Exhibit 13.0

                       ANNUAL REPORT TO SECURITY HOLDERS

                  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA


REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

SHAREHOLDERS AND BOARD OF DIRECTORS
INTER-TEL, INCORPORATED

We have  audited the  accompanying  consolidated  balance  sheets of  Inter-Tel,
Incorporated  and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of operations,  shareholders' equity, and cash flows for
each of the three years in the period ended  December 31, 2002.  Our audits also
included the financial  statement  schedule  listed in the Index to consolidated
financial  statements and schedule.  These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable  assurance about whether the financial  statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.  We believe  that our audits  provide a  reasonable  basis for our
opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all  material  respects,  the  consolidated  financial  position  of  Inter-Tel,
Incorporated   and   subsidiaries  at  December  31,  2002  and  2001,  and  the
consolidated  results of their  operations  and their cash flows for each of the
three years in the period ended December 31, 2002, in conformity with accounting
principles  generally accepted in the United States.  Also, in our opinion,  the
related financial statement  schedule,  when considered in relation to the basic
financial statements taken as a whole,  presents fairly in all material respects
the information set forth therein.

As discussed in Note A to the  consolidated  financial  statements,  in 2002 the
Company changed its method of accounting for goodwill.

                                        /s/ ERNST & YOUNG LLP

Phoenix, Arizona
February 14, 2003

                                       1
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001

(In thousands, except share amounts)

<TABLE>
<CAPTION>
                                                                       2002         2001
                                                                    ---------    ---------
<S>                                                                 <C>          <C>
ASSETS
CURRENT ASSETS
Cash and equivalents                                                $  84,923    $  58,795
Short-term investments                                                 40,916        3,000
                                                                    ---------    ---------
Total cash and short-term investments                                 125,839       61,795

Accounts receivable, net of allowances of $12,159 in 2002
  and $11,858 in 2001                                                  42,566       45,962
Inventories, net of allowances of $10,558 in 2002 and
  $13,202 in 2001                                                      11,329       20,848
Net investment in sales-leases, net of allowances of $516 in 2002
  and $640 in 2001                                                     13,344       13,799
Income taxes receivable                                                 2,604        3,257
Deferred income taxes                                                   2,377        8,467
Prepaid expenses and other assets                                       6,705        4,891
                                                                    ---------    ---------
TOTAL CURRENT ASSETS                                                  204,764      159,019

PROPERTY, PLANT & EQUIPMENT                                            24,795       23,905
GOODWILL                                                               17,646       13,656
PURCHASED INTANGIBLE ASSETS                                             7,416        5,003
NET INVESTMENT IN SALES-LEASES, net of allowances of $1,411 in
  2002 and $1,206 in 2001                                              24,692       21,735
OTHER ASSETS                                                            2,749        4,144
                                                                    ---------    ---------
                                                                    $ 282,062    $ 227,462
                                                                    =========    =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable                                                    $  23,089    $  21,812
Other current liabilities                                              50,051       44,051
                                                                    ---------    ---------
TOTAL CURRENT LIABILITIES                                              73,140       65,863

DEFERRED TAX LIABILITY                                                 16,320       17,390
LEASE RECOURSE LIABILITY                                               11,125        8,890
RESTRUCTURING RESERVE                                                   1,049        3,060
OTHER LIABILITIES                                                       6,525        5,422

SHAREHOLDERS' EQUITY
Common stock, no par  value-authorized  100,000,000 shares;
  issued - 27,161,823 shares; outstanding - 24,908,983 shares
  at December 31, 2002 and 24,166,430 shares at December 31, 2001     111,639      108,968
Less: Shareholder loans                                                  (338)        (942)
Retained earnings                                                      89,643       54,877
Accumulated other comprehensive income                                    195          151
                                                                    ---------    ---------
                                                                      201,139      163,054
Less: Treasury stock at cost - 2,252,840 shares in 2002 and
  2,995,393 shares in 2001                                            (27,236)     (36,217)
                                                                    ---------    ---------
TOTAL SHAREHOLDERS' EQUITY                                            173,903      126,837
                                                                    ---------    ---------
                                                                    $ 282,062    $ 227,462
                                                                    =========    =========
</TABLE>

See accompanying notes.

                                       2
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2002, 2001 and 2000

(In thousands, except per share data)

<TABLE>
<CAPTION>
                                                                2002         2001         2000
                                                             ---------    ---------    ---------
<S>                                                          <C>          <C>          <C>
NET SALES                                                    $ 381,456    $ 385,655    $ 402,723
Cost of sales                                                  186,983      211,161      236,046
Cost of sales - Executone restructuring                             --           --        7,639
                                                             ---------    ---------    ---------
GROSS PROFIT                                                   194,473      174,494      159,038

Research and development                                        19,340       17,556       19,489
Selling, general and administrative                            128,284      128,604      124,664
Amortization of goodwill                                            --        1,876        2,228
Amortization of purchased intangible assets                      1,122          677          576
In-process research and development                                 --           --        5,433
Other charges                                                       --        5,357       45,245
                                                             ---------    ---------    ---------
                                                               148,746      154,070      197,635
                                                             ---------    ---------    ---------
OPERATING INCOME (LOSS)                                         45,727       20,424      (38,597)
                                                             ---------    ---------    ---------
Litigation settlement (net of costs except for taxes)           15,516           --           --
Write-down of investment in Inter-Tel.NET/Vianet                (1,200)          --           --
Equity share of Cirilium Corp.'s net losses                         --           --       (5,938)
Write-off of Cirilium Corp. investment                              --           --       (2,045)
Interest and other income                                        1,936        1,081        1,474
Foreign currency transaction gains (losses)                        330         (337)        (421)
Interest expense                                                  (156)        (468)        (213)
                                                             ---------    ---------    ---------
INCOME (LOSS) BEFORE INCOME TAXES (BENEFIT)                     62,153       20,700      (45,740)

INCOME TAXES (BENEFIT)
Current                                                         18,495       (3,647)      (9,904)
Deferred                                                         5,021       11,306       (6,913)
                                                             ---------    ---------    ---------
                                                                23,516        7,659      (16,817)
                                                             ---------    ---------    ---------
NET INCOME (LOSS)                                            $  38,637    $  13,041    $ (28,923)
                                                             ---------    ---------    ---------
NET INCOME (LOSS) PER SHARE
Basic                                                        $    1.58    $    0.53    $   (1.10)
Diluted                                                      $    1.49    $    0.52    $   (1.10)
                                                             ---------    ---------    ---------

Weighted average basic common shares                            24,444       24,488       26,273

Weighted average diluted common shares                          25,864       25,240       26,273
                                                             ---------    ---------    ---------
</TABLE>

See accompanying notes.

                                       3
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2002, 2001 and 2000

<TABLE>
<CAPTION>
(in thousands)
                                                                                 Accumulated
                                                          Share-                    Other
                                             Common       holder     Retained    Comprehensive   Treasury
                                             Stock        Loans      Earnings    Income (loss)     Stock        Total
                                           ---------    ---------    ---------   -------------   ---------    ---------
<S>                                        <C>          <C>          <C>         <C>             <C>          <C>
BALANCE AT DECEMBER 31, 1999               $ 106,853    $  (1,116)   $  75,835     $     177     $ (13,628)   $ 168,121
Net loss                                                               (28,923)                                 (28,923)
Loss on currency translation                                                            (457)                     (457)
                                                                                                              ---------
Comprehensive loss                                                                                              (29,380)
Stock repurchase                                                                                    (6,711)      (6,711)
Exercise of stock options                                               (1,468)                      3,496        2,028
Tax benefit from stock options                 1,852                                                              1,852
Shareholder loan repayments                                    98                                                    98
Stock issued under ESPP                                                   (293)                      1,346        1,053
Issuance of shares in acquisition                427                                                                427
Dividends                                                               (1,052)                                  (1,052)
                                           ---------    ---------    ---------     ---------     ---------    ---------
BALANCE AT DECEMBER 31, 2000                 109,132       (1,018)      44,099          (280)      (15,497)     136,436
Net income                                                              13,041                                   13,041
Gain on currency translation                                                             431                        431
                                                                                                              ---------
Comprehensive income                                                                                             13,472
Stock repurchase                                                                                   (28,905)     (28,905)
Exercise of stock options                                                 (509)                      1,806        1,297
Tax benefit from stock options                   263                                                                263
Shareholder loan repayments                                    76                                                    76
Stock issued under ESPP                                                    (91)                      1,057          966
Issuance of treasury shares in
  conversion of subsidiary stock                (427)                     (471)                      5,322        4,424
Dividends                                                               (1,192)                                  (1,192)
                                           ---------    ---------    ---------     ---------     ---------    ---------
BALANCE AT DECEMBER 31, 2001                 108,968         (942)      54,877           151       (36,217)     126,837
Net income                                                              38,637                                   38,637
Gain on currency translation                                                              44                         44
                                                                                                              ---------
Comprehensive income                                                                                             38,681
Stock repurchase                                                          (16)                           3          (13)
Exercise of stock options                                              (1,626)                       8,234        6,608
Tax benefit from stock options                 2,671                                                              2,671
Shareholder loan repayments                                   604                                                   604
Stock issued under ESPP                                                    228                         744          972
Dividends                                                               (2,457)                                  (2,457)
                                           ---------    ---------    ---------     ---------     ---------    ---------
BALANCE AT DECEMBER 31, 2002               $ 111,639    $    (338)   $  89,643     $     195     $ (27,236)   $ 173,903
                                           ---------    ---------    ---------     ---------     ---------    ---------
</TABLE>

See accompanying notes.

                                       4
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2002, 2001 and 2000

(In thousands)

<TABLE>
<CAPTION>
                                                                     2002        2001        2000
                                                                   --------    --------    --------
<S>                                                                <C>         <C>         <C>
OPERATING ACTIVITIES:
Net income (loss)                                                  $ 38,637    $ 13,041    $(28,923)
Adjustments to reconcile net income (loss) to net cash
    provided by operating activities:
  Depreciation of fixed assets                                        7,310       8,742       9,724
  Amortization of goodwill and purchased intangibles                  1,122       2,553       2,804
  Amortization of patents included in R&D expenses                      222         222         218
  Non-cash portion of other charges                                   1,200       5,357      41,783
  Provision for losses on receivables                                 4,177       6,260       6,793
  Provision for losses on leases                                      6,356       5,840       4,927
  Provision for inventory valuation                                   1,526       1,614       1,653
  Increase in other liabilities                                      (3,937)     (1,289)      4,989
  Gain (loss) on sale of property and equipment:                         37         (39)        157
  Deferred income taxes (benefit)                                     5,021      11,306      (6,913)
  Effect of exchange rate changes                                        44         431        (457)
  Purchased in-process research and development                          --          --       5,433
  Changes in operating assets and liabilities                        15,480      20,968     (24,849)
                                                                   --------    --------    --------
NET CASH PROVIDED BY OPERATING ACTIVITIES                            77,195      75,006      17,339
                                                                   --------    --------    --------
INVESTING ACTIVITIES:
Purchases of short-term investments                                 (67,682)     (3,000)         --
Maturities and sales of short-term investments                       29,766          --          --
Additions to property and equipment and equipment held under
  lease                                                              (7,600)     (7,988)     (9,719)
Proceeds from sale of property and equipment
  and equipment held under lease                                        328         173          39
Cash received from disposition of business segment                       --          --       6,602
Cash used in acquisitions and joint ventures                        (11,377)     (6,789)     (2,855)
                                                                   --------    --------    --------
NET CASH USED IN INVESTING ACTIVITIES                               (56,565)    (17,604)     (5,933)
                                                                   --------    --------    --------
FINANCING ACTIVITIES:
Cash dividends paid                                                  (2,192)       (983)     (1,054)
Payments on term debt                                                  (481)     (1,548)     (2,262)
Treasury stock purchases                                                (13)    (28,905)     (6,711)
Proceeds from term debt                                                  --       3,387       3,319
Proceeds from stock issued under the
  Employee Stock Purchase Plan                                          972         966       1,053
Proceeds from exercise of stock options, including
  shareholder loan repayments                                         7,212       1,373       2,126
                                                                   --------    --------    --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                   5,498     (25,710)     (3,529)
                                                                   --------    --------    --------
INCREASE IN CASH AND EQUIVALENTS                                     26,128      31,692       7,877

CASH AND EQUIVALENTS AT BEGINNING OF YEAR                            58,795      27,103      19,226
                                                                   --------    --------    --------

CASH AND EQUIVALENTS AT END OF YEAR                                $ 84,923    $ 58,795    $ 27,103
                                                                   --------    --------    --------
</TABLE>

See accompanying notes.

                                       5
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001 and 2000


NOTE A - SIGNIFICANT ACCOUNTING POLICIES

     DESCRIPTION OF BUSINESS. Inter-Tel, incorporated in 1969, is a single point
of  contact,  full  service  provider  of  converged  voice  and  data  business
communications  systems,  voice mail  systems and  networking  applications.  We
market and sell voice processing and unified messaging software, call accounting
software,   Internet  Protocol  (IP)  telephony   software,   computer-telephone
integration (CTI)  applications,  local and long distance calling services,  and
other communications  services.  Our products and services include the Axxess by
Inter-Tel,   ECLIPSE(2)   by  Inter-Tel   and  Encore  by   Inter-Tel   business
communication  systems,  with integrated voice processing and unified  messaging
systems, IP telephony voice and data routers, and e-commerce  software.  We also
provide  maintenance,  leasing  and  support  services  for  our  products.  Our
customers  include  business  enterprises,  government  agencies and  non-profit
organizations.  Our common stock is quoted on the Nasdaq  National Market System
under the symbol "INTL."

     PRINCIPLES OF CONSOLIDATION.  The consolidated financial statements include
the  accounts  of  Inter-Tel,  Incorporated  and all  significant  subsidiaries.
Intercompany accounts and transactions have been eliminated in consolidation.

     CASH AND  EQUIVALENTS  AND  SHORT-TERM  INVESTMENTS.  Cash and  equivalents
include all highly liquid  investments with a remaining maturity of three months
or less at date of acquisition.  Cash and equivalents are primarily  invested in
mutual funds  comprised of foreign and domestic high quality dollar  denominated
money  market  instruments  rated A-1 by  Standard & Poor's  Ratings  Group,  or
equivalent.

     The  Company  accounts  for  short-term   investments  in  accordance  with
Financial  Accounting  Standard No. 115,  "Accounting for Certain Investments in
Debt and Equity Securities." The Company's short-term investments are classified
as available for sale, and have been recorded at fair value,  which approximates
cost.

     ALLOWANCE  FOR  DOUBTFUL  ACCOUNTS.  We maintain  allowances  for  doubtful
accounts for estimated  losses  resulting from the inability of our customers to
make required payments.  Additional reserves or allowances for doubtful accounts
are recorded for our sales-type  leases,  discussed below in  "Sales-Leases." We
establish and maintain  reserves against  estimated losses based upon historical
loss  experience,  past due accounts and specific account  analysis.  Management
reviews the level of the allowances for doubtful accounts on a regular basis and
adjusts  the level of the  allowances  as needed.  At  December  31,  2002,  our
allowance for doubtful  accounts for accounts  receivable  were $12.2 million of
our $54.7 million in gross accounts  receivable.  If the financial  condition of
our  customers  or  channel  partners  were  to  deteriorate,  resulting  in  an
impairment  of their  ability to make  payments,  additional  allowances  may be
required.

     INVENTORIES.  We value our inventories at the lower of cost or market. Cost
is determined by the first-in,  first-out  (FIFO)  method,  including  material,
labor and overhead. Significant management judgment is required to determine the
reserve for obsolete or excess  inventory.  Inventory on hand may exceed  future
demand  either  because the product is  outdated,  or  obsolete,  or because the
amount on hand is more  than can be used to meet  future  need,  or  excess.  We
currently consider all inventory that has no activity within one year as well as
any additional  specifically  identified inventory to be excess. We also provide
for the total value of  inventories  that we determine  to be obsolete  based on
criteria such as customer demand, product life-cycles, changing technologies and
market conditions.  We write down our excess and obsolete inventory equal to the
difference  between the cost of inventory  and the estimated  market  value.  At
December  31,  2002,  our  inventory  reserves  were $10.6  million of our $21.9
million gross  inventories.  If actual  customer  demand,  product  life-cycles,
changing  technologies  and  market  conditions  are less  favorable  than those
projected by management, additional inventory write-downs may be required.

     PROPERTY,  PLANT AND EQUIPMENT.  Property, plant and equipment is stated at
cost. Depreciation is computed using the straight-line method over the estimated
useful lives of the related real and personal property, which range from 3 years
to 30 years.  Leasehold  improvements  are  depreciated  over the shorter of the
related lease terms or the estimated  useful lives of the  improvements.  Within

                                       6
<PAGE>
the category "computer systems and equipment," including database and enterprise
software,  WAN and LAN equipment and software,  personal computers,  servers and
related software, the range for estimated useful lives is 3 years to 7 years.

     GOODWILL AND OTHER INTANGIBLE ASSETS. On January 1, 2002, Inter-Tel adopted
SFAS No.  141,  BUSINESS  COMBINATIONS,  and SFAS No.  142,  GOODWILL  AND OTHER
INTANGIBLE ASSETS. Purchase prices of acquired businesses that are accounted for
as purchases have been allocated to the assets and liabilities acquired based on
the estimated fair values on the respective  acquisition  dates.  Based on these
values,  the  excess  purchase  prices  over  the fair  value of the net  assets
acquired were allocated to goodwill.

     Prior to January 1, 2002, Inter-Tel amortized goodwill over the useful life
of the underlying  asset, not to exceed 40 years. On January 1, 2002,  Inter-Tel
began  accounting for goodwill under the provisions of SFAS Nos. 141 and 142 and
discontinued  the amortization of goodwill.  As at December 31, 2002,  Inter-Tel
had  gross  goodwill  of $22.7  million  and  accumulated  amortization  of $5.0
million.  For the year ended  December 31,  2002,  Inter-Tel  did not  recognize
amortization  expense related to goodwill.  Inter-Tel completed two acquisitions
in 2002 and has not recorded any amortization for these  acquisitions on amounts
allocated to goodwill in accordance with SFAS No. 141.

     In  assessing  the   recoverability  of  Inter-Tel's   goodwill  and  other
intangibles,  Inter-Tel must make  assumptions  regarding  estimated future cash
flows and other factors to determine the fair value of the respective assets. If
these estimates or their related assumptions change in the future, Inter-Tel may
be  required  to record  impairment  charges  for these  assets  not  previously
recorded.  Some factors  considered  important which could trigger an impairment
review include significant  underperformance  relative to expected historical or
projected future operating results,  significant changes in the manner of use of
the acquired assets or the strategy for the overall business, Inter-Tel's market
capitalization  relative to net book value, and significant negative industry or
economic trends.

     The Company has tested goodwill for impairment  using the two-step  process
prescribed in SFAS No. 142. The first step is a screen for potential impairment,
while the second step measures the amount of the impairment,  if any.  Inter-Tel
performed the first of the required  impairment tests for goodwill as of October
1, 2002 and determined  that goodwill is not impaired and it is not necessary to
record any impairment losses related to goodwill and other intangible assets.

       Net income,  basic earnings per share and diluted  earnings per share for
the years ended  December 31,  2002,  2001 and 2000,  respectively,  adjusted to
exclude  amortization  expense  for  goodwill,  are as follows  (net of tax,  in
thousands, except per share data):

                                                  Year Ended December 31,
                                           ------------------------------------
                                              2002         2001         2000
                                           ----------   ----------   ----------
   Reported net income                     $   38,637   $   13,041   $  (28,923)
   Add back: goodwill amortization                 --          694          819
                                           ----------   ----------   ----------
   Adjusted net income                     $   38,637   $   13,735   $  (28,104)
                                           ==========   ==========   ==========

   Reported earnings per share - basic     $     1.58   $     0.53   $    (1.10)
   Add back: goodwill amortization                 --         0.03         0.03
                                           ----------   ----------   ----------
   Adjusted earnings per share - basic     $     1.58   $     0.56   $    (1.07)
                                           ==========   ==========   ==========

   Reported earnings per share - diluted   $     1.49   $     0.52   $    (1.10)
   Add back: goodwill amortization                 --         0.03         0.03
                                           ----------   ----------   ----------
   Adjusted earnings per share - diluted   $     1.49   $     0.54   $    (1.07)
                                           ==========   ==========   ==========

     At December 31, 2002, goodwill,  net of accumulated  amortization,  totaled
$17.7  million.  Other  acquisition-related   intangibles,  net  of  accumulated
amortization,   totaled  $7.4   million  at  December   31,  2002.   Accumulated
amortization  through  December 31, 2002 was $9.0 million.  This amount includes
$5.0 million of  amortization  of goodwill and $4.0 million of  amortization  of
other acquisition-related  intangibles.  Other acquisition-related  intangibles,
comprised primarily of developed technology,  customer lists and non-competition
agreements,  are amortized on a  straight-line  basis over periods  ranging from
5-17 years.  See Note G to  Consolidated  Financial  Statements  for  additional
information.

                                       7
<PAGE>
     SALES-LEASES.  For our sales-type lease accounting,  we follow the guidance
provided by FASB Statement No. 13,  Accounting for Leases and FASB Statement No.
140,   Accounting   for  Transfers   and  Servicing  of  Financial   Assets  and
Extinguishments  of  Liabilities - A Replacement  of FASB  Statement No. 125. We
record the discounted present values of minimum rental payments under sales-type
leases as sales,  net of  provisions  for  continuing  administration  and other
expenses over the lease period.  We record the lease sales at the time of system
sale and  installation  pursuant  to  Staff  Accounting  Bulletin  No.  101,  as
discussed  above  for  sales to end user  customers,  and  upon  receipt  of the
executed  lease   documents.   The  costs  of  systems   installed  under  these
sales-leases,  net of  residual  values  at the end of the  lease  periods,  are
recorded as costs of sales.  The net rental streams are sold to funding  sources
on a regular basis with the income  streams  discounted by prevailing  like-term
rates at the time of sale. Gains or losses resulting from the sale of net rental
payments  from such leases are recorded as net sales.  We establish and maintain
reserves against potential  recourse following the resales based upon historical
loss experience,  past due accounts and specific account analysis. The allowance
for  uncollectible  minimum lease payments and recourse  liability at the end of
the year  represent  reserves  against the entire  lease  portfolio.  Management
reviews  the  adequacy  of the  allowance  on a regular  basis and  adjusts  the
allowance  as  required.  These  reserves  are  either  netted  in the  accounts
receivable,   current  and   long-term   components  of  "Net   investments   in
Sales-Leases" on the balance sheet, or included in long-term  liabilities on our
balance sheet for off-balance sheet leases.

     INCOME TAXES.  Deferred  income taxes result from temporary  differences in
the recognition of revenues and expenses for financial  reporting and income tax
purposes.

     ADVERTISING.  The cost of advertising is expensed as incurred.  We incurred
$443,000;  $596,000;  and $513,000 in advertising  costs during 2002,  2001, and
2000, respectively.

     REVENUE  RECOGNITION.  We recognize  revenue  pursuant to Staff  Accounting
Bulletin No. 101 "Revenue  Recognition  in Financial  Statements."  Accordingly,
revenue is  recognized  when all four of the  following  criteria  are met:  (i)
persuasive  evidence  that  arrangement  exists;  (ii)  delivery of the products
and/or  services  has  occurred;  (iii)  the  selling  price is both  fixed  and
determinable and; (iv)  collectibility is reasonably  probable.  Revenue derived
from sales of systems and  services to end-user  customers  is  recognized  upon
installation  of the  systems and  performance  of the  services,  respectively,
allowing  for  use  by  our  customers  of  these  systems.   Pre-payments   for
communications   services  are  deferred  and   recognized  as  revenue  as  the
communications services are provided.

     For shipments to dealers and other distributors,  our revenues are recorded
as products are shipped and services are rendered,  because the sales process is
complete.  These shipments are primarily to third-party dealers and distributors
and title passes when goods are shipped  (free-on-board  shipping  point).  Long
distance services revenues are recognized as service is provided.

     SHIPPING  AND  HANDLING  COSTS.  EITF 00-10  "Accounting  for  Shipping and
Handling  Fees and Costs,"  addresses the  accounting  for shipping and handling
fees and costs.  Our policy is  primarily  not to bill  customers  for  shipping
costs,  unless the customer requests priority  shipping.  Any amounts billed are
recorded net in cost of goods sold.  Billed  shipping and handling costs in 2002
represented  less  than  $1.1  million,  or  0.3%  of net  sales,  and are not a
significant component of our operations.

     STOCK  BASED  COMPENSATION.  We grant stock  options for a fixed  number of
shares to  employees  and  directors  with an  exercise  price equal to the fair
market  value of the  shares at the date of grant.  We  account  for such  stock
option grants using the intrinsic-value  method of accounting in accordance with
Accounting  Principles  Board  Opinion No. 25,  "Accounting  for Stock Issued to
Employees," ("APB 25") and related  Interpretations.  Under APB 25, we generally
recognize no compensation  expense with respect to such awards.  Also, we do not
record any  compensation  expense in connection with our Employee Stock Purchase
Plan as long as the purchase price is not less than 85% of the fair market value
at the beginning or end of each offering period, whichever is lower.

     The pro forma  impact on net income and net income per share as if the fair
value of  stock-based  compensation  plans had been  recorded as a component  of
compensation expense in the consolidated  financial statements as of the date of
grant of  awards  related  to such  plans,  pursuant  to the  provisions  of the
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation"  and  Statement  of  Financial   Accounting   Standards  No.  148,
"Accounting  for  Stock-Based   Compensation  -  Transition  and  Disclosure  an
amendment of FASB Statement No. 123," is disclosed as follows and in Note M.

                                       8
<PAGE>
<TABLE>
<CAPTION>
                                                                       Years Ended December 31,
                                                                --------------------------------------
   (in thousands, except per share data)                           2002          2001          2000
                                                                ----------    ----------    ----------
   <S>                                                          <C>           <C>           <C>
   Net income (loss), as reported                               $   38,637    $   13,041    $  (28,923)
   Deduct: Total stock-based employee compensation expense
     determined under fair value based method for all awards,
     net of related tax effects                                     (3,062)       (2,446)       (1,557)
                                                                ----------    ----------    ----------
   Pro forma net income (loss)                                  $   35,575    $   10,595    $  (30,480)
                                                                ==========    ==========    ==========


   Earnings per share:
     Basic - as reported                                        $     1.58    $     0.53    $    (1.10)
     Basic - pro forma                                          $     1.46    $     0.43    $    (1.16)
     Diluted - as reported                                      $     1.49    $     0.52    $    (1.10)
     Diluted - pro forma                                        $     1.38    $     0.42    $    (1.16)
</TABLE>

     Pro forma results  disclosed are based on the  provisions of SFAS 123 using
the Black-Scholes option valuation model and are not likely to be representative
of the  effects  on pro forma net  income for future  years.  In  addition,  the
Black-Scholes  option  valuation  model was developed for use in estimating  the
fair value of traded options,  which have no vesting  restrictions and are fully
transferable.  In addition,  option valuation models require the input of highly
subjective  assumptions  including the expected stock price volatility.  Because
our stock options have  characteristics  significantly  different  from those of
traded  options,  and because  changes in the subjective  input  assumptions can
materially affect the fair value estimate, in our opinion, the estimating models
do not  necessarily  provide a reliable  single measure of the fair value of our
stock options.  See Note M for further  discussion of the Company's  stock-based
employee compensation.

     FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS.  For our foreign operations,
the local currency is the functional  currency.  All assets and  liabilities are
translated at period-end  exchange  rates and all income  statement  amounts are
translated at an average of month-end  rates.  Adjustments  resulting  from this
translation  are recorded in accumulated  other  comprehensive  income.  Foreign
currency transaction gains and losses also result from transactions  denominated
in a  currency  other  than  U.S.  dollars;  gains  and  losses  resulting  from
remeasuring  monetary  assets and  liability  accounts that are  denominated  in
currencies other than a subsidiary's  functional  currency are included in other
income under the caption "Foreign currency transaction gains (losses)."

     CONTINGENCIES.  We are a party to  various  claims  and  litigation  in the
normal course of business.  Management's  current  estimated  range of liability
related to various  claims and pending  litigation  is based on claims for which
our  management  can  estimate  the  amount  and range of loss.  Because  of the
uncertainties  related  to both the  amount  and range of loss on the  remaining
pending  claims  and  litigation,  management  is  unable  to make a  reasonable
estimate of the  liability  that could result from an  unfavorable  outcome.  As
additional information becomes available, we will assess the potential liability
related to our pending  litigation and revise our  estimates.  Such revisions in
our estimates of the potential  liability could materially impact our results of
operations and financial position.

     Divisions  of the United  States  Department  of Justice are  investigating
other  companies' and Inter-Tel's  participation in a  federally-funded  "E-Rate
program"  to  connect  schools  and  libraries  to  the  Internet.  The  Justice
Department  has not provided  Inter-Tel  with a  description  of the evidence on
which the investigations are based.  Inter-Tel is presently unable to predict or
determine the final  outcome of, or to estimate the potential  range of loss (if
any) with respect to, the investigations. If Inter-Tel is convicted of any crime
or subjected to sanctions,  or if penalties,  damages or other monetary remedies
are  assessed  against  Inter-Tel in  connection  with any  investigations,  our
business and operating results could be materially and adversely affected. Based
upon the information known at this time, we do not expect the  investigations to
result in a material  adverse  impact upon the  Company's  business or financial
condition.  Nevertheless,  the  early  nature  of the  investigations  makes  it
difficult to determine  whether the likelihood of a material  adverse outcome is
unlikely.

                                       9
<PAGE>
     USE OF ESTIMATES.  The preparation of the consolidated financial statements
in conformity with accounting principles generally accepted in the United States
requires  management to make estimates and  assumptions  that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.

     RECLASSIFICATIONS. Certain reclassifications have been made to the 2001 and
2000 financial statements to conform to the 2002 presentation.

RECENT ACCOUNTING PRONOUNCEMENTS

     In August 2001, the Financial  Accounting  Standards  Board issued SFAS No.
144,  "Accounting  for the  Impairment or Disposal of Long-Lived  Assets," which
addresses  financial  accounting and reporting for the impairment or disposal of
long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment or
Disposal of Long-Lived  Assets and for Long-Lived Assets to be Disposed Of," and
the  accounting and reporting  provisions of APB Opinion No. 30,  "Reporting the
Results of Operations"  for a disposal of a segment of a business.  SFAS No. 144
was effective for fiscal years  beginning  after December 15, 2001, with earlier
application encouraged.  The Company's adoption of SFAS No. 144 had no effect on
the Company's financial position or results of operation.

     In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146
supersedes Emerging Issues Task Force ("EITF") No. 94-3, "Liability  Recognition
for Certain  Employee  Termination  Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)."  SFAS No. 146 eliminates
the  provisions of EITF No. 94-3 that required a liability to be recognized  for
certain exit or disposal  activities at the date an entity  committed to an exit
plan.  SFAS No. 146 requires a liability  for costs  associated  with an exit or
disposal activity to be recognized when the liability is incurred.  SFAS No. 146
is effective for exit or disposal  activities  that are initiated after December
31, 2002.  The Company does not expect the adoption of this  statement to have a
material impact on its results of operations or financial position.

     In December 2002, the Financial  Accounting Standards Board issued SFAS No.
148,  "Accounting  for Stock-Based  Compensation -- Transition and  Disclosure."
SFAS No.  148  amends  FASB  Statement  No.  123,  "Accounting  for  Stock-Based
Compensation",  to provide  alternative  methods of transition to SFAS No. 123's
fair value method of accounting for stock-based employee compensation. Statement
148 also amends the  disclosure  provisions  of SFAS No. 123 and APB Opinion No.
28,  "Interim  Financial  Reporting,"  to require  disclosure  in the summary of
significant  accounting policies of the effects of an entity's accounting policy
with respect to  stock-based  employee  compensation  on reported net income and
earnings per share in annual and interim  financial  statements.  While SFAS No.
148 does not amend SFAS No. 123 to require  companies  to account  for  employee
stock options using the fair value method, the disclosure provisions of SFAS No.
148 are  applicable to all companies  with  stock-based  employee  compensation,
regardless  of whether they account for that  compensation  using the fair value
method of SFAS No. 123 or the  intrinsic  value method of APB Opinion No. 25. As
allowed by SFAS No.  123,  the  Company  has  elected to continue to utilize the
accounting  method  prescribed  by APB  Opinion  No.  25  and  has  adopted  the
disclosure  requirements  of SFAS No. 123 as of  December  31,  2002.  We do not
expect  the  adoption  of this  statement  to have an impact on its  results  of
operations or financial position.

NOTE B - ACQUISITIONS, DISPOSITIONS AND RESTRUCTURING CHARGES

     MCLEOD.  On January 24,  2002,  we  acquired  certain  assets of  McLeodUSA
Integrated  Business  Systems,  Inc.  ("McLeod") for cash plus the assumption of
various specific  liabilities and related acquisition costs.  Inter-Tel acquired
McLeod's  voice  customer  base in  Minnesota,  Iowa and  Colorado  and  DataNet
operations in South Dakota, which also included the related accounts receivable,
inventory  and  fixed  assets  along  with  assumption  of  scheduled   specific
liabilities for warranty and  maintenance  obligations.  The aggregate  purchase
price of $7.9  million  was  allocated  to the  fair  value  of the  assets  and
liabilities acquired.

     We recorded  goodwill of  approximately  $4.0  million and other  purchased
intangible  assets of $0.5 million,  for a total of $4.5 million,  in connection
with the McLeod  acquisition.  The goodwill  balance  will be  accounted  for in
accordance  with SFAS 141 and 142. The balances  included in the $0.5 million in
other  purchased  intangible  assets will be amortized over periods ranging from
two to five  years  from  the date of the  acquisition.  During  the year  ended

                                       10
<PAGE>
December 31, 2002, the amortization of purchased  intangible  assets from McLeod
was approximately $138,000.

     SWAN.  On  December  3,  2002,  Inter-Tel  Integrated  Systems,  Inc.,  our
wholly-owned  subsidiary,  acquired 100% of the capital stock of Swan  Solutions
Limited (Swan) in England and Wales,  for $4.0 million in cash. $3.0 million was
paid at closing,  $250,000 is payable in six months and  $250,000 is payable one
year from closing date. The remaining  $500,000 is subject to the achievement of
five performance milestones at $100,000 each. As of March 10, 2003, the first of
the $100,000 milestones was achieved and paid to the Swan shareholders. Payments
relating  to the  achievement  of  performance  milestones  will be  charged  to
expense, in the period earned, if applicable.  The Company recorded  amortizable
intangible  technology  assets  totaling  $3.4 million in  connection  with this
acquisition. These technology assets are being amortized over 5 years.

     CONVERGENT.  On  January  26,  2001,  Inter-Tel  Technologies,   Inc.,  our
wholly-owned  subsidiary,  acquired certain assets of Convergent  Communications
Services,  Inc.  (Convergent)  for cash plus the assumption of various  specific
liabilities and related  acquisition costs. The Company acquired segments of the
voice customer base, accounts receivable,  specified inventory and fixed assets,
and assumed liabilities for warranty,  maintenance and specified leased premises
costs.

     The  adjusted  purchase  price  paid  by us in the  Convergent  transaction
included cash of $3.9 million plus assumption of specific  liabilities  totaling
$6.3 million.  The final  purchase  price was adjusted  pursuant to a settlement
agreement with  Convergent  representatives  which  specified the return of $6.7
million to Inter-Tel,  representing  funds from escrow and other amounts owed to
Inter-Tel by Convergent that were previously set aside by the bankruptcy  court,
as well as adjustments  for assets to be acquired and liabilities to be assumed.
The settlement payments only required  adjustments or reallocations based on the
specified  assets  acquired  and  liabilities  assumed  in  connection  with the
purchase, and differences have been represented as adjustments to the net assets
acquired.  The Company recorded goodwill of $880,000 and other intangible assets
of $120,000 in connection with this  acquisition.  Goodwill and intangibles were
amortized  through December 31, 2001. The net goodwill balance of $810,000 as of
December 31, 2001 will no longer be  amortized,  but accounted for in accordance
with SFAS 141 and 142.  The net  balance of $98,000 in other  intangible  assets
will continue to be amortized for five years from the date of the acquisition.

     MASTERMIND.  On October 19, 2001, Inter-Tel  Integrated Systems,  Inc., our
wholly-owned  subsidiary,  acquired  certain of the assets and  assumed  certain
stated liabilities from MasterMind  Technologies,  Inc.  (MasterMind),  for $2.0
million.  $1.79  million was paid at or before  closing with the balance  placed
into a bonus pool with  earn-out  provisions  for  MasterMind  shareholders  and
employees based on performance parameters. The portion relating to employees who
have  joined  Inter-Tel  will be  charged  to  expenses.  The  Company  recorded
amortizable  intangible  technology  assets  totaling $1.4 million in connection
with this acquisition. These technology assets are being amortized over 5 years.

     Each  of the  acquisitions  discussed  above  were  not  material  business
acquisitions  either  individually or  collectively  and have been accounted for
using the purchase  method of  accounting.  The results of operations of each of
these   acquisitions  have  been  included  in  our  accompanying   consolidated
statements of operations from the date of acquisitions.

     INTER-TEL.NET/COMM-SERVICES/VIANET.  During  the  second  quarter  of 2000,
Inter-Tel recorded a pre-tax charge associated with Inter-Tel.NET  operations of
$2.0  million  ($1.2  million  after-tax),  related  to  the  write-down  to net
realizable  value of network  equipment and lease  termination  costs of certain
redundant  facilities.  The reserves  established  at the time of the write-down
have been fully utilized as of December 31, 2001.

     On July 24, 2001, Inter-Tel sold 83% of the stock of Inter-Tel.NET, Inc. to
Comm-Services  Corporation  for a  note  of  $4.95  million,  collateralized  by
Comm-Services  stock,  other  marketable   securities  of  the  shareholders  of
Comm-Services  and 100% of the net assets of  Inter-Tel.NET.  In connection with
the sale of 83% of  Inter-Tel.NET,  we assessed the fair value of the  remaining
17% investment in  Inter-Tel.NET.  Pursuant to SFAS 121, we recorded a charge as

                                       11
<PAGE>
of the close of the second  quarter of 2001 of $5.4 million  ($3.4 million after
tax)  associated with the impairment of our investment in  Inter-Tel.NET.  After
the impairment charge, the carrying value of our investment (the note receivable
from Vianet plus the 17% ownership  interest in Vianet)  totaled $3.7 million as
of December 31, 2001. The charge was primarily non-cash.

     Inter-Tel's   management  has  not   participated   in  the  management  of
Inter-Tel.NET since the sale in July 2001. As a result,  since July 24, 2001, we
have accounted for the remaining  Inter-Tel.NET/Comm-Services  investment  using
the cost method of accounting.  On December 30, 2001, Comm-Services entered into
a merger agreement with Vianet.  Inter-Tel's 17% investment in Comm-Services was
converted to approximately 10% of Vianet stock and as a result, the loan for the
purchase was assumed by Vianet and Inter-Tel  continued to hold  collateral from
the former  shareholders of Comm-Services until March 2003. During 2002, the net
investment  in the  notes  receivable  and  10%  interest  in  Vianet  (formerly
Comm-Services) was written down by $1.2 million and was recorded in other assets
at a carrying value of approximately $2.5 million as of December 31, 2002, which
approximated management's estimate of the related collateral value at that time.

     During 1999,  2000 and 2001,  Inter-Tel.NET  entered into  operating  lease
agreements  totaling  approximately  $6.5 million  from an equipment  vendor for
network equipment and software.  The lease agreements required  Inter-Tel.NET to
purchase vendor maintenance on their products.  Inter-Tel originally  guaranteed
the  indebtedness.  In February  2003, we executed an agreement  with Vianet and
this  vendor  releasing  Inter-Tel  from its  guarantee  of any and all of these
obligations,  and Inter-Tel and Vianet  released the vendor from claims  arising
from the failure of the network  equipment and software  previously  leased.  As
part  of this  agreement,  Inter-Tel  also  received  payment  from  the  Vianet
shareholders  of $1.45  million,  in exchange  for the release of the  remaining
collateral  and as payment of the loan.  Inter-Tel  also  retained a  collateral
interest in a Vianet shareholder's variable forward option contract that matures
in July 2003 for an amount up to  $250,000.  We have not  recorded  an asset for
this right as the amount is not guaranteed or reasonably  estimable based on the
fluctuations of future stock prices.  The value received in this transaction was
equivalent  to our  remaining  investment  value,  less  accruals for  potential
obligations to the vendor discussed above.

     Inter-Tel  also retains its  ownership  interest in Vianet and will account
for the remaining  investment  interest of approximately 10% in Vianet using the
cost method of accounting.

     EXECUTONE.   On  January  1,  2000  Inter-Tel  purchased  certain  computer
telephony  assets and  assumed  certain  liabilities  of  Executone  Information
Systems, Inc. (Executone). The Executone transaction was accounted for using the
purchase method of accounting. The aggregate purchase price was allocated to the
fair value of the assets and liabilities  acquired,  of which $5.4 million ($3.4
million  after  taxes) was  written-off  as  purchased  in-process  research and
development.  In connection with the Executone acquisition,  we sold Executone's
manufacturing  assets and liabilities to Varian of Tempe,  Arizona at a net book
value of $6.6 million.

     During  the  second  quarter  of 2000,  we  decided  to close  the  primary
Executone  facility in Milford,  Connecticut  and to  recognize a  restructuring
charge related to our exit plan and closure of the Executone operations. We have
accounted for the restructuring of the Executone operations, including severance
and related costs,  the shut down and  consolidation of the Milford facility and
the impairment of assets  associated  with the  restructuring.  We finalized our
plan for the exiting of activities and the involuntary termination or relocation
of the  employees.  Accrued  costs  associated  with this  plan were  estimates,
although the original  estimates made for the second quarter of 2000 for reserve
balances have not changed significantly as of December 31, 2002.

     Exit  costs  associated  with the  closure  of the  Milford  facility  also
included  liabilities  for building,  furniture and equipment  lease,  and other
contractual  obligations.  We are liable for the lease on the Milford  buildings
through January 2005.  Various other  furniture,  computer and equipment  leases
terminated  on varying dates  through  September  2002. To date, we have entered
into  sublease  agreements  with  third  parties  to  sublease  portions  of the
facility. The reserve for lease and other contractual  obligations is identified
in the table below.

     The total restructuring  charge from this event totaled $50.9 million.  The
following tables  summarize  details of the  restructuring  charge in connection
with the Executone acquisition, including the description of the type and amount
of liabilities  assumed,  and activity in the reserve  balances from the date of
the charge  through  December 31, 2002.  Activity  represents  payments  made or
amounts written off.

<TABLE>
<CAPTION>
                                                                                                                RESERVE
                                           CASH/      RESTRUCTURING     2000          2001         2002         BALANCE
      DESCRIPTION                         NON-CASH       CHARGE       ACTIVITY      ACTIVITY     ACTIVITY     AT 12/31/02
      -----------                         --------      --------      --------      --------     --------     -----------
                                                                           (In thousands)
<S>                                       <C>         <C>             <C>           <C>          <C>          <C>
PERSONNEL COSTS:
  Severance and termination Costs           Cash        $ (1,583)     $  1,558      $      2     $     20      $     (3)
  Other Plant closure costs                 Cash            (230)           30           200           --            --

LEASE TERMINATION AND OTHER
CONTRACTUAL OBLIGATIONS
(NET OF ANTICIPATED RECOVERY):
  Building and equipment Leases             Cash          (7,444)        1,348         1,489        2,594        (2,013
  Other contractual obligations             Cash          (1,700)           --         1,700           --            --

IMPAIRMENT OF ASSETS:
  Inventories                             Non-Cash        (3,454)        1,376           209        1,869            --
  Prepaid inventory and other Expenses    Non-Cash        (2,485)        2,485            --           --
  Accounts receivable                     Non-Cash        (1,685)          521           245           88          (831)
  Fixed assets                            Non-Cash        (3,151)        2,942            --           53          (156)
  Net intangible assets                   Non-Cash       (29,184)       29,184            --           --            --
                                                        --------      --------      --------     --------      --------
TOTAL                                                   $(50,916)     $ 39,444      $  3,845     $  4,624      $ (3,003)
                                                        ========      ========      ========     ========      ========
</TABLE>

Included in the total Executone  restructuring costs of $50.9 million is a $43.3
million  restructuring  charge  for exit  costs and asset  impairment,  and $7.6
million  associated  with the impairment of  inventories,  which has accordingly
been recorded as additional costs of sales.

NOTE C - PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE

     During the first quarter of 2000,  Inter-Tel  completed the  acquisition of
Executone  (see  NOTE  B).  The  aggregate   purchase  price  of  the  Executone
acquisition  was  allocated  to the fair  value of the  assets  and  liabilities
acquired, of which $5.4 million ($3.4 million after taxes), or $0.13 per diluted
share, was written-off as purchased in-process research and development.

NOTE D - SHORT-TERM INVESTMENTS

     The  Company  accounts  for  short-term   investments  in  accordance  with
Financial  Accounting  Standard No. 115,  "Accounting for Certain Investments in
Debt and  Equity  Securities."  The  Company's  short-term  investments  are all
classified  as available for sale,  and have been recorded at fair value,  which
approximates cost. At December 31, 2002 and December 31, 2001, $40.9 million and
$3.0 million, respectively, were recorded as short-term investments.  Short-term
investments include certificates of deposit, auction rate certificates,  auction
rate preferred securities,  municipal preferred securities and mutual funds. The
auction rate securities are adjustable-rate  securities with dividend rates that
are reset  periodically by bidders through periodic "Dutch  auctions"  generally
conducted  every 7 to 49 days by a trust company or  broker/dealer  on behalf of
the issuer.  The Company believes these securities are highly liquid investments
through the related  auctions;  however,  the  collateralizing  securities  have
stated terms of up to thirty (30) years. These instruments are rated A or higher
by Standard & Poor's Ratings Group, or equivalent.

                                       12
<PAGE>
     The  Company's   short-term   investments   are  intended  to  establish  a
high-quality  portfolio that preserves principal,  meets liquidity needs, avoids
inappropriate  concentrations  and delivers an appropriate yield in relationship
to the Company's investment guidelines and market conditions.

     The following is a summary of available-for-sale securities:

                                                December 31, 2002
                                   ---------------------------------------------
   (in thousands)                               Gross       Gross
                                              Unrealized  Unrealized  Gross Fair
                                     Cost       Gains       Losses      Value
                                   -------     -------     -------     -------
   Equity securities               $27,900     $    --     $    --     $27,900
   Municipal bonds and notes         7,875          --          --       7,875
   Certificate of deposit            5,000          --          --       5,000
   Mutual funds                        141          --          --         141
                                   -------     -------     -------     -------
                                   $40,916     $    --     $    --     $40,916
                                   =======     =======     =======     =======

                                                December 31, 2001
                                   ---------------------------------------------
   (in thousands)                               Gross       Gross
                                              Unrealized  Unrealized  Gross Fair
                                     Cost       Gains       Losses      Value
                                   -------     -------     -------     -------
   Equity securities               $ 3,000     $    --     $    --     $ 3,000
   Municipal bonds and notes            --          --          --          --
   Mutual funds                         --          --          --          --
                                        --          --          --          --
                                   -------     -------     -------     -------
                                   $ 3,000     $    --     $    --     $ 3,000
                                   =======     =======     =======     =======

     The amortized cost and estimated fair value of the available-for-sale  debt
securities  at  December  31,  2002,  by  maturity,  are shown  below.  Expected
maturities will differ from  contractual  maturities  because the issuers of the
securities  may  have  the  right  to  prepay  obligations   without  prepayment
penalties, and the Company views its available-for-sale  securities as available
for current  operations.  Equity  securities and mutual funds do not have stated
maturities  and are  therefore  excluded  from the  table  below.  In  addition,
although  the debt  securities  have stated  maturities  of more than ten years,
these  securities  are  highly  liquid  and are  traded in "Dutch  auctions"  as
described above.

                                                              December 31, 2002
                                                            --------------------
   (in thousands)
                                                                      Estimated
   Available-for-sale             Description                 Cost    Fair Value
   ------------------             -----------               -------   ----------
   Due in less than one year      Certificate of deposit    $ 5,000    $ 5,000
   Due from one to ten years      None                           --         --
   Due after ten years            Debt securities             7,875      7,875
                                                            -------    -------
                                                            $12,875    $12,875
                                                            =======    =======

NOTE E - NET INVESTMENT IN SALES-LEASES

     Net  investment  in  sales-leases  represents  the  value  of  sales-leases
presently  held under our Total Solution  program.  We currently sell the rental
payments due to us from some of the  sales-leases.  We maintain reserves against
our estimate of potential  recourse for the balance of sales-leases  and for the
balance of sold rental payments remaining unbilled. The following table provides
detail on the total net balances in sales-leases (In thousands):

                                       13
<PAGE>
<TABLE>
<CAPTION>
                                                                            December 31
                                                                   ------------------------------
                                                                     2002       2001       2000
                                                                   --------   --------   --------
   <S>                                                             <C>        <C>        <C>
   Lease balances included in consolidated accounts receivable,
   net of allowances of $2,562 in 2002; $3,112 in 2001; and
   $2,227 in 2000                                                  $  6,470   $  7,924   $  7,935

   Net investment in Sales-Leases:

     Current portion, net of allowances of $516 in 2002,
       $640 in 2001; and $582 in 2000                                13,344     13,799     14,629

      Long-term portion, includes residual amounts of
        $518 in 2002, $907 in 2001 and $807 in 2000,
        net of allowances of $1,411 in 2002; $1,206 in
        2001; and $921 in 2000                                       24,692     21,735     22,808
                                                                   --------   --------   --------
   Total investment in Sales-Leases, net of allowances
     of $4,489 in 2002; $4,958 in 2001; and $3,730 in 2000           44,506     43,458     45,372

   Soldrental payments remaining unbilled (subject to limited
     recourse provisions), net of allowances of $11,125 in 2002;
     $8,890 in 2001; and $7,697 in 2000                             194,684    193,825    190,664
                                                                   --------   --------   --------
   Total balance of sales-leases and sold rental payments
     remaining unbilled, net of allowances                         $239,190   $237,283   $236,036
                                                                   ========   ========   ========

   Total allowances for entire lease portfolio (including
     limited recourse liabilities)                                 $ 15,614   $ 13,848   $ 11,427
                                                                   ========   ========   ========
</TABLE>

     Reserve levels are established  based on portfolio  size, loss  experience,
levels of past due accounts and  periodic,  detailed  reviews of the  portfolio.
Recourse on the sold rental payments is contractually limited to a percentage of
the net credit  losses in a given  annual  period as compared  to the  beginning
portfolio balance for a specific portfolio of sold leases. While our recourse is
limited,  we maintain  reserves at a level  sufficient to cover all  anticipated
credit  losses.  The  aggregate  reserve for  uncollectible  lease  payments and
recourse liability represents the reserve for the entire lease portfolio.  These
reserves are either netted from consolidated accounts receivable, netted against
current or  long-term  "investment  in  sales-leases"  or included in  long-term
liabilities  for sold  rental  payments  remaining  unbilled.  Sales  of  rental
payments per period:

                                                     Year Ended December 31
                                                ------------------------------
   (In thousands)                                 2002       2001       2000
                                                --------   --------   --------
   Sales of rental payments                     $ 83,141   $ 86,788   $ 95,127
   Sold payments remaining unbilled
     at end of year                             $205,809   $202,715   $198,361

     Sales of  rental  payments  represents  the  gross  selling  price or total
present value of the payment stream on the sale of the rental  payments to third
parties.  Sold payments remaining unbilled at the end of the year represents the
total  balance of leases that are not included in our balance  sheet.  We do not
expect to incur any  significant  losses in excess of reserves from the recourse
provisions related to the sale of rental payments.  Inter-Tel is compensated for
administration and servicing of rental payments sold.

     At December 31, 2002,  future  minimum lease  payments  related to the sold
rental  streams  remaining  unbilled are: 2003 -- $68.9  million,  2004 -- $56.8
million,  2005 --  $42.1  million,  2006 - $27.6  million,  thereafter  -- $10.4
million.

     At December 31, 2002,  future  minimum  lease  receipts due from  customers
related to the lease  portfolio  included in our December 31, 2002 balance sheet
are: 2003 -- $14.3 million,  2004 -- $15.7 million, 2005 -- $4.2 million, 2006 -
$2.6 million, 2007 -- $1.6 million, thereafter - $1.1 million.

                                       14
<PAGE>
NOTE F - PROPERTY, PLANT & EQUIPMENT

                                                                  December 31
                                                               -----------------
   (In thousands)                                                2002      2001
                                                               -------   -------
   Computer systems, data processing and other
     office equipment                                          $40,089   $44,025
   Transportation equipment                                      2,328     2,872
   Furniture and fixtures                                        4,942     5,056
   Leasehold improvements                                        4,215     3,770
   Building                                                      7,297     7,297
   Land                                                          2,499     2,629
                                                               -------   -------
                                                                61,370    65,649
   Less: Accumulated depreciation and amortization              36,575    41,744
                                                               -------   -------
   Net property, plant & equipment                             $24,795   $23,905
                                                               -------   -------

NOTE G - GOODWILL AND PURCHASED INTANGIBLE ASSETS

                                                                  December 31
                                                               -----------------
   (In thousands)                                                2002      2001
                                                               -------   -------
   Goodwill                                                    $22,671   $18,681
   Less: Accumulated amortization                                5,025     5,025
                                                               -------   -------
   Net Goodwill                                                 17,646    13,656

   Purchased intangible assets:
     Acquired developed technology                               9,065     5,786
     Customer lists and non-competition agreements               2,319     1,841
                                                               -------   -------
                                                                11,384     7,627
   Less: Accumulated amortization                                3,968     2,624
                                                               -------   -------
   Net purchased intangible assets                               7,416     5,003
                                                               -------   -------

   Net goodwill and purchased intangible assets                $25,062   $18,659
                                                               -------   -------

NOTE H - OTHER ASSETS

                                                                  December 31
                                                               -----------------
   (In thousands)                                                2002      2001
                                                               -------   -------
   Note receivable and investment in Vianet
     (formerly Inter-Tel.Net)                                  $ 2,500   $ 3,669
   Other assets                                                    249       475
                                                               -------   -------
                                                               $ 2,749   $ 4,144
                                                               -------   -------

     Refer to Notes B and T to Consolidated  Financial Statements for additional
information regarding our investment in Vianet and a subsequent event related to
this investment.

NOTE I - OTHER CURRENT LIABILITIES

                                                                  December 31
                                                               -----------------
   (In thousands)                                                2002      2001
                                                               -------   -------
   Compensation and employee benefits                          $18,325   $12,947
   Customer deposits                                             5,331     5,251
   Restructuring Charge                                            955     1,389
   Deferred revenues                                             7,324     6,445
   Miscellaneous taxes payable                                   2,569     3,934
   Other accrued expenses                                       15,547    14,085
                                                               -------   -------
                                                               $50,051   $44,051
                                                               -------   -------

                                       15
<PAGE>
NOTE J - CREDIT LINE

     We maintain a $10 million unsecured bank credit line at prime rate to cover
international  letters of credit and for other  purposes.  The credit  agreement
matures June 1, 2003 and contains certain  restrictions and financial covenants.
At December 31, 2002,  $544,841 of the credit line was committed under letter of
credit arrangements.

NOTE K - LEASES

     Rental expense amounted to $9,800,000;  $9,679,000; and $8,818,000 in 2002,
2001, and 2000, respectively.  Noncancellable operating leases are primarily for
buildings.  Certain of the leases  contain  provisions  for renewal  options and
scheduled rent increases. At December 31, 2002, future minimum commitments under
noncancellable  leases,  including our new  headquarters  facility and a 15 year
lease for our  research  and  development  facility  and 63 month  lease for our
distribution and support facility,  are as follows: 2003 -- $9,390,000;  2004 --
$9,000,000; 2005 -- $4,939,000; 2006 - $3,185,000; 2007 -- $1,957,000 thereafter
- $348,000.

NOTE L - INCOME TAXES

     We  account  for income  taxes  under  Statement  of  Financial  Accounting
Standards No. 109,  "Accounting for Income Taxes" ("SFAS 109").  Under SFAS 109,
the liability method is used in accounting for income taxes.  Under this method,
deferred tax assets and liabilities are determined (and classified as current or
long-term)  based on differences  between  financial  reporting and tax bases of
assets and  liabilities  and are  measured  using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.

     Significant  components  of our deferred tax  liabilities  and assets as of
December 31 are as follows:

                                                                  December 31
   (in thousands)                                              -----------------
                                                                 2002      2001
                                                               -------   -------
   Deferred tax liabilities:
     Other                                                     $ 4,929   $ 4,944
     Lease--sales and capitalized costs                         36,739    32,027
                                                               -------   -------
   Total deferred tax liabilities                               41,668    36,971
                                                               -------   -------
   Deferred tax assets:
     Inventory basis differences                                 1,224     3,285
     Accounts receivable reserves                                4,244     2,789
     Accrued vacation pay                                        1,524     1,223
     Book over tax depreciation                                    277       771
     Foreign loss carryforwards                                    537       956
     In-process R&D write-off                                    5,949     6,581
     Restructuring reserves                                      2,227     3,036
     Lease receivable reserves                                   4,766     3,995
     Other - net                                                 7,510     6,226
                                                               -------   -------
   Deferred tax assets                                          28,258    28,862
     Less valuation reserve                                        537       814
                                                               -------   -------
   Net deferred tax assets                                      27,721    28,048
                                                               -------   -------
   Net deferred tax liabilities                                $13,943   $ 8,923
                                                               -------   -------

     During  2002,  2001 and 2000,  we recorded  income of  $295,000,  a loss of
$437,000,  and income of $226,000,  respectively,  from foreign  operations.  At
December  31,  2002,  we  had  foreign  loss   carryforwards   of  approximately
$1,342,000,  a portion of which began to expire in 2002. The valuation allowance
in 2002  decreased by $277,000 and $544,000 in 2001 due to expiration of foreign
loss carryforwards.

                                       16
<PAGE>
     Federal and state income taxes (benefit) consisted of the following:

   (In thousands)                                 2002       2001        2000
                                                --------   --------    --------
   Federal                                      $ 20,206   $  5,076    $(15,101)
   State                                           2,584      2,583      (1,716)
   Foreign                                           726         --          --
                                                --------   --------    --------
                                                $ 23,516   $  7,659    $(16,817)
                                                --------   --------    --------

       The principal reasons for the difference between total income tax expense
(benefit) and the amount  computed by applying the statutory  federal income tax
rate to income before taxes are as follows:

                                                  2002       2001        2000
                                                --------   --------    --------
   Federal tax at statutory rates
     Applied to pre-tax income                     35%        35%        (35)%
   State tax net of federal benefit                 2          5          (4)
   Credit for research activities                  (1)        (5)         --
   Other - net                                      2          2           2
                                                 ----       ----        ----
                                                   38%        37%         (37)%
                                                 ----       ----        ----

NOTE M - EQUITY TRANSACTIONS

     TREASURY  STOCK.  During the first  quarter of 2001,  we  initiated a stock
repurchase program under which the Board of Directors  authorized the repurchase
of up to 4,000,000 shares of our Common Stock. During the third quarter of 2000,
we  initiated a stock  repurchase  program  under  which the Board of  Directors
authorized the repurchase of up to 2,000,000  shares of Inter-Tel  Common Stock.
Under these authorizations, we did not repurchase shares during 2002, other than
$13,000  expended to repurchase  shares for cash pay-outs to former employees in
place of ESOP share  distributions.  During  2001,  we  purchased  approximately
2,523,000 shares and expended approximately $28.9 million for stock repurchases,
which was funded  primarily  through  existing cash  balances.  We also expended
approximately  $6.7 million for repurchases of  approximately  562,000 shares of
Inter-Tel's  Common  Stock  during  2000,  which was  funded  primarily  through
existing cash balances. We reissued approximately  743,000,  671,000 and 379,000
shares in 2002, 2001 and 2000,  respectively,  through stock option and employee
stock purchase plan  exercises and issuances,  and stock issued in conversion of
subsidiary  stock through an  acquisition.  The proceeds  received for the stock
reissued were less than our total cost basis.  Accordingly,  the  difference was
recorded as a reduction to retained earnings.

     DIVIDEND POLICY.  From December 31, 1997 through the third quarter of 2001,
we paid quarterly cash dividends (the "cash  dividend") of $0.01 for every share
of Common Stock, to shareholders of record. We have made quarterly cash dividend
payments  for each quarter  since the  dividend was declared in September  1997,
with  dividend  payments  commencing  on or about 15 days  after the end of each
fiscal quarter.  On October 23, 2001, our Board of Directors  increased the cash
dividend from $0.01 to $0.02 for every share of Common Stock,  payable quarterly
to  shareholders  of record  beginning  December 31, 2001. On July 16, 2002, our
Board of Directors  increased  the cash  dividend  from $0.02 to $0.03 for every
share of Common Stock,  payable  quarterly to shareholders  of record  beginning
September  30,  2002.  Prior  to the  cash  dividend,  we had  declared  no cash
dividends on our Common Stock since incorporation.

     STOCK OPTION PLANS. In July 1990, we adopted the Director Stock Option Plan
("the Director Plan") and reserved a total of 500,000 shares of Common Stock for
issuance thereunder. Commencing with the adoption of the Plan through 2001, each
Eligible Director  received a one-time  automatic grant of an option to purchase
5,000  shares of our Common  Stock.  In  addition,  through  2001 each  Eligible
Director  was granted an option to purchase  5,000 shares upon the date five (5)
days after such person became  Director,  and an  additional  option to purchase
5,000  shares  five (5) days  after the date of the  regularly  scheduled  board
meeting  following the close of our third quarter.  All options  granted through
2001 had a  five-year  term and fully  vested at the end of six months  from the
grant date.

                                       17
<PAGE>
     In July 2001,  as  approved  by  shareholders  at the annual  shareholders'
meeting in April 2002, the board of directors  extended the term of the Director
Plan to 2010. Our  shareholders  also approved  amendments to change the date of
the annual grant to directors  under the Director Plan to five (5) business days
after the  re-election  of  directors  at the annual  meeting  of  shareholders,
increased the initial  automatic  option grant and each annual option grant from
5,000 to 7,500 shares.  The term of options  granted under the Director Plan was
also increased from five (5) years to ten (10) years.  These  amendments did not
increase  the  number  of  shares  authorized  for the  Director  Plan.  In each
instance,  Director  Plan  options  must be granted at not less than 100% of the
fair market value of our stock at the dates of grant.

     In  November  1993,  the  Board  of  Directors  authorized  the  Inter-Tel,
Incorporated  Long-Term  Incentive Plan ("the 1994 Long Term Plan").  A total of
2,000,000  shares of Common Stock has been reserved for issuance  under the 1994
Long Term Plan to selected  officers and key employees.  Options must be granted
at not less  than  100% of the fair  market  value of our  stock at the dates of
grant.  Options  generally  vest over four or five years and expire  five to ten
years from the date of grant.

     In  February  1997,  the  Board  of  Directors  authorized  the  Inter-Tel,
Incorporated 1997 Long-Term  Incentive Plan ("the 1997 Long Term Plan"). A total
of  2,400,000  shares of Common Stock has been  reserved for issuance  under the
1997 Long Term Plan to  selected  officers  and key  employees.  Option  must be
granted at not less than 100% of the fair market value of our stock at the dates
of grant.  Options  generally  vest over four or five years and expire ten years
from the date of grant.  In March 2000,  the Board of  Directors  authorized  an
amendment  to the 1997  Long Term Plan to add  1,250,000  more  shares of Common
Stock to the 1997 Long Term  Plan for  issuance  to  selected  officers  and key
employees  and to limit our ability to reprice  options under the 1997 Long Term
Plan.

     On February 27, 2001 our Board of Directors  authorized an amendment to the
1997  Long  Term  Plan,  approved  by the  stockholders,  that  provides  for an
automatic  increase in the number of shares of Common Stock reserved  thereunder
on the  first day of each  fiscal  year  equal to the  lesser of (a) 2.5% of the
outstanding  shares on that date,  (b) 750,000  shares  (subject to  appropriate
adjustment  for  all  stock  splits,  dividends,   subdivisions,   combinations,
recapitalizations and like transactions) or (c) a lesser amount as determined by
the Board of  Directors  (the  "Renewal  Feature").  For  2002,  based on shares
outstanding  at January 1, 2002 and as  approved  by the Board of  Directors  in
February 2002, this renewal  feature  provided for an increase of 604,161 shares
for  issuance  under  the 1997  Long  Term  Plan.  For  2003,  based  on  shares
outstanding  at January 1, 2003 and as  approved  by the Board of  Directors  in
February 2003, this renewal  feature  provided for an increase of 622,725 shares
for issuance under the 1997 Long Term Plan.

     Under the 1994 and 1997 Long Term Plans, in some  instances,  predetermined
share market value increases must be met to allow acceleration of option vesting
provisions before the end of the option term.

     In  April  1998,   the  Board  of  Directors   authorized   the  Inter-Tel,
Incorporated  Acquisition  Stock Option Plan (the Acquisition  Plan). A total of
82,428  shares of Common Stock was reserved for issuance  under the  Acquisition
Plan to selected key employees hired as a result of the acquisition of TMSI. New
options  must be granted at not less than 100% of the fair  market  value of our
stock at the dates of grant.  Options generally vest over four or five years and
expire ten years from the date of grant.  A portion of the options  granted were
replacements  for  options  held to  purchase  shares  of stock  of the  selling
company;  such replacement  grants retained the original terms,  including grant
dates for vesting  purposes and the original  grant prices,  adjusted  using the
applicable  conversion ratio of the fair value of Inter-Tel's  stock compared to
that of the selling company.

     In March 2000,  the Board of Directors  authorized  an  additional  216,000
shares of Common  Stock for  issuance  under the  Acquisition  Plan to  selected
employees  hired as a result of the acquisition of selected assets of Executone.
In February 2001, the Board of Directors authorized an additional 300,000 shares
of Common Stock for issuance under the  Acquisition  Plan to selected  employees
hired as a result  of the  acquisition  of  selected  assets of  Convergent.  In
addition,  in October  2001,  the Board of Directors  authorized  an  additional
150,000  shares  of Common  Stock for  issuance  under the  Acquisition  Plan to
selected   employees  hired  as  a  result  of  the  acquisition  of  Mastermind
Technologies.  Options in each instance must be granted at not less than 100% of
the fair market value of our stock at the dates of grant. Options vest over five
years and expire ten years from the date of grant.

                                       18
<PAGE>
     Option activity for the past three years under all plans is as follows:

<TABLE>
<CAPTION>
                                                       Number of Shares
                                           --------------------------------------
                                              2002          2001          2000
                                           ----------    ----------    ----------
<S>                                        <C>           <C>           <C>
   Outstanding at beginning of year         4,567,945     3,143,292     2,486,696
   Granted                                    608,000     2,007,500     1,213,500
   Exercised                                 (710,304)     (210,633)     (279,654)
   Expired or canceled                       (277,000)     (372,214)     (277,250)
                                           ----------    ----------    ----------
   Outstanding at end of year               4,188,641     4,567,945     3,143,292
                                           ----------    ----------    ----------

   Exercisable at end of year               1,628,533     1,458,388     1,188,356
   Weighted-average grant price of
     options granted                       $    13.40    $    12.26    $    13.65
   Weighted-average fair value (FAS 123)
     of options granted during the year    $     9.32    $     6.42    $     6.83
</TABLE>

     At December 31, 2002, we have reserved 4,815,292 shares of Common Stock for
issuance in connection with the stock option plans.

     As permitted under Statement of Financial Accounting Standards No. 123 (FAS
123)  "Accounting  for  Stock-Based  Compensation,"  we have  elected  to follow
Accounting  Principles  Board  Opinion No. 25,  "Accounting  for Stock Issued to
Employees," and related Interpretations, in accounting for stock based awards to
employees.  Under APB 25, we generally  recognize no  compensation  expense with
respect to such awards.

     The following table summarizes  information about stock options outstanding
at December 31, 2002:

                               OPTIONS OUTSTANDING

<TABLE>
<CAPTION>
                                 Number           Weighted-Average           Weighted
        Range of               Outstanding           Remaining                Average
     Exercise Price            at 12-31-02        Contractual Life         Exercise Price
     --------------            -----------        ----------------         --------------
<S>                            <C>                <C>                      <C>
     $ 2.24 - $ 4.31              138,179              2 years                 $ 3.00
     $ 4.81 - $ 7.06              146,400              4 years                 $ 5.77
     $ 7.25 - $13.44            2,487,020              7 years                 $10.36
     $15.13 - $43.44            1,417,042              8 years                 $20.53
</TABLE>

                               OPTIONS EXERCISABLE

<TABLE>
<CAPTION>
                                 Number           Weighted-Average           Weighted
        Range of               Outstanding           Remaining                Average
     Exercise Price            at 12-31-02        Contractual Life         Exercise Price
     --------------            -----------        ----------------         --------------
<S>                            <C>                <C>                      <C>

     $ 2.24 - $ 4.31              138,179              2 years                 $ 3.00
     $ 4.81 - $ 7.06              146,400              4 years                 $ 5.77
     $ 7.25 - $13.44              835,040              7 years                 $10.13
     $15.13 - $43.44              508,914              8 years                 $21.79
</TABLE>

     During  2002,  the  weighted  average  exercise  price of options  granted,
exercised, and expired or canceled was $19.18, $10.33 and $15.33, respectively.

     Pro forma  information  regarding  net income and net income per share,  as
disclosed in Note A, has been determined as if the Company had accounted for its
employee stock-based  compensation plans under the fair value method of SFAS No.
123.

     The fair value for these options was estimated at the date of grant using a
Black-Scholes  option pricing model using the low end of reasonable  assumptions
for input variables  rather than  attempting to identify a best-point  estimate.

                                       19
<PAGE>
The option pricing model utilized the following weighted average assumptions for
2002, 2001 and 2000,  respectively:  risk free interest rates of 2.73% for 2002,
4.5% for 2001 and 5.5% for 2000; dividend yields of .75% for 2002, .50% for 2001
and .25% for 2000;  volatility factors of the expected market price of our stock
averaged .576 for 2002,  .766 for 2001 and .30 for 2000; and a weighted  average
expected  life of the option of 4 to 5 years for employee  stock  options  which
vest over four to five year periods with a weighted  average  vesting  period of
2.5 years and 1.5 years for director options which vest at the end of six months
from the grant date.

     1997 EMPLOYEE  STOCK  PURCHASE  PLAN. In April 1997, the Board of Directors
and  stockholders  adopted the Employee  Stock Purchase Plan (the Purchase Plan)
and reserved 500,000 shares for issuance to eligible  employees.  In April 2002,
the Board of  Directors  and  stockholders  approved an amendment to the Plan to
increase  the  number of  authorized  shares by  500,000  shares  for a total of
1,000,000 authorized thereunder.  Under the Purchase Plan, employees are granted
the right to purchase shares of Common Stock at a price per share that is 85% of
the lesser of the fair  market  value of the  shares  at: (i) the  participant's
entry  date  into  each  six-month  offering  period,  or  (ii)  the end of each
six-month  offering  period.   Employees  may  designate  up  to  10%  of  their
compensation  for the purchase of stock.  Under the Plan,  we sold 61,562 shares
for  approximately  $972,000  ($15.80 per share) to employees  in 2002,  108,742
shares for  approximately  $966,000  ($8.89 per share) to employees in 2001, and
105,944 shares for  approximately  $1,053,000  ($9.94 per share) to employees in
2000. At December 31, 2002, 574,649 shares remained authorized under the Plan.

     STOCK  OPTION  LOANS.  During  1999,  selected  officers  and  employees of
Inter-Tel were offered loans to acquire Inter-Tel common stock. Promissory Notes
were  established  to cover the cost of  exercise  of stock  options,  including
applicable  taxes,  or the cost of Inter-Tel  common stock purchased in the open
market  during  May and June of 1999.  The loans are  interest-only  notes  with
balloon payments due on or before March 15, 2004. The loans bear interest at the
mid-term  applicable  federal  interest  rate,  compounded  annually.   Interest
payments  are due on or before March 15 of each  anniversary  beginning on March
15,  2000.  The notes are full  recourse  loans and we retain the  common  stock
certificates  as  collateral.  Several  of the loans  have been paid in full and
loans to only two officers remain  outstanding.  The outstanding  balance of the
remaining loans at December 31, 2002 totaled $338,253.

NOTE N - EARNINGS PER SHARE

     The  following  table  sets  forth the  computation  of basic  and  diluted
earnings per share:

(In thousands, except per share amounts)           2002       2001       2000
                                                 --------   --------   --------
   Numerator:
     Net income (loss)                           $ 38,637   $ 13,041   $(28,923)
                                                 --------   --------   --------
   Denominator:
     Denominator for basic earnings per
     Share - weighted average shares               24,444     24,488     26,273

   Effect of dilutive securities:
     Employee and director stock options            1,420        752         --
                                                 --------   --------   --------

   Denominator for diluted earnings per
     Share - adjusted weighted average
     shares and assumed conversions                25,864     25,240     26,273
                                                 --------   --------   --------

   Basic income (loss) per share                 $   1.58   $   0.53   $  (1.10)
                                                 --------   --------   --------

   Diluted income (loss) per share               $   1.49   $   0.52   $  (1.10)
                                                 --------   --------   --------

     In 2002, 2001 and 2000, options to purchase 280,580,  577,800 and 2,489,354
shares,  respectively,  of Inter-Tel stock were excluded from the calculation of
diluted net earnings per share  because the exercise  price of these options was
greater than the average  market price of the common  shares for the  respective
fiscal  years,   and   therefore  the  effect  would  have  been   antidilutive.
Additionally,   in  fiscal   2000,   diluted  loss  per  share   included   only
weighted-average  shares  outstanding  as the  inclusion  of 689,000  additional
potential common stock equivalents would have been antidilutive  since Inter-Tel
incurred a net loss for that period.

                                       20
<PAGE>
NOTE O - RETIREMENT PLANS

     We have two retirement  plans for the benefit of our  employees.  Under our
401(k) Retirement Plan, participants may contribute on an annual basis up to the
maximum amount allowed by the Internal Revenue Service. We make voluntary annual
contributions to the Plan of 50% of contributions  made by Plan  participants of
up to 6 percent of each participant's  compensation.  Our matching contributions
to the Plan totaled $1,567,000;  $1,476,000;  and $1,381,000;  in 2002, 2001 and
2000, respectively.

     In 1992, we initiated an Employee Stock  Ownership  Plan (ESOP),  advancing
$500,000 to the ESOP Trust for the  purpose of  purchasing  Common  Stock of the
Company.  The Trust purchased  307,000 shares of Inter-Tel  Common Stock in July
1992. The loan was paid in full during 1997. As the principal amount of the loan
was repaid to Inter-Tel  through  Company annual  contributions,  the equivalent
number of shares released were allocated to employees' accounts to be held until
retirement.  Total shares so allocated were 32,380 in 1997. Contributions to the
ESOP  totaled  $62,500 in 1997,  and were based  upon the  historic  cost of the
shares  purchased by the ESOP. After the final allocation of shares in 1997, the
ESOP plan was  "frozen,"  so that all eligible  participants  as of July 1, 1997
became  100%  vested in their  accounts,  regardless  of length of  service.  No
further  purchases are  anticipated  through the ESOP,  and we do not anticipate
making future  allocations  of shares from this plan. In October 2002, our Board
of Directors authorized the termination of this plan, allowing one-time rollover
contributions  to be made to participants in our 401(k)  Retirement  Plan, other
qualified  plans or as early  taxable  distributions.  We  expect  that the Plan
assets will be distributed in their entirety during 2003, as allowed pursuant to
a favorable determination letter that was issued by the Internal Revenue Service
on January 16, 2003.

NOTE P - SEGMENT INFORMATION

     Inter-Tel  adopted  Statement of Financial  Accounting  Standards  No. 131,
"Disclosures  about  Segments of an Enterprise and Related  Information"  ("SFAS
131") in the fiscal year ended December 31, 1998. SFAS 131 establishes standards
for  reporting  information  regarding  operating  segments in annual  financial
statements and requires selected  information for those segments to be presented
in interim financial  reports issued to stockholders.  SFAS 131 also establishes
standards for related  disclosures  about  products and services and  geographic
areas.  Operating  segments are identified as components of an enterprise  about
which separate discrete financial information is available for evaluation by the
chief operating decision maker, or decision making group, in making decisions as
to how to  allocate  resources  and  assess  performance.  The  Company's  chief
decision maker, as defined under SFAS 131, is the Chief Executive Officer.

     Prior to 2000,  we had viewed our  operations as  principally  one segment:
telephone systems,  telecommunications  software and hardware,  and related long
distance  calling  services.  These services are provided  through the Company's
direct sales offices and dealer  network to business  customers  throughout  the
United States,  Europe,  Asia, Mexico and South America. As a result,  financial
information disclosed previously represented  substantially all of the financial
information related to the Company's principal operating segment.

     During 2000, the operations of Executone were identified  separately in the
first and second quarters of 2000.  Beginning in the 3rd quarter and directly as
a  result  of the  charge  and  reorganization  associated  with  the  Executone
operations, we no longer account for or directly report the Executone operations
on a stand-alone  basis.  The operations have been integrated with the Company's
existing wholesale, and national and government account, operations.

     In  December  1999,  Inter-Tel  entered  into an  agreement  with  Hypercom
Corporation  to  jointly  form  Cirilium  Corporation   ("Cirilium").   Cirilium
comprises parts of Hypercom's data and Inter-Tel's packet telephony products and
services, including Inter-Tel's Vocal'Net gateway products and technology. As of
the close of the third quarter of 2000,  we wrote off our  remaining  investment
and basis in Cirilium of $2.0 million.  Total pre-tax  losses from Cirilium from
all sources were $8.6 million ($0.21 per diluted share) during 2000. As a result
of the  write-off,  we do not expect to report the  operations  of Cirilium as a
separate  business  segment.  Refer to the  table  below  for a  summary  of the
operations for 2000.

     During  2000,  we  determined   that  the   operations  of   Inter-Tel.NET,
Inter-Tel's former IP long distance subsidiary, would be separately disclosed as
a business segment. The operations  represented a more significant  component of

                                       21
<PAGE>
the  consolidated  operations  in  2000  compared  to  prior  years  and  had  a
significant  impact on the revenues and net losses. On July 24, 2001,  Inter-Tel
agreed to sell 83% of Inter-Tel.NET to Comm-Services  Corporation.  As a result,
since   July   24,   2001,   we   have   accounted   for   the   remaining   17%
Inter-Tel.NET/Comm-Services  investment using the cost method of accounting.  On
December 30, 2001,  Comm-Services  entered into a merger  agreement with Vianet.
Inter-Tel's  17%  investment  in  Inter-Tel.NET/Comm-Services  was  converted to
approximately 10% of Vianet stock.  Inter-Tel will account for the remaining 10%
investment in Vianet using the cost method of accounting.

     Commencing  the third  quarter of 2001,  we began  disclosing as a separate
business  segment  operating  results relating to local and long distance resale
services.  Inter-Tel  offers these  services to its customers as part of a total
telephony  solution  approach.  Results of operations  for this segment,  if the
operations  were not included as part of the  consolidated  group,  could differ
materially,  as the  operations  are  integral to the total  telephony  solution
offered by us to our customers.

     For the  years  ended  December  31,  we  generated  income  from  business
segments, including charges, as follows:

<TABLE>
<CAPTION>
                                                                                                  RESALE OF
                                                                                                  LOCAL AND
                                                                     SUBTOTAL                        LONG
(In thousands, except per                 PRINCIPAL    LITIGATION    PRINCIPAL    INTER-TEL.NET    DISTANCE
share amounts)                             SEGMENT     SETTLEMENT     SEGMENT        /VIANET       SERVICES       TOTAL
                                          ---------    ---------     ---------      ---------      ---------    ---------
<S>                                       <C>          <C>           <C>            <C>            <C>          <C>
2002
----
Net sales                                 $ 351,414    $      --     $ 351,414      $      --      $  30,042    $ 381,456
Gross profit                                185,847           --       185,847             --          8,626      194,473
Operating income                             41,837           --        41,837             --          3,890       45,727
Interest and other income                     1,772       15,516        17,288         (1,200)           164       16,252
Gain on foreign currency transactions           330           --           330             --             --          330
Interest expense                               (155)          --          (155)            --             (1)        (156)
Net income (loss)                         $  27,371    $   9,492     $  36,863      $    (746)     $   2,520    $  38,637
Net income (loss) per diluted share (1)   $    1.06    $    0.37     $    1.43      $   (0.03)     $    0.10    $    1.49
Weighted average diluted shares (1)          25,864       25,864        25,864         24,444         25,864       25,864
Total assets                              $ 266,015    $      --     $ 266,015      $      --      $  16,047    $ 282,062
Depreciation and amortization                 8,574           --         8,574             --             80        8,654

                                                                    RESALE OF
                                                                    LOCAL AND
                                                                       LONG
(In thousands, except per                 PRINCIPAL  INTER-TEL.NET   DISTANCE
share amounts)                             SEGMENT      /VIANET      SERVICES         TOTAL
                                          ---------    ---------     ---------      ---------
2001
----
Net sales                                 $ 346,094    $  13,986     $  25,575      $ 385,655
Gross profit (loss)                         173,823       (5,892)        6,563        174,494
Charge (see Note B)                              --       (5,357)           --         (5,357)
Operating income (loss)                      30,911      (13,718)        3,231         20,424
Interest and other income                       970           (1)          112          1,081
Loss on foreign currency transactions          (337)          --            --           (337)
Interest expense                               (293)        (173)           (2)          (468)
Net income (loss)                         $  19,688    $  (8,752)    $   2,105      $  13,041
Net income (loss) per diluted share (1)   $    0.78    $   (0.36)    $    0.08      $    0.52
Weighted average diluted shares (1)          25,240       24,488        25,240         25,240
Total assets                              $ 215,340    $      --     $  12,122      $ 227,462
Depreciation and amortization                 9,367        1,994           156         11,517
</TABLE>

                                       22
<PAGE>
<TABLE>
<CAPTION>
                                                                                                          RESALE OF
                                                                                                          LOCAL AND
                                                              EXECUTONE                                      LONG
(In thousands, except per                      PRINCIPAL      (CHARGES                                     DISTANCE
share amounts)                                  SEGMENT         ONLY)        CIRILIUM     INTER-TEL.NET    SERVICES         TOTAL
                                               ---------      ---------      ---------    -------------    ---------      ---------
<S>                                            <C>            <C>            <C>          <C>              <C>            <C>
2000
----
Net sales                                      $ 353,313      $      --      $      --      $  22,834      $  26,576      $ 402,723
Cost of goods sold - Executone restructuring          --         (7,639)            --             --             --         (7,639)
Gross profit (loss)                              173,328         (7,639)            --        (11,212)         4,561        159,038
Charges and write-off of IPRD
  (see Notes B and C)                                 --        (48,710)            --         (1,968)            --        (50,678)
Operating income (loss)                           37,546        (56,349)          (574)       (19,087)          (133)       (38,597)
Equity share of Cirilium losses                       --             --         (5,938)            --             --         (5,938)
Write-off of Cirilium investment                      --             --         (2,045)            --             --         (2,045)
Interest and other income                          1,423             --             --              2             49          1,474
Loss on foreign translation adjustments             (421)            --             --             --             --           (421)
Interest expense                                    (128)            --             --            (85)            --           (213)
Net income (loss)                              $  24,294      $ (35,631)     $  (5,411)     $ (12,122)     $     (53)     $ (28,923)
Net income (loss) per diluted share (1)        $    0.90      $   (1.36)     $   (0.21)     $   (0.46)     $   (0.00)     $   (1.10)
Weighted average diluted shares (1)               26,962         26,273         26,273         26,273         26,273         26,273
Depreciation and amortization                     10,664             --             --          1,878            204         12,746
</TABLE>

(1)  Options that are  antidilutive  because the exercise price was greater than
     the  average  market  price of the common  shares are not  included  in the
     computation of diluted earnings per share when a net loss is recorded.  See
     Note M for additional information.

     Our  revenues  are  generated  predominantly  in the United  States.  Total
revenues generated from U.S.  customers totaled $371.3 million,  $375.6 million,
and $392.1  million,  of total  revenues for the years ended  December 31, 2002,
2001 and 2000, respectively.  Revenues from international sources were primarily
generated from customers located in the United Kingdom, Europe, Asia, Mexico and
South  America.  In  2002,  2001  and  2000,  revenues  from  customers  located
internationally   accounted  for  2.7%,   2.6%,  and  2.6%  of  total  revenues,
respectively.

NOTE Q - FINANCIAL INSTRUMENTS

     CONCENTRATION  OF  CREDIT  RISK.  Financial  instruments  that  potentially
subject   Inter-Tel  to  significant   concentrations  of  credit  risk  consist
principally of cash investments,  trade accounts receivable,  and net investment
in  sales-leases.  We maintain cash and equivalents not invested in money market
funds with a major bank in our marketplace.  We perform periodic  evaluations of
the relative credit  standing of the financial  institution.  Concentrations  of
credit risk with respect to trade  accounts  receivable  and net  investment  in
sales-leases  are limited due to the large  number of  entities  comprising  our
customer base.

     FAIR  VALUE OF  FINANCIAL  INSTRUMENTS.  The  carrying  amount  of cash and
equivalents,  accounts receivable, net investment in sales-leases,  and accounts
payable  reported in the  consolidated  balance  sheets  approximate  their fair
value.

                                       23
<PAGE>
NOTE R - SUPPLEMENTAL CASH FLOW

<TABLE>
<CAPTION>
   (In thousands)                                                    2002        2001        2000
                                                                   --------    --------    --------
<S>                                                                <C>         <C>         <C>
   CASH PAID FOR:
     Interest                                                      $    156    $    468    $    213
     Income taxes paid (received)                                  $ 15,424    $(11,398)   $  4,788
                                                                   --------    --------    --------
   CHANGES IN OPERATING ASSETS AND LIABILITIES:
     (Increase) decrease in receivables and current net
       investment in sales-leases                                  $  1,907    $  7,556    $ (3,857)
     (Increase) decrease in inventories                               9,759      14,647     (15,034)
     (Increase) decrease in prepaid expenses and
       other assets                                                   1,577      15,620     (20,640)
     (Increase) decrease in long-term net investment in
       sales-leases and other assets                                 (3,448)        927      14,224
     Increase (decrease) in accounts payable and other
       current liabilities                                            5,685     (17,782)        458
                                                                   --------    --------    --------
                                                                   $ 15,480    $ 20,968    $(24,849)
                                                                   --------    --------    --------
</TABLE>

NOTE S - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

     A summary  of the  quarterly  results  of  operations  for the years  ended
December 31, 2002 and 2001 follows:

(In thousands, except per share amounts)

<TABLE>
<CAPTION>
   2002                                      1ST QTR    2ND QTR    3RD QTR    4TH QTR
   ----                                     --------   --------   --------   --------
<S>                                         <C>        <C>        <C>        <C>
   Net sales                                $ 90,070   $ 95,948   $ 96,665   $ 98,774
   Gross profit                               45,054     48,475     49,050     51,895
   Net income                                 15,395      7,035      7,543      8,664
   Net income per share--Basic              $   0.64   $   0.29   $   0.31   $   0.35
   Net income per share--Diluted            $   0.60   $   0.28   $   0.29   $   0.33
   Weighted average basic common shares       24,179     24,270     24,544     24,783
   Weighted average diluted common shares     25,550     25,562     26,033     26,307

   2001                                      1ST QTR    2ND QTR    3RD QTR    4TH QTR
   ----                                     --------   --------   --------   --------
   Net sales                                $ 93,702   $103,835   $ 93,487   $ 94,630
   Gross profit                               39,648     44,920     43,276     46,650
   Net income                                  1,948        185      4,378      6,531
   Net income per share--Basic              $   0.08   $   0.01   $   0.18   $   0.27
   Net income per share--Diluted            $   0.08   $   0.01   $   0.18   $   0.26
   Weighted average basic common shares       25,500     24,389     23,949     24,116
   Weighted average diluted common shares     25,843     24,910     24,804     25,334
</TABLE>

NOTE T - SUBSEQUENT EVENT

     In February 2003, we executed an agreement with Vianet (See Note B) and the
vendor  releasing  Inter-Tel  from  its  guarantee  of  any  and  all  of  these
obligations,  and Inter-Tel and Vianet  released the vendor from claims  arising
from the failure of the network  equipment and software  previously  leased.  As
part  of this  agreement,  Inter-Tel  also  received  payment  from  the  Vianet
shareholders  of $1.45  million,  in exchange  for the release of the  remaining
collateral  and as payment of the loan.  Inter-Tel  also  retained a  collateral
interest in a Vianet shareholder's variable forward option contract that matures
in July 2003 for an amount up to  $250,000.  We have not  recorded  an asset for
this right as the amount is not guaranteed or reasonably  estimable based on the
fluctuations of future stock prices.  The value received in this transaction was
equivalent  to our  remaining  investment  value,  less  accruals for  potential
obligations to the vendor discussed above.

     Inter-Tel  also retains its  ownership  interest in Vianet and will account
for the remaining  investment  interest of approximately 10% in Vianet using the
cost method of accounting.

                                       24