesystems, Inc. ("Telesystems") for approximately
$300,000. This asset acquisition was also accounted for using the purchase
method of accounting. Acquisitions require a significant amount of the Company's
management attention and financial and operational resources, all of which are
limited. The integration of TMSI, ITS, Southcom or any other acquired entities
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 TMSI, ITS, Southcom, or any other acquired
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 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
19
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.
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, or intellectual property of TMSI that the Company has agreed to
purchase, 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 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. If any
such claim is asserted against the Company, the Company may seek to obtain a
license under the third party's intellectual property rights. There can be no
assurance that a license will be available on 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.
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
20
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. Because it does not own
transmission facilities, the Company relies 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 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; 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. 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
21
impact operating results, particularly in an environment of fluctuating interest
rates. Long distance sales, which have lower gross margins than the Company's
core business, have grown in recent periods at a faster rate than the Company's
overall net sales. As a result, gross margins could be adversely affected in the
event that long distance calling services continue to increase as a percentage
of net sales. In addition, the Company is subject to seasonality in its
operating results, as net sales for the first and third quarters are frequently
less than those experienced, in the fourth and second quarters, respectively. As
a result of these and other factors, the Company has in the past experienced,
and could in the future experience, fluctuations in sales and operating results
on a quarterly basis. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
VOLATILITY OF STOCK PRICE
The market price for the Company's Common Stock has been highly
volatile. The Company believes that factors such as announcements of
developments relating to the Company's business, fluctuations in the Company's
operating results, shortfalls in revenue or earnings relative to securities
analysts' expectations, announcements of technological innovations or new
products or enhancements by the Company or its competitors, 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 is currently in the process of updating
its information systems with systems that are designed to be Year 2000 ready.
This decision was made in the ordinary course of managing the Company's
information resources and not specifically implemented to address Year 2000
readiness issues. The Company is in the process of upgrading its long distance
billing system, which is designed to be Year 2000 ready. In addition, the
Company is reviewing its lease billing and collections system, which has been
warranted to be Year 2000 ready. Currently, the total cost of each system is
being capitalized, and the Company does not currently anticipate additional
costs of becoming Year 2000 ready. The Company expects its information systems
to be Year 2000 ready by the end of fiscal 1999, and 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
22
recent testing of such products by our engineers have indicated that such
products are Year 2000 ready, in accordance with our test procedures. Costs to
develop and update the Company's products for Year 2000 readiness have been part
of the research and development efforts on an ongoing basis. Any disruption in
manufacturing services provided by the Company as a result of Year 2000
noncompliance would 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.
CONCENTRATION OF OWNERSHIP
As of March 12, 1999, Steven G. Mihaylo, the Company's Chairman of the Board of
Directors, Chief Executive Officer and President beneficially owned
approximately 20.4% 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.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AGE POSITION
- ---- --- --------
Steven G. Mihaylo 55 Chairman of the Board of
Directors, Chief Executive Officer
and President
Norman Stout 41 Executive Vice President/Chief
Administrative Officer
Craig W. Rauchle 43 Executive Vice President
23
Ross McAlpine 47 Sr. Vice President
Jeffrey T. Ford 37 Senior Vice President/Chief
Technology Officer
Kurt R. Kneip 36 Chief Financial Officer,
Vice President and Secretary
J. Robert Anderson 62 Director
Gary Edens 57 Director
Maurice H. Esperseth 73 Director
C. Roland Haden 58 Director
MR. MIHAYLO, the founder of the Company, has served as Chairman of the
Board of Directors of the Company since September 1983, as President since May
1998 and as Chief Executive Officer of the Company since its formation in July
1969. Mr. Mihaylo served as President of the Company from 1969 to 1983 and from
1984 to December 1994, and as Chairman of the Board of Directors from July 1969
to October 1982. Mr. Mihaylo is also a director of MicroAge, Inc. and Microtest,
Inc.
MR. STOUT was elected Executive Vice President and Chief Administrative
Officer in June 1998. From October 1994 to June 1998, he served as a director of
the Company. Mr. Stout had been President of Superlite Block, a manufacturer of
concrete block, since February 1993. Since 1996 Mr. Stout also had served as
President of Oldcastle Architectural West, the parent company of Superlite Block
and ten other concrete products plants. Prior thereto he was employed by
Boorhem-Fields, Inc. of Dallas, Texas, a manufacturer of crushed stone, as Chief
Executive Officer from 1990 to 1993 and as Chief Financial Officer from 1986 to
1990. Previously, Mr. Stout was a Certified Public Accountant with Coopers &
Lybrand. Mr. Stout holds an undergraduate degree in Accounting from Texas A&M
and an MBA from the University of Texas.
MR. RAUCHLE was elected Executive Vice President in December 1994. He
had been Senior Vice President of the Company and continues as President of
Inter-Tel Technologies, Inc., a wholly owned sales subsidiary of the Company. In
addition, he currently serves the Company and all subsidiaries in corporate
strategic planning and in mergers and acquisitions. Mr. Rauchle joined the
Company in 1979 as Branch General Manager of the Denver Direct Sales Office and
in 1983 was appointed the Central Region Vice President and subsequently the
Western Regional Vice President. From 1990 to 1992, Mr. Rauchle served as
President of Inter-Tel Communications, Inc. Mr. Rauchle holds a Bachelor of Arts
degree in Communications from the University of Denver.
MR. MCALPINE was elected Senior Vice President in September 1997. He
also has served as President of Inter-Tel Leasing, Inc., a wholly-owned
subsidiary of the Company, since April 1993, and President of both
Inter-Tel.net, Inc. and Inter-Tel NetSolutions, Inc. since 1997. He also served
as Vice President of Inter-Tel Communications, Inc. from April 1991 to April
1992 and Treasurer since April 1992. He joined the Company in July 1991 when
Inter-Tel acquired Telecommunications Specialists, Inc. Prior to joining
Inter-Tel, Mr. McAlpine worked 17 years in the leasing and financial services
industry. Mr. McAlpine holds an undergraduate degree in Accounting from
Southwest Texas State University.
MR. FORD was elected Senior Vice President in May 1998 and has served
as the Company's Chief Technology Officer since 1997. He was elected President
of Inter-Tel Integrated Systems, Inc. ("IIS") in May 1998, after serving as
Senior Vice President of IIS for one year and Vice President of Software
Engineering from 1993 to 1997. He joined Inter-Tel in 1983 as a software design
engineer. Mr. Ford holds a bachelor of science degree in computer systems
engineering from Arizona State University.
MR. KNEIP has served as Vice President and Chief Financial Officer of
the Company since September 1993. He was elected Secretary and Treasurer in
October 1994. In May 1996 he was elected Assistant Treasurer, as John Abbott was
elected Treasurer. He joined the Company in May 1992 as Director of Corporate
Tax, after seven years with the accounting firm of Ernst & Young. Mr.
24
Kneip is a Certified Public Accountant, and holds an undergraduate degree in
Commercial Economics from South Dakota State University and a Masters Degree in
Professional Accountancy from the University of South Dakota.
MR. ANDERSON has been a director of the Company since February 1997.
Mr. Anderson held various positions at Ford Motor Company from 1963 to 1983,
serving from 1978 to 1983 as President of the Ford Motor Land Development
Corporation. He served as Senior Vice President, Chief Financial Officer and a
member of the Board of Directors of The Firestone Tire and Rubber Company from
1983 to 1989, and as Vice Chairman of Bridgestone/Firestone, Inc. from 1989
through 1991. He most recently served as Vice Chairman, Chief Financial Officer
and a member of the Board of Directors of the Grumman Corporation from 1991 to
1994. Mr. Anderson is currently semi-retired, and he is an active leader in
various business, civic and philanthropic organizations.
MR. EDENS has been a director of the Company since October 1994. He was
a broadcasting media executive from 1970 to 1994, serving as Chairman and Chief
Executive Officer of Edens Broadcasting, Inc. from 1984 to 1994, when that
corporation's nine radio stations were sold. He is currently President of The
Hanover Companies, Inc., an investment firm. He is an active leader in various
business, civic and philanthropic organizations.
MR. ESPERSETH has been a director of the Company since October 1986.
Mr. Esperseth joined the Company in January 1983 as Senior Vice
President-Research and Development, after a 32-year career with GTE, and served
as Executive Vice President of Inter-Tel from 1986 to 1988. Mr. Esperseth
retired as an officer of the Company on December 31, 1989.
DR. HADEN has been a director of the Company since 1983. Dr. Haden has
been Vice Chancellor and Dean of Engineering of Texas A&M University since 1993.
Previously, he served as Vice Chancellor of Louisiana State University from 1991
to 1993, Dean of the College of Engineering and Applied Sciences at Arizona
State University from 1989 to 1991, Vice President for Academic Affairs at
Arizona State University from 1987 to 1988, and Dean of the College of
Engineering and Applied Sciences from 1978 to 1987. Dr. Haden holds a doctoral
degree in Electrical Engineering from the University of Texas and has also
served on the faculty of the University of Oklahoma.
The Board of Directors has an Audit Committee and a Compensation
Committee. The Audit Committee, consisting of Directors Anderson and Haden as of
December 31, 1998, is charged with reviewing the Company's annual audit and
meets with the Company's independent auditors to review the Company's internal
controls and financial management practices. The Audit Committee met two times
during the last fiscal year. The Compensation Committee, consisting of Messrs.
Esperseth and Edens as of December 31, 1998, recommends to the Board of
Directors compensation for the Company's key employees and administers the
Company's stock option plans. The Compensation Committee met three times during
the last fiscal year.
ITEM 2. PROPERTIES
The Company maintains its corporate headquarters in 23,000 square feet of a
building located in Phoenix, Arizona pursuant to a lease that expires in 2000,
and its principal manufacturing operations in an 96,000 square foot building
located in Chandler, Arizona pursuant to a lease that expires in 2008. The
Company also leases sales and support offices in a total of 37 locations in the
United States and three locations overseas. The Company's aggregate monthly
payments under these leases are currently approximately $380,000. The Company
believes that its facilities will be adequate to meet its current needs and that
additional or alternative space will be available as necessary in the future on
commercially reasonable terms. See "Factors That May Effect Future Operating
Results--Management of Growth; Implementation of New Management Information
Systems."
25
ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time in litigation incidental to its
business. The Company believes that the outcome of current litigation will not
have a material adverse effect upon its business, financial condition or results
of operations and will not disrupt the normal operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The information required by this Item is incorporated by reference to
Exhibit 13.0 and Page 30 of the Company's 1998 Annual Report to
Shareholders.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is incorporated by reference to
Exhibit 13.0 and Page 8 of the Company's 1998 Annual Report to
Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this Item is incorporated by reference to
Exhibit 13.0 and Pages 20 through 29 of the Company's 1998 Annual
Report to Shareholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about the Company's market risk disclosures
involves forward-looking statements. Actual results could differ
materially from those projected in the forward-looking statements. The
Company is exposed to market risk related to changes in interest rates
and foreign currency exchange rates. The Company does not use
derivative financial instruments.
INVESTMENT PORTFOLIO. The Company does not use derivative financial
instruments in its non-trading investment portfolio. Inter-Tel
maintains a portfolio of highly liquid cash equivalents typically
maturing in three months or less as of the date of purchase. Inter-Tel
places its investments in instruments that meet high credit quality
standards, as specified in the Company's investment policy guidelines.
Given the short-term nature of these investments, and that the Company
has no borrowings outstanding other than short-term letters of credit,
the Company is not subject to significant interest rate risk.
LEASE PORTFOLIO. The Company offers to its customers lease financing
and other services, including its Totalease program, through its
Inter-Tel Leasing subsidiary. The Company funds these programs in part
through the sale to financial institutions of rental income streams
under the leases. Although the Company to date has been able to resell
the rental streams from leases under its lease programs 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 were required to repurchase rental
streams and realize losses thereon in amounts exceeding its reserves,
its operating results could be materially adversely affected. See
"Liquidity and Capital Resources" in Management's Discussion and
Analysis for more information regarding the Company's lease portfolio
and financing.
26
IMPACT OF FOREIGN CURRENCY RATE CHANGES. Inter-Tel invoices the
customers of its international subsidiaries primarily in the local
currencies of its subsidiaries for product and service revenues.
Inter-Tel is exposed to foreign exchange rate fluctuations as the
financial results of foreign subsidiaries are translated into U.S.
dollars in consolidation. The impact of foreign currency rate changes
have historically been insignificant.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference to
Exhibit 13.0 and Pages 9 through 19 of the Company's 1998 Annual Report
to Shareholders.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Certain information required by Part III is omitted from this report in
that the Registrant will file a definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this Report, and the information included therein is
incorporated herein by reference to the extent stated below.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors and executive officers is
included at the end of Part I, Item 1 on Pages 24 to 26 of this report
under the caption "Directors and Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
Pages 5 to 9 of the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to
Pages 3 and 4 of the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
27
1. FINANCIAL STATEMENTS
The following consolidated financial statements of Inter-Tel, Incorporated,
and subsidiaries, are incorporated by reference to Exhibit 13.0 and Pages 9
to 19 of the Company's Annual Report:
Report of Ernst & Young LLP, Independent Auditors
Consolidated balance sheets--December 31, 1998 and 1997
Consolidated statements of income--years ended December 31, 1998, 1997
and 1996
Consolidated statements of shareholders' equity--years ended December 31,
1998, 1997 and 1996
Consolidated statements of cash flows--years ended December 31, 1998, 1997
and 1996
Notes to consolidated financial statements
2. FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedule of Inter-Tel,
Incorporated, and subsidiaries is filed as part of this Report and should
be read in conjunction with the Consolidated Financial Statements of
Inter-Tel, Incorporated and subsidiaries, and the notes thereto.
Schedule for the three years ended December 31, 1998:
Page No.
--------
Schedule II--Valuation and Qualifying Accounts 31
Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or notes thereto.
3. EXHIBITS
3.1(10) Articles of Incorporation, as amended.
3.2(16) By-Laws, as amended.
10.15(1) Registrant's form of standard Distributor Agreement.
10.16(1) Registrant's form of standard Service Agreement.
10.34(2) 1984 Incentive Stock Option Plan and forms of Stock Option
Agreement.
10.35(3) Agreement between Registrant and Samsung Semiconductor and
Telecommunications Company, Ltd. dated October 17, 1984.
10.37(3) Tax Deferred Savings Plan.
10.51(11) 1990 Directors' Stock Option Plan and form of Stock Option
Agreement.
10.52(15) Inter-Tel, Incorporated Long-Term Incentive Plan and forms of
Stock Option Agreements.
28
10.53(12) Agreement between Registrant and Maxon Systems, Inc. dated
February 27, 1990.
10.54(12) Agreement between Registrant and Varian Tempe Electronics Center
dated February 26, 1991.
10.55(12) Agreement between Registrant and Jetcrown Industrial Ltd. dated
February 18, 1993.
10.56(13) Employee Stock Ownership Plan.
10.57(14) Loan and Security Agreement dated March 4, 1997 between Bank One,
Arizona, N.A. and Registrant and Modification Agreement dated
July 25, 1997.
10.58(16) Development, Supply and License Agreement between Registrant and
QUALCOMM dated January 17, 1996.
- ----------
(1) Previously filed with Registrant's Registration Statement on Form S-1 (File
No. 2-70437).
(2) Previously filed with Registrant's Registration Statement on Form S-8 (File
No. 2-94805).
(3) Previously filed with Registrant's Annual Report on Form 10-K for the year
ended November 30, 1984 (File No. 0-10211).
(10) Previously filed with Registrant's Annual Report on Form 10-K for the year
ended December 31, 1988 (File No. 0-10211).
(11) Previously filed with Registrant's Registration Statement on Form S-8 (File
No. 33-40353).
(12) Previously filed with Registrant's Registration Statement on Form S-1 (File
No. 33-70054).
(13) Previously filed with Registrant's Registration Statement on Form S-8 (File
No. 33-73620).
(14) Filed herewith.
(15) Previously filed with Registrant's Proxy Statement dated March 23, 1994.
(16) Previously filed with Registrant's Annual Report on Form 10-K for the year
ended December 31, 1995 (File No. 0-10211).
(17) Filed herewith, except as noted.
(b) Reports on Form 8-K.
None.
(c) Exhibits.
13.0 Excerpts from Annual Report to Security Holders. (not
attached herewith; a copy of the excerpts of the Company's
Annual Report to Security Holders was filed with the
Securities and Exchange Commission and a complete copy of
the Annual Report is available upon request by writing to
Shareholder Relations, Inter-Tel, Incorporated, 120 N. 44th
Street, Suite 200, Phoenix, Arizona 85034)
29
EXHIBIT 22.1
22.1 Subsidiaries of Inter-Tel, Incorporated (Page 53)
23.0 Consent of Ernst & Young LLP, Independent Auditors.
(Page 54)
24.1 Power of Attorney. (Page 55)
See Item 14(a) (3) also.
(d) Financial Statement Schedules
The response to this portion of Item 14 is submitted as a
separate section of this report. See Item 8.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Inter-Tel, Incorporated, has duly caused
this Report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTER-TEL, INCORPORATED
By: /s/ Steven G. Mihaylo
----------------------------------------
Steven G. Mihaylo
Chairman and Chief Executive Officer
Dated: March 12, 1999
30
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
COL. A COL. B COL. C COL. D COL. E
------ ------ ------ ------ ------
ADDITIONS
Charged Charged
Balance at to to Other Charged to Balance
Beginning Costs & Accounts Deductions at End of
DESCRIPTION of Period Expenses Describe Describe Period
----------- --------- -------- -------- -------- ------
YEAR ENDED DECEMBER 31, 1998
Deducted from asset accounts:
Allowance for doubtful
accounts $3,722 $2,963 $137(6) $2,218(1) $4,604
------ ------ ---- ------ ------
Allowance for lease
accounts $3,969 $2,688 $ -- $ 941(1) $5,716
------ ------ ---- ------ ------
Inventory allowance $5,740 $1,828 $ -- $2,115(2) $5,453
------ ------ ---- ------ ------
YEAR ENDED DECEMBER 31, 1997
Deducted from asset accounts:
Allowance for doubtful
accounts $3,096 $2,194 $ 17 $1,585(1) $3,722
------ ------ ---- ------ ------
Allowance for lease
accounts $2,706 $1,910 $ -- $ 647(1) $3,969
------ ------ ---- ------ ------
Inventory allowance $2,979 $4,021 $ -- $1,260(2) $5,740
------ ------ ---- ------ ------
YEAR ENDED DECEMBER 31, 1996
Deducted from asset accounts:
Allowance for doubtful
accounts (4) $1,822 $1,801 $ 87(3) $ 614(1) $3,096
------ ------ ---- ------ ------
Allowance for lease
accounts $1,513 $1,945 $(87)(3) $ 665(1) $2,706
------ ------ ---- ------ ------
Inventory allowance (4) $2,499 $ 609 $175(5) $ 304(2) $2,979
------ ------ ---- ------ ------
- ----------
(1) Uncollectible accounts written off, net of recoveries.
(2) Inventory written off.
(3) Reclassed between appropriate valuation and qualifying accounts.
(4) Adjusted for pooling of Florida Telephone Systems, Inc.
(5) Acquired in purchase of NTL Corporation (dba ComNet of Ohio).
(6) Acquired in purchase of TMSI and Integrated Telecom Services Corporation.
31