| INTER TEL INC ITEM 1A RISK FACTORS FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS This Report on Form 10-K contains 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 |
| Actual results could differ materially from those projected in the forward-looking statements as a result of many risk factors including, without limitation, those set forth under “Factors That May Affect Future Results Of Operations” below |
| In evaluating Inter-Tel’s business, shareholders and prospective investors should consider carefully the following factors in addition to the other information set forth in this document |
| Risks Related to Our Business Our operating results have historically depended on a number of factors, and these factors may cause our operating results to fluctuate in the future |
| Our quarterly operating results have historically depended on, and may fluctuate in the future as a result of, many factors including: • volume and timing of orders received during the quarter; • gross margin fluctuations associated with the mix of products sold; • the mix of distribution channels; • general economic conditions and the condition of the markets our business addresses; 15 _________________________________________________________________ [69]Table of Contents • patterns of capital spending by customers; • the timing of new product announcements and releases by us and our competitors and other competitive factors; • pricing pressures; • the cost and effects of acquisitions; • the availability and cost of products and components from our suppliers, including shipping and manufacturing problems associated with subcontracted vendors; • the impact on our business of the e-Rate settlement, possible FCC debarment, and expected fines and penalties associated with the GSA variances and noncompliance which could affect both our government business and our commercial business; • the impact on our business of settlements, continuing litigations, proceedings and other contingencies, which could affect our business; • the potential impact of new accounting pronouncements such as FAS 123R; • national and regional weather patterns; and • threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances |
| In addition, we have historically operated with a relatively small backlog (excluding our contractual maintenance arrangements and contracts associated with long distance resale activity), with sales and operating results in any quarter depending principally on orders booked and shipped in that quarter |
| In the past, we have recorded a substantial portion of our net sales for a given quarter in the third month of that quarter, with a concentration of such net sales in the last two weeks of the quarter |
| Market demand for investment in capital equipment such as business communications systems and associated call processing and voice processing software applications depends largely on general economic conditions and can vary significantly as a result of changing conditions in the economy as a whole, as well as heightened competitive pressures |
| We cannot assure you that we can continue to be successful operating with a small backlog or whether historical backlog trends will continue in the future |
| Our expense levels are based in part on expectations of future sales and, if sales levels do not meet expectations, our operating results could be harmed |
| In addition, because sales of business communications systems through our dealers, including dealers from our acquired Lake operations, typically produce lower gross margins than sales through our direct sales organization, operating results have varied, and will continue to vary based upon the mix of sales through direct and indirect channels |
| In addition, in the recent past we have derived a significant part of our revenue from recurring revenue streams, which typically produce higher gross margins |
| If we do not maintain recurring revenue streams at current or historic levels, our operating results would suffer unless we significantly increased sales to new customers |
| Moreover, particularly in an environment of fluctuating interest rates, the timing and profitability of lease resales from quarter to quarter could impact operating results |
| Long distance and DataNet sales, which typically carry lower gross margins than our core business, have grown in recent periods at a faster rate than our overall net sales, although gross margins may fluctuate in these divisions from period to period |
| Consolidated gross margins could be harmed if long distance calling services continue to increase as a percentage of net sales or if gross margins from this division decline |
| We also experience seasonal fluctuations in our operating results, as net sales for the first quarter is frequently less than the fourth quarter, and net sales for the third quarter is frequently less than the second quarter |
| As a result of these and other factors, we have historically experienced, and could continue to experience in the future, fluctuations in net sales and operating results on a quarterly basis |
| Our market is subject to rapid technological change and to compete successfully, we must continually introduce new and enhanced products and services that achieve broad market acceptance |
| The market for our products and services is characterized by rapid technological change, evolving industry standards and vigorous customer demand for new products, applications and services |
| To compete successfully, we must continually enhance our existing telecommunications products, related software and customer services, and develop new technologies and applications in a timely and cost-effective manner |
| If we fail to introduce new products and services that achieve broad market acceptance and on a timely basis, or if we do not adapt our existing products and services to customer demands or evolving industry standards, our business could be significantly harmed |
| Problems and delays associated with new product development have in the past contributed to lost sales |
| In particular, we believe that the delayed roll-out of the Inter-Tel 5000 Network Communication Platform contributed to lost sales in 2005 |
| In addition, current competitors or new market entrants may offer products, applications or services that are better adapted to changing 16 _________________________________________________________________ [70]Table of Contents technology or customer demands and that could render our products and services unmarketable or obsolete |
| This could lead to write-downs of inventory that could be material to our results of operations |
| In addition, if the markets for computer-telephony applications, Internet Protocol network products, SIP products and applications, or related products fail to develop or continue to develop more slowly than we anticipate, or if we are unable for any reason to capitalize on any of these emerging market opportunities, our business, financial condition and operating results could be significantly harmed |
| Our future success largely depends on increased commercial acceptance of our Inter-Tel 5000 and 7000 Network Communications Solutions, Axxessâ system, the Lake OfficeLink product (branded EncoreCXâ in North America), the Lake Sigma product (branded Sprint Connection Central^TM in North America), speech recognition, Interactive Voice Response, presence management, collaboration, messaging products, Session Initiation Protocol (SIP) applications, and related computer-telephony products |
| Over the past two years, we have introduced a number of new products and platforms, including: Enterpriseâ Conferencing and Enterpriseâ Instant Messaging software, a SIP-based web and audio conferencing application; Inter-Tel Webconferencing and Inter-Tel Remote support (collaboration) solutions; Model 8500 series digital endpoints; Model 8600 series Multi-protocol SIP endpoints; the Inter-Tel 5000 Network Communications Platform and updates; enhanced convergence features on the Axxess system; integrated web collaboration and video conferencing capabilities into our Unified Communicator^® application, and several other telephony-related products |
| In recent history, sales of our Axxess business communications systems and related software have comprised a substantial portion of our net sales |
| Our future success depends, in large part, upon increased commercial acceptance and adoption of the products or platforms identified above, including the Axxess system, the Inter-Tel 5000 and 7000 Network Communications products, the Unified Communicator^® products, Call Center Suite ACD products, the Linktivity and Enterprise Conferencing collaboration technology, the Lake Communications converged systems and software, SIP standards-based applications and devices, new speech recognition and Interactive Voice Response products, and future upgrades and enhancements to these products and networking platforms |
| We cannot assure you that these products or platforms will achieve commercial acceptance in the future |
| We have many competitors and expect new competitors to enter our market, which could increase price competition and spending on research and development and which may impair our ability to compete successfully |
| The markets for our products and services are extremely competitive and we expect competition to increase in the future |
| Our current and potential competitors in our primary business segments include: • PABX, converged systems and IP-PBX providers, distributors, or resellers such as Adtran, Alcatel, Altigen, Avaya, Cisco Systems, 3Com, EADS Telecom, Iwatsu, Interactive Intelligence, Lucky Goldstar, Mitel, NEC, Nortel, Panasonic, Samsung, ShoreTel, Siemens, Toshiba, Vertical Networks/ArtiSoft/Comdial and Vodavi; • large data routing and convergence companies such as 3Com, Adtran and Cisco Systems; • voice processing applications providers such as ADC, InterVoice-Brite, Active Voice (a subsidiary of NEC America), Avaya, and Captaris (formerly AVT); • web collaboration product and service providers, such as Centra, eDial (a division of Alcatel), IBM, Microsoft, Raindance Communications, and WebEx; • hosting service providers such as Layered Technologies and Vonage using servers to host call processing functions that have traditionally been owned by customers; • long distance services providers such as AT&T, MCI, Qwest and Sprint; • large computer and software corporations such as IBM, HP, Intel and Microsoft; • peer-to-peer softphone services such as Skype (which recently announced an agreement to be acquired by eBay); • regional Bell operating companies, or RBOCs, competitive local exchange companies, or CLECs; cable television companies, IP Centrex service providers, and satellite and other wireless and wireline broadband service providers offering IP centrex services such as AT&T, Covad, Level-3, Qwest, SBC, and Time-Warner Telecom; and • independent leasing companies that provide telecom equipment financing |
| 17 _________________________________________________________________ [71]Table of Contents These and other companies may form strategic relationships with each other to compete with us |
| These relationships may take the form of strategic investments, joint-marketing agreements, licenses or other contractual arrangements |
| Strategic relationships and business combinations could increase our competitors’ ability to address customer needs with their product and service offerings that are broader than the product and service offerings we provide |
| Many of our competitors and potential competitors have substantially greater financial, customer support, technical and marketing resources, larger customer bases, longer operating histories, greater name recognition and more established relationships in the industry than we do |
| We cannot be sure that we will have the resources or expertise to compete successfully, particularly as the market for IP network voice communications evolves and competitors like Cisco become more prominent in our industry |
| Compared to us, our competitors may be able to: • offer broader product and service offerings; • develop and expand their product and service offerings more quickly; • offer greater price discounts or make substantial product promotions; • adapt to new or emerging technologies and changing customer needs faster; • take advantage of acquisitions and other opportunities more readily; • negotiate more favorable licensing agreements with vendors; • devote greater resources to the marketing and sale of their products; and • address customers’ service-related issues more adequately |
| Some of our competitors may also be able to provide customers with additional benefits at lower overall costs or to reduce their gross margins aggressively in an effort to increase market share |
| We cannot be sure we will be able to match cost reductions by our competitors |
| In recent periods, due to competitive pressures, we have discounted pricing on our telephone systems and offered promotions and these actions have negatively impacted our revenues, gross margins and operating results |
| In addition, we believe there is likely to be further consolidation in our markets, which could lead to having even larger and more formidable competition and other forms of competition that could cause our business to suffer |
| Our products are complex and may contain errors or defects that are detected only after their release, which may cause us to incur significant unexpected expenses and lost sales |
| Our telecommunications products and software are highly complex |
| Although our new products and upgrades are examined and tested prior to release, they can only be fully tested when used by a large customer base |
| Consequently, our customers have in the past and may in the future discover program errors, or “bugs,” or other defects after new products and upgrades have been released |
| Some of these bugs may result from defects contained in component parts or software from our suppliers or other third parties that are intended to be compatible with our products and over which we have little or no control |
| Although we have test procedures and quality control standards in place designed to minimize the number of errors and defects in our products, we cannot assure you that our new products and upgrades will be free of bugs when released |
| If we are unable to quickly or successfully correct bugs identified after release, we could experience the following, any of which would harm our business: • costs associated with the remediation of any problems; • costs associated with design modifications; • loss of or delay in revenues; • loss of customers; • damage to our reputation; • failure to achieve market acceptance or loss of market share; • increased service and warranty costs; • liabilities to our customers; and • increased insurance costs |
| The complexity of our products could cause delays in the development and release of new products and services |
| Additionally, changes in technology could render current inventories obsolete |
| Due to the complexity of our products and software, we have in the past experienced and expect in the future to experience delays in the development and release of new products or product enhancements |
| If we 18 _________________________________________________________________ [72]Table of Contents fail to introduce new software, products or services in a timely manner, or fail to release upgrades to our existing systems or products and software on a regular and timely basis, customer demand for our products and software could decline, which would harm our business |
| For instance, we believe that a delay in connection with our release of the Inter-Tel 5000 Network Communications Platform may have unfavorably impacted our sales efforts in 2005 |
| Additionally, as technology changes and as we or our competitors release new products, there is a risk that our current products and inventories could become obsolete or excessive leading to write-downs of our inventory balances in amounts that could be material to our results of operations |
| Our founder and former Chief Executive Officer controls approximately 19dtta7prca of our Common Stock and may be able to exert significant influence over the Company |
| As of December 31, 2005, Steven G Mihaylo, a shareholder and former member of Inter-Tel’s Board of Directors, beneficially owned approximately 19dtta7prca of the existing outstanding shares of the common stock of Inter-Tel |
| 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 accelerating, delaying or preventing a change in control of Inter-Tel |
| On February 22, 2006, Mr |
| Mihaylo resigned as Chief Executive Officer of Inter-Tel, and on March 6, 2006, Mr |
| Mihaylo resigned as a director of Inter-Tel |
| Mihaylo is considering his alternatives with respect to the future of Inter-Tel and his investment therein |
| Mihaylo has engaged legal counsel and RBC Capital Markets Corporation as financial advisor |
| In connection with his evaluation of alternatives, Mr |
| Mihaylo has stated that he may acquire additional shares of Common Stock or dispose of shares of Common Stock, or may suggest or propose to Inter-Tel’s management or Board, or take a position with respect to, an extraordinary corporate transaction, sale or transfer of assets of Inter-Tel, changes in the Board or management of Inter-Tel, changes in the capitalization of Inter-Tel, changes in Inter-Tel’s business or corporate structure and/or similar actions and transactions, including without limitation, a proposal to acquire Inter-Tel in a going private transaction, tender offer or similar transaction |
| Mihaylo chooses to pursue any of the aforementioned alternatives or otherwise utilize his influence over matters requiring shareholder approval, we cannot assure you that any actions undertaken by Mr |
| Mihaylo will be in the best interests of the Company or its other shareholders |
| Furthermore, if our Board of Directors determines that such actions are not in the best interests of the Company and its shareholders, we may decide to oppose any such efforts, and this may divert the attention of our Board of Directors and management from the conduct of the Company’s business and may cause us to incur significant legal, advisory and other expenses |
| Business acquisitions, new business ventures, dispositions or joint ventures entail numerous risks and may disrupt our business, dilute shareholder value and distract management attention |
| As part of our business strategy, we consider acquisitions of, or significant investments in, businesses that offer products, services and technologies complementary to ours |
| Such acquisitions could materially adversely affect our operating results and/or the price of our common stock |
| Acquisitions also entail numerous risks, some of which we have experienced and may continue to experience, including: • unanticipated costs and liabilities; • difficulty of assimilating the operations, products and personnel of the acquired business; • difficulties in managing the financial and strategic position of acquired or developed products, services and technologies; • difficulties in maintaining customer relationships; • difficulties in servicing and maintaining acquired products, in particular where a substantial portion of the target’s sales were derived from our competitor’s products and services; • difficulty of assimilating the vendors and independent contractors of the acquired business; • the diversion of management’s attention from the core business; • inability to maintain uniform standards, controls, policies and procedures; and 19 _________________________________________________________________ [73]Table of Contents • impairment of relationships with acquired employees and customers occurring as a result of integration of the acquired business |
| In particular, in prior years our operating results were materially adversely affected by several of the factors described above, including substantial operating losses and impairment charges resulting from Executone |
| Refer to Note C to the Condensed Consolidated Financial Statements for additional information concerning our acquisitions |
| We completed one acquisition and one technology investment in 2003, four acquisitions and one technology investment in 2004 and one acquisition in 2005 |
| In 2003, we acquired selected assets and assumed certain liabilities of a former Inter-Tel dealer and we acquired the rights to certain developed technology |
| In 2004, we acquired certain assets and assumed certain liabilities of four former Inter-Tel dealers |
| In addition, we completed one technology related acquisition, coupled with a license of technology in 2004 |
| In March 2005, we acquired all of the outstanding stock of several related entities in Ireland |
| These entities are similar in nature to our wholesale operations and also include significant technology-related assets |
| These acquisitions are subject to risks and uncertainties including, but not limited to, those indicated above |
| Finally, to the extent that shares of our stock or the rights to purchase stock are issued in connection with any future acquisitions, dilution to our existing shareholders will result and our earnings per share may suffer |
| Any future acquisitions may not generate additional revenue or provide any benefit to our business, and we may not achieve a satisfactory return on our investment in any acquired businesses |
| We may not be able to adequately protect our proprietary technology and may be infringing upon third-party intellectual property rights |
| Our success depends upon the protection of our proprietary technology |
| As of December 31, 2005, we held 40 US issued patents and issued patents in several foreign countries for telecommunication and messaging products, systems and processes |
| There are 18 pending US patent applications and several pending foreign patent applications that may mature to enforceable patents |
| We also rely on copyright, trademark and trade secret laws as well as contractual provisions to protect our intellectual property |
| Despite these precautions, third parties could copy or otherwise obtain and use our technology without authorization, or independently develop similar technology |
| Any patent, trademark or copyright that we own or have applied for is subject to being invalidated, circumvented or challenged by a third party |
| Effective protection of intellectual property rights may be unavailable or limited in foreign countries |
| The telecommunications and networking industries are heavily patented, and we cannot assure that the protection of our proprietary rights will be adequate or that competitors will not independently develop similar technology, duplicate our services, or design around any patents or other intellectual property rights we hold |
| Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity |
| Litigation could be costly, absorb significant management time and harm our business |
| Many of our competitors have large patent portfolios, and we are or could become subject to third-party claims that our current or future products or services infringe upon the rights of others |
| For example, we are subject to claims initiated by Avaya and Lucent, two of our primary competitors, alleging that certain of our key products infringe upon their intellectual property rights, including patents, trademarks, copyrights, or other intellectual property rights |
| We have viewed presentations from Avaya and Lucent alleging that our Axxess business communications system, associated applications and related 3^rd party products that we distribute utilize inventions covered by certain of their patents |
| We have also made claims against Avaya for infringement of our patents |
| We are continuing the process of investigating these matters |
| The ultimate outcomes by their nature are uncertain, and we cannot ensure that these matters, individually or collectively, would not have a material adverse impact on our financial position and future results of operations |
| When any such claims are asserted against us, among other means to resolve the dispute, we may seek to license the third party’s intellectual property rights |
| Purchasing such licenses can be expensive, and we cannot ensure that a license will be available on prices or other terms acceptable to us, if at all |
| Alternatively, we could resort to litigation to challenge such a claim |
| Litigation could require us to expend significant sums of cash and divert our management’s attention |
| In the event a court renders an enforceable decision with respect to our intellectual property, we may be required to pay significant damages, develop 20 _________________________________________________________________ [74]Table of Contents non-infringing technology, or acquire licenses to the technology subject to the alleged infringement |
| If we are unable or choose not to license technology, or decide not to challenge a third-party’s rights, we could encounter substantial and costly delays in product introductions |
| These delays could result from efforts to design around asserted third-party rights or our discovery that the development, manufacture or sale of products requiring these licenses could be foreclosed |
| Our reliance on a limited number of suppliers for key components and our dependence on contract manufacturers could impair our ability to manufacture and deliver our products and services in a timely and cost-effective manner |
| We currently obtain certain key components for our communication platforms, including certain microprocessors, integrated circuits, power supplies, voice processing interface cards and IP telephony cards, from a limited number of suppliers and manufacturers |
| Our reliance on these limited suppliers and contract manufacturers involves risks and uncertainties, including the possibility of a shortage or delivery delay for some key components, quality assurance and costs |
| We currently manufacture our products, including products manufactured for Lake, through third-party subcontractors located in the United States, Mexico, the People’s Republic of China and the United Kingdom |
| Jabil Circuit, Inc |
| currently manufactures a significant portion of our products at its Tempe, Arizona, facility, including substantially all of the printed circuit boards used in the Axxess systems and Inter-Tel 5000 systems |
| Foreign manufacturing facilities are subject to changes in governmental policies, imposition of tariffs and import restrictions and other factors beyond our control |
| We have experienced occasional delays in the supply of components and finished goods that have harmed our business |
| If inventory levels are not adequately maintained and managed we are at risk of not having the appropriate inventory quantities on hand to meet sales demand |
| If inventory levels are not adequately maintained and managed, we are at risk of not having the appropriate inventory quantities on hand to meet sales demand |
| Our reliance on third party manufacturers and OEM partners involves a number of additional risks, including reduced control over delivery schedules, quality assurance and costs |
| Our business may be harmed by any delay in delivery or any shortage of supply of components or finished goods from a supplier caused by any number of factors, including but not limited to the acquisition of the vendor by another company |
| Our business may also be harmed if we are unable to develop alternative or additional supply sources as necessary |
| To date, we have been able to obtain supplies of components and products in a timely manner even though we do not have long-term supply contracts with any of our contract manufacturers |
| However, we cannot assure you we will be able to continue to obtain components or finished goods in sufficient quantities or quality or on favorable pricing or delivery terms in the future |
| We derive a substantial portion of our net sales from our dealer network and if these dealers do not effectively promote and sell our products, our business and operating results could be harmed |
| We derive a substantial portion of our net sales through our network of independent dealers |
| We face intense competition from other telephone, voice processing, and voice and data router system manufacturers for these dealers’ business, as most of our dealers carry other products that compete with our products |
| Our dealers may choose to promote the products of our competitors to our detriment |
| We have developed programs and expended capital as incentives to our dealers to promote our products, and we cannot assure you that these techniques will continue to be successful |
| The loss of any significant dealer or group of dealers, or any event or condition harming our dealer network, could harm our business, financial condition and operating results |
| We have been the subject of government investigations, which have resulted in convictions and civil penalties and may cause further competitive and financial harm to our business |
| On January 5, 2005, the Company received court approval of a civil settlement agreement (the “Civil Settlement”) and a criminal plea agreement (the “Plea Agreement”) with the United States of America, each dated as of December 8, 2004 and disclosed on that same date |
| The court approval of the Civil Settlement and Plea Agreement resolved the investigation of the Department of Justice into the participation of Inter-Tel Technologies, Inc, the Company’s wholly-owned subsidiary (“Technologies”) in a federally administered “e-Rate program” to connect schools and libraries to the Internet |
| In connection with the Civil Settlement, Technologies paid a penalty of dlra6dtta7 million and forgave the collection of certain accounts receivable of dlra0dtta3 million related to Technologies’ participation in the e-Rate program |
| In connection with the Plea Agreement, Technologies entered guilty pleas to charges of mail fraud and an antitrust violation |
| Under the Plea Agreement, Technologies paid a fine of dlra1dtta7 million and is observing a three-year probationary period, which 21 _________________________________________________________________ [75]Table of Contents has, among other things, required Technologies to implement a comprehensive corporate compliance program |
| On December 20, 2005, in connection with the Civil Settlement, Technologies paid outside counsel for the plaintiffs in that action dlra0dtta1 million in settlement of their demand for attorney’s fees and costs |
| On March 10, 2006, Technologies agreed to pay an additional dlra0dtta4 million to plaintiffs’ inside counsel in settlement of their separate demand for fees and costs |
| In addition, on January 21, 2005, Technologies received notification from the Federal Communications Commission that Technologies was temporarily suspended from participation in the e-Rate program pending a final hearing to determine debarment |
| Technologies has contested the scope and length of the proposed debarment from the e-Rate program, but there can be no assurance that Technologies will be successful in this regard |
| Revenues in 2005 and 2004 relating to Technologies’ participation in the e-Rate program were not significant |
| The existence and disclosure of the Civil Settlement, Plea Agreement and FCC Notice may have already caused competitive harm to Inter-Tel, and these matters may further harm Inter-Tel’s business |
| During the second quarter of 2005, we identified variances in our sales processes as they relate to certain terms included in the US General Services Administration (GSA) pricing and trade agreement requirements applicable to our business |
| As a result of this identification, Inter-Tel made voluntary self-disclosure of the matter to the Inspector General of the GSA The potential variances relate primarily to compliance with certain pricing thresholds and compliance with trade agreements that are applicable to transactions with certain government agencies |
| We continue to review our compliance and have taken appropriate corrective measures with respect to these potential variances |
| In the second quarter, we accrued dlra1dtta8 million in estimated pre-tax adjustments, including reductions in net sales and increases to costs, fines and penalties that may be incurred to correct this issue, of which we have paid dlra1dtta2 million through December 31, 2005 |
| There can be no assurance that our actual costs, including fines and penalties, if any, associated with this matter will not be more or less than our estimate, although our estimate at December 31, 2005 remains the same as the total identified as of the end of the second quarter of 2005 |
| The total sales potentially subject to the GSA agreements were approximately dlra5dtta5 million during the period from March 28, 2001 through June 10, 2005 |
| Our current contract with the GSA expires in March 2006, but we have requested and expect to receive a five-year contract extension |
| We have been involved in legal disputes, which have resulted in a jury verdict, legal settlement and associated legal costs, which may cause further competitive and financial harm to our business |
| During the quarter ended September 30, 2005, pre-tax costs associated with a legal judgment, legal settlement and related costs identified separately in the consolidated statements of income totaled dlra10dtta4 million (dlra0dtta26 per diluted share after taxes), net of amounts previously accrued |
| As disclosed in August 2005 on Form 8-K filed with the SEC, a Florida state court jury rendered a verdict against Inter-Tel (“the Florida trial”) in the net amount of approximately dlra7dtta4 million |
| The Company also accrued additional legal costs in connection with the Florida trial |
| Although the Company is appealing the verdict, the Company has accrued the net verdict amount, plus legal costs incurred in the third quarter |
| Should the Company be successful or unsuccessful in the appeals process, these costs may be adjusted in the future |
| In connection with the appeal of the Florida trial, the Company posted collateral of dlra6dtta3 million in order to secure an appellate bond |
| The Company also reached a separate settlement in another legal matter during the third quarter in connection with a longstanding dispute with a third-party vendor and customer |
| The net settlement plus related legal fees incurred during the third quarter for both events totaled approximately dlra3dtta0 million, net of amounts previously accrued, and are included in the pre-tax total costs of dlra10dtta4 million identified above |
| Further, in March 2006, other prior Executone dealers filed a complaint in Columbus, Ohio similar to the complaint in the Florida trial |
| Any such similar litigation would subject Inter-Tel to additional expenses and could have an adverse effect on our operating results |
| Subsequent to December 31, 2005, the Company settled another legal matter in connection with a longstanding dispute with a former international dealer that existed as of December 31, 2005 |
| The Company recorded an accrual for the settlement amount and related fourth quarter legal fees as of December 31, 2005 |
| The settlement plus costs and related fourth quarter legal fees totaled dlra1dtta6 million |
| Additional legal fees and costs totaling approximately dlra1dtta2 million are expected to be recorded as period costs during the first quarter of 2006 relating to this matter |
| 22 _________________________________________________________________ [76]Table of Contents Inter-Tel is also subject to litigation in the ordinary course of business |
| We cannot assure you that any adverse outcome in connection with the litigation described above or ordinary course litigation would not materially impair our business or financial condition |
| Managing our international sales efforts may expose us to additional business risks, which may result in reduced sales or profitability in our international markets |
| We are currently expending resources to maintain and expand our international dealer network in the countries in which we already have a presence and in new countries and regions |
| International sales are subject to a number of risks, including changes in foreign government regulations and telecommunication standards, export license requirements, tariffs and taxes, other trade barriers, difficulties in protecting our intellectual property, fluctuations in currency exchange rates, difficulty in collecting receivables, difficulty in staffing and managing foreign operations, and political and economic instability |
| In particular, the continued hostilities in Iraq and turmoil in the Middle East and North Korea have created an uncertain international economic environment and we cannot predict the impact of these acts, any future terrorist acts or any related military action on our efforts to expand our international sales |
| Fluctuations in currency exchange rates could cause our 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 or an international dealer network may not be offset by increased sales in the short term, or at all |
| Any of these risks could cause our products to become relatively more expensive to customers in a particular country, leading to reduced sales or profitability in that country |
| The Lake acquisition closed in March 2005 |
| Among other acquisition-related risks, we face risks of deterioration of international sales during the integration process, loss of key customers or that projected growth could be delayed or may not materialize at all |
| If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may not be able to achieve our objectives |
| We depend on the continued service of, and our ability to attract and retain, qualified technical, marketing, sales and managerial personnel, many of whom would be difficult to replace |
| Competition for qualified personnel is intense, and we have historically had difficulty in hiring employees in the timeframe we desire, particularly skilled engineers or sales personnel |
| The loss of any of our key personnel or our failure to effectively recruit additional key personnel could make it difficult for us to manage our business, complete timely product introductions or meet other critical business objectives |
| Moreover, our operating results could be impaired if we lose a substantial number of key employees from recent acquisitions, including personnel from acquisitions identified in Note C to the Consolidated Financial Statements |
| We cannot assure you we will be able to continue to attract and retain the qualified personnel necessary for the development of our business |
| Our IP network products may be vulnerable to viruses, other system failure risks and security concerns, which may result in lost customers or slow commercial acceptance of our IP network products |
| Inter-Tel’s IP telephony and network products may be vulnerable to computer viruses or similar disruptive problems |
| Computer viruses or problems caused by third parties could lead to interruptions, delays or cessation of service that could harm our operations and revenues |
| In addition, we may lose customers if inappropriate use of the Internet or other IP networks by third parties jeopardizes the security of confidential information, such as credit card or bank account information or the content of conversations over the IP network |
| In addition, user concerns about privacy and security may cause IP networks in general to grow more slowly, and impair market acceptance of our IP network products in particular, until more comprehensive security technologies are developed and deployed industry-wide |
| We may be unable to achieve or manage our growth effectively, which may harm our business |
| The ability to operate our business in an evolving market requires an effective planning and management process |
| Our efforts to achieve growth in our business have placed, and are expected to continue to place, a significant strain on our personnel, management information systems, infrastructure and other resources |
| In addition, our ability to manage any potential future growth effectively will require us to successfully attract, train, motivate and manage new employees, to integrate new employees into our overall operations and to continue to improve our operational, financial and management controls and procedures |
| Furthermore, we expect we will be required to manage an increasing number of relationships with suppliers, 23 _________________________________________________________________ [77]Table of Contents manufacturers, customers and other third parties |
| If we are unable to implement adequate controls or integrate new employees into our business in an efficient and timely manner, our operations could be adversely affected and our growth could be impaired |
| The introduction of new products and services has lengthened our sales cycles, which may result in significant sales and marketing expenses |
| In the past few years, we introduced IP telephony enhancements to the Axxessâ system as well as presence management and collaboration applications, which are typically sold to larger customers at a higher average selling price and often represent a significant expenditure in communications infrastructure by the prospective enterprise customer |
| Accordingly, the purchase of our products typically involves numerous internal approvals relating to the evaluation, testing, implementation and acceptance of new technologies |
| This evaluation process frequently results in a lengthy sales process, which can range from a few months to more than 12 months, thereby subjecting our sales cycle to a number of significant uncertainties concerning budgetary constraints and internal acceptance reviews |
| The length of our sales cycle also may vary substantially from customer to customer and along product lines |
| While our customers are evaluating our products before placing an order with us, we may incur substantial sales and marketing expenses and expend significant management effort |
| In addition, installation of multiple systems for large, multi-site customers may occur over an extended period of time, and depending on the contract terms with these customers, revenues may be recognized over more than one quarter, as systems are completed in separate phases and accepted by the customers |
| Consequently, if sales forecasted from such customers for a particular quarter are not realized in that quarter, our operating results could be materially adversely affected |
| We rely heavily upon third-party packaged software systems to manage and run our business processes, to provide certain products and services and to produce our financial statements |
| From time to time we upgrade these systems to ensure continuation of support and to expand the functionality of the systems to meet our business needs |
| The risks associated with the upgrade process include disruption of our business processes, which could harm our business |
| We currently run third-party applications for data processing in our distribution center operations, shipping, materials movement, customer service, invoicing, sales functions, financial record keeping and reporting, and for other operations and administrative functions |
| The nature of the software industry is to upgrade software systems to make architectural changes, increase functionality, improve controls and address software bugs |
| Over time, older versions of the software become less supported or unsupported by our vendors for financial and other reasons and eventually become obsolete |
| The primary supplier of our third-party applications, provides notice of the dates that the supplier will de-support the software and companies are expected to either make plans to upgrade to newer versions or operate without their support |
| While our primary third-party supplier and other third-party vendors may provide advanced notice of product upgrade schedules and take other steps to make the upgrade process as straightforward as possible, we are subject to risks associated with the process, and in some cases we may choose to continue to utilize and maintain the unsupported third-party software using our own information systems personnel |
| Our software systems could become unstable following an upgrade process and impact our ability to process data properly in these systems, including timely and accurate shipment of products, invoicing our customers properly and the production of accurate and timely financial statements |
| There are risks associated with failing to apply necessary security upgrades intended to resolve vulnerabilities |
| While we strive to take necessary precautions and properly test security-related upgrades before applying these upgrades, we must weigh the risks of not applying the upgrade against the risks of vulnerabilities being exploited for malicious purposes by an outside entity |
| Should a security vulnerability be exploited, our systems could become unstable and/or data could be compromised, thereby adversely affecting our business |
| We expect to affect software upgrades in the future and cannot assure you these software upgrades or enhancements will operate as intended or be free from bugs or that we will be able to operate effectively using unsupported third-party software using our existing personnel and resources |
| If we are unable to successfully integrate new software into our information systems, our operations, customer service and financial reporting could be adversely affected and could harm our business |
| Our stock price has been and may continue to be volatile, impairing your ability to sell your shares at or above purchase price |
| The market price for our common stock has been highly volatile |
| The volatility of our stock could be subject to continued wide fluctuations in response to many risk factors listed in this section, and others beyond our control, including: 24 _________________________________________________________________ [78]Table of Contents • announcements of developments relating to our business; • fluctuations in our operating results; • the impact of our dividend announcements, repurchase program or sales of stock by officers and directors; • shortfalls in revenue or earnings relative to securities analysts’ expectations; • announcements of technological innovations or new products or enhancements by us or our competitors, including product delays; • announcements of acquisitions or planned acquisitions of other companies or businesses; • investors’ reactions to acquisition announcements or any forecasts of our future results; • general economic conditions in the telecommunications industry; • the market for Internet-related voice and data products and services; • changes in the national or worldwide economy; • changes in legislation or regulation affecting the telecommunications industry; • developments relating to our intellectual property rights and the intellectual property rights of third parties; • litigation or governmental investigations of our business practices; • the impact on our business of the e-Rate settlement, possible FCC debarment, and expected fines and penalties associated with the GSA variances and noncompliance which could affect both our government business and our commercial business; • the impact on our business of settlements, continuing litigations, proceedings and other contingencies, which could affect our business; • changes in our relationships with our customers and suppliers, including shipping and manufacturing problems associated with subcontracted vendors; • national and regional weather patterns; and • threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances |
| In addition, stock prices of technology companies in general, and for voice and data communications companies in particular, have experienced extreme price fluctuations in recent years which have often been unrelated to the operating performance of affected companies |
| We cannot assure you the market price of our common stock will not experience significant fluctuations in the future, including fluctuations unrelated to our performance |
| Changes in stock option accounting rules may adversely impact our reported operating results prepared in accordance with generally accepted accounting principles, our stock price and our competitiveness in the employee marketplace |
| Technology companies like ours have a history of using broad-based employee stock option programs to hire, provide incentives for and retain our workforce in a competitive marketplace |
| Statement of Financial Accounting Standards Nodtta 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) allowed companies the choice of either using a fair value method of accounting for options, which would result in expense recognition for all options granted, or using an intrinsic value method, as prescribed by Accounting Principles Board Opinion Nodtta 25, “Accounting for Stock Issued to Employees” (APB 25), with a pro forma disclosure of the impact on net income (loss) of using the fair value option expense recognition method |
| We have elected to apply APB 25 and accordingly we generally do not recognize any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our Common Stock on the date of grant |
| In December 2004, the FASB issued Statement Nodtta 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which replaces SFAS Nodtta 123, Accounting for Stock-Based Compensation, (SFAS 123) and supersedes APB Opinion Nodtta 25, Accounting for Stock Issued to Employees |
| SFAS 123R requires all share-based payments to employees, including grants of employee stock options and employee stock purchase plan shares, to be recognized in the financial statements over the period during which employees are required to provide services based on their grant-date fair values |
| The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition |
| We are required to adopt SFAS 123R in the first quarter of fiscal 2006, beginning January 1, 2006 |
| We plan to adopt SFAS Nodtta 123R using the modified prospective application method as defined by SFAS Nodtta 123R and accordingly will begin recognizing compensation expense for all unvested and partially vested stock options, employee stock purchase plan shares and restricted stock, if applicable, in the first 25 _________________________________________________________________ [79]Table of Contents quarter of 2006 |
| We are evaluating the requirements of SFAS 123R and expect that the adoption of SFAS 123R will have a material impact on our consolidated results of operations and earnings per share |
| In addition, this new statement could impact our ability to utilize broad-based employee stock plans to reward employees and could result in a competitive disadvantage to us in the employee marketplace |
| Risks Related to Our Industry Reductions in spending on enterprise communications equipment may materially and adversely affect our business |
| The overall economic conditions of the last several years have had and may continue to have a harmful effect on the market for enterprise communications equipment |
| Our customers have reduced significantly their capital spending on communications equipment in an effort to reduce their own costs and bolster their revenues |
| The market for enterprise communications equipment may only grow at a modest rate or possibly not grow at all, and our financial performance has been and may continue to be materially and adversely affected by the reductions in spending on enterprise communications equipment |
| The emerging market for IP network telephony is subject to market risks and uncertainties that could cause significant delays and expenses |
| The market for IP network voice communications products has begun to develop only recently, is evolving rapidly and is characterized by an increasing number of market entrants who have introduced or developed products and services for Internet or other IP network voice communications |
| As is typical of a new and rapidly evolving industry, the demand for and market acceptance of, recently introduced IP network products and services are highly uncertain |
| We cannot assure you that IP voice networks will become widespread |
| Even if IP voice networks become more widespread in the future, we cannot assure that our products, including the IP telephony features of the Axxess systems, the Inter-Tel 5000 Network Communication Solutions, the upcoming Inter-Tel 7000 Network Communication Solutions, our SIP/IP endpoints and IP applications will successfully compete against other market players and attain broad market acceptance |
| Moreover, the adoption of IP voice networks and importance of development of products using industry standards such as SIP, generally require the acceptance of a new way of exchanging information |
| In particular, enterprises that have already invested substantial resources in other means of communicating information may be reluctant or slow to adopt a new approach to communications |
| If the market for IP network voice communications fails to develop or develops more slowly than we anticipate, our IP network telephony products could fail to achieve market acceptance, which in turn could significantly harm our business, financial condition and operating results |
| This growth may be inhibited by a number of factors, such as quality of infrastructure; security concerns; equipment, software or other technology failures; regulatory encroachments; inconsistent quality of service; poor voice quality over IP networks as compared to circuit-switched networks; and lack of availability of cost-effective, high-speed network capacity |
| Moreover, as IP-based data communications and telephony usage grow, the infrastructure used to support these IP networks, whether public or private, may not be able to support the demands placed on them and their performance or reliability may decline |
| The technology that allows voice and facsimile communications over the Internet and other data networks, and the delivery of other value-added services, is still in the early stages of development |
| Government regulation of third party long distance and network service entities on which we rely may harm our business |
| Our supply of telecommunications services and information depends on several long distance carriers, RBOCs, local exchange carriers, or LECs, and competitive local exchange carriers, or CLECs |
| We rely on these carriers to provide local and long distance services, including voice and data circuits, to our customers and to provide us with billing information |
| Long distance services are subject to extensive and uncertain governmental regulation on both the federal and state level |
| We cannot assure you that the increase in regulations will not harm our business |
| Our current contracts for the resale of services through long distance carriers include multi-year periods during which we have minimum use requirements and/or costs |
| The market for long distance services is experiencing, and is expected to continue to experience significant price competition, and this may cause a decrease in end-user rates |
| We cannot assure you that we will meet minimum use commitments, that we will be able to negotiate lower rates with carriers if end-user rates 26 _________________________________________________________________ [80]Table of Contents decrease or that we will be able to extend our contracts with carriers at favorable prices |
| If we are unable to secure reliable Network Services from certain long distance carriers, RBOCs, LECs and CLECs, or if these entities are unwilling or unable to provide telecommunications services and billing information to us on favorable terms, our ability to expand our own Network Services will be harmed |
| Carriers that provide telecommunications services to us may also experience financial difficulties, up to and including bankruptcies, which could harm our ability to offer telecommunications services |
| Consolidation within the telecommunications industry could increase competition and adversely affect our business |
| There has been a trend in the telecommunications industry toward consolidation and we expect this trend to continue as the industry evolves |
| As a result of this consolidation trend, new stronger companies may emerge that have improved financial resources, enhanced research and development capabilities and a larger and more diverse customer base |
| The changes within the telecommunications industry may adversely affect our business, operating results and financial condition |
| Terrorist activities and resulting military and other actions could harm our business |
| Terrorist attacks in New York and Washington, DC in September of 2001 disrupted commerce throughout the world |
| The continued threat of terrorism, the conflict in Iraq and the potential for additional military action and heightened security measures in response to these threats may continue to cause significant disruption to commerce throughout the world |
| To the extent that disruptions result in a general decrease in corporate spending on information technology or advertising, our business and results of operations could be harmed |
| We are unable to predict whether the conflict in Iraq and its aftermath, the threat of terrorism or the responses thereto will result in any long-term commercial disruptions or if such activities or responses will have a long-term adverse effect on our business, results of operations or financial condition |
| Additionally, if any future terrorist attacks were to affect the operation of the Internet or key data centers, our business could be harmed |
| These and other developments arising out of the potential attacks may make the occurrence of one or more of the factors discussed herein more likely to occur |
| We are spending an increased amount of management time and external resources to comply with existing and changing laws, regulations and standards in general, and specifically relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations, PCAOB and Nasdaq Stock Market rules, as well as commercial dealings with other government entities |
| In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal control systems, and attestations of the effectiveness of these systems by our management and by our independent auditors |
| We completed our documentation and testing of our internal control systems and procedures as required for 2004 and 2005 |
| This process required us to hire additional personnel and use outside advisory services and resulted in additional accounting and legal expenses |
| The results of the documentation and testing for 2004 and 2005 indicated that we had adequate internal controls over financial reporting |
| However, if in the future our chief executive officer, chief financial officer or independent auditors determine that our controls over financial reporting are not effective as defined under Section 404, investor perceptions of Inter-Tel may be adversely affected and could cause a decline in the market price or our stock |
| Failure to comply with other existing and changing laws, regulations and standards could also adversely affect the Company |