EXHIBIT 13.0
                 EXCERPTS FROM 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, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three  years in the period  ended  December  31,  1997.  These  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  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,  1997  and  1996,  and  the
consolidated  results of their  operations  and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity  with generally
accepted accounting principles.

                              /s/Ernst & Young LLP

Phoenix, Arizona
February 20, 1998
<PAGE>
 INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996


--------------------------------------------------------------------------------
(In thousands, except share amounts)                        1997          1996

ASSETS
CURRENT ASSETS
Cash and equivalents                                      $ 88,805      $ 38,936
Accounts receivable, less allowances of
   $3,722  in 1997 and $3,096 in 1996                       32,234        29,998
Inventories, less allowances of $5,740 in
   1997 and $2,979 in 1996                                  21,539        21,280
Net investment in sales-leases                               9,196         8,243
Prepaid expenses and other assets                            5,625         7,008

--------------------------------------------------------------------------------
TOTAL CURRENT ASSETS                                       157,399       105,465
PROPERTY, PLANT & EQUIPMENT                                 19,559        11,189
OTHER ASSETS`                                               18,030        15,957

--------------------------------------------------------------------------------
                                                         $ 194,988     $ 132,611

--------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable                                          $ 14,864       $ 8,915
Other current liabilities                                   18,721        16,841

--------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES                                   33,585        25,756

DEFERRED TAX LIABILITY                                      11,343         8,635
OTHER LIABILITIES                                            4,555         3,286

SHAREHOLDERS' EQUITY
Common stock, no par value - authorized 100,000,000
   shares, issued and outstanding - 26,687,766 shares
   in 1997 and 25,888,572 shares in 1996                    99,229        59,875
Retained earnings                                           46,547        35,464
Currency translation adjustment                              (271)         (359)

--------------------------------------------------------------------------------
                                                           145,505        94,980
Less receivable from Employee Stock Ownership Trust              -          (46)

--------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY                                 145,505        94,934

--------------------------------------------------------------------------------
                                                         $ 194,988     $ 132,611

================================================================================
See accompanying notes.
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1997, 1996 and 1995

--------------------------------------------------------------------------------

(In thousands, except per share data)     1997          1996         1995

NET SALES                               $ 223,569    $ 185,884    $ 150,533
Cost of sales                             122,363      104,966       87,696
--------------------------------------------------------------------------------
GROSS PROFIT                              101,206       80,918       62,837

Research and development                    7,998        6,581        5,764
Selling, general and administrative        69,942       56,386       43,578
Special charge                               --          4,542        1,315
--------------------------------------------------------------------------------

OPERATING INCOME                           23,266       13,409       12,180
--------------------------------------------------------------------------------

Other income                                1,383        1,974        1,674
Interest expense                              (47)         (77)        (106)
--------------------------------------------------------------------------------

INCOME BEFORE INCOME TAXES                 24,602       15,306       13,748

INCOME TAXES
Current                                     8,850        3,480        1,007
Deferred                                    1,070        2,784        4,242
--------------------------------------------------------------------------------
                                            9,920        6,264        5,249

--------------------------------------------------------------------------------

NET INCOME                              $  14,682    $   9,042    $   8,499
--------------------------------------------------------------------------------

NET INCOME PER SHARE
Basic                                   $    0.59    $    0.35    $    0.37
Diluted                                 $    0.57    $    0.34    $    0.36
--------------------------------------------------------------------------------

Average common shares outstanding          24,836       25,780       23,056

Average common shares outstanding
   assuming dilution                       25,983       26,572       23,766
--------------------------------------------------------------------------------

See accompanying notes.
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------
                                                                                  Currency     Receivable
(In thousands, except                    Common       Treasury      Retained    Translation       From
 share amounts)                          Stock         Stock        Earnings     Adjustment       ESOP         Total
-------------------------------------------------------------------------------------------------------------------------
<S>                                       <C>             <C>         <C>             <C>           <C>         <C>
Balance at December 31, 1994              $ 27,585        $   --      $ 17,923        $ (122)       $ (264)     $ 45,122

Issuance of 4,000,000 shares of
  common stock                              30,670                                                                30,670
Exercise of stock options                      503                                                                   503
Tax benefit from stock options                 208                                                                   208
Net income                                                               8,499                                     8,499
Gain on currency translation                                                              10                          10
Collection from ESOP                                                                                   105           105

-------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995                58,966            --        26,422          (112)         (159)       85,117

Exercise of stock options                      611                                                                   611
Tax benefit from stock options                 417                                                                   417
Escrow share cancellation from
  prior stock acquisition                     (119)                                                                 (119)
Net income                                                               9,042                                     9,042
Loss on currency translation                                                            (247)                       (247)
Collection from ESOP                                                                                   113           113

-------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996                59,875            --        35,464          (359)          (46)       94,934

Stock repurchase                                         (27,194)                                                (27,194)
Exercise of stock options                      642         4,533        (3,332)                                    1,843
Tax benefit from stock options               1,967                                                                 1,967
Net income                                                              14,682                                    14,682
Gain on currency translation                                                              88                          88
Collection from ESOP                                                                                    46            46
Stock issued under
   Employee Stock Purchase Plan                256                                                                   256
Issuance of 3,000,000 shares of
   common stock                             36,489        22,661                                                  59,150
Dividends                                                                 (267)                                     (267)

-------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997              $ 99,229         $  --      $ 46,547        $ (271)        $  --     $ 145,505
=========================================================================================================================
</TABLE>

See accompanying notes.
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------

(In thousands)                                                1997              1996             1995

<S>                                                        <C>                <C>               <C>
OPERATING ACTIVITIES:
Net income                                                 $ 14,682           $ 9,042           $ 8,499
Adjustments to reconcile net income
    to net cash provided by operating activities:
      Depreciation and amortization                           4,578             4,097             2,267
      Provision for losses on receivables                     4,104             3,746             1,594
      Provision for inventory valuation                       4,021               609             1,109
      Net contribution to ESOP                                   46               113               105
      Increase/(decrease) in other liabilities                1,269              (604)            1,111
      (Gain)/loss on sale of property and equipment             (25)            3,421                16
      Deferred income taxes                                   1,070             2,784             4,242
      Effect of exchange rate changes                            88              (247)               10
      Changes in operating assets and liabilities            (1,633)          (15,704)          (18,141)

----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY
    OPERATING ACTIVITIES                                     28,200             7,257               812

----------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Additions to property and equipment                         (12,449)           (6,951)           (7,921)
Proceeds from sale of property and equipment                     63               159                 9
Cash used in acquisitions                                        --            (1,780)               --

----------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING
    ACTIVITIES                                              (12,386)           (8,572)           (7,912)

----------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net proceeds from stock offering                             59,150                --            30,670
Proceeds from exercise of stock options                       1,843               611               503
Proceeds from stock issued under the
   Employee Stock Purchase Plan                                 256                --                --
Treasury stock purchases                                    (27,194)               --                --

----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY
  FINANCING ACTIVITIES                                       34,055               611            31,173

----------------------------------------------------------------------------------------------------------
INCREASE (DECREASE)
  IN CASH AND EQUIVALENTS                                    49,869              (704)           24,073

CASH AND EQUIVALENTS AT BEGINNING
    OF YEAR                                                  38,936            39,640            15,567

----------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS AT END OF YEAR                         $88,805          $ 38,936          $ 39,640
----------------------------------------------------------------------------------------------------------
</TABLE>

See accompanying notes.
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
--------------------------------------------------------------------------------

NOTE A -- SIGNIFICANT ACCOUNTING POLICIES

         Description of Business.  Inter-Tel is a single point of contact,  full
service  provider  of  digital  business  telephone  systems,   call  processing
software, voice processing software, call accounting software, Internet Protocol
(IP) telephony software,  computer telephone  integration  applications and long
distance calling services.  Inter-Tel's products and services include the AXXESS
and Inter-Tel  Axxent digital business  communication  software  platforms,  the
AXXESSORY Talk voice processing  platform,  the Inter-Tel Vocal'Net IP telephony
gateway,  the Inter-Tel  Vocal'Net  Service  Provider  Software and  Centralized
Accounting  Software and  Inter-Tel.net,  an IP telephony  packet  switched long
distance  service.  The Company also provides  maintenance,  leasing and support
services for its products.

         Principles of  Consolidation.  The  consolidated  financial  statements
include the accounts of Inter-Tel, Incorporated and all significant subsidiaries
(the Company).  Intercompany  accounts and transactions  have been eliminated in
consolidation.

         Cash and  Equivalents.  Cash and equivalents  include all highly liquid
investments  with a  remaining  maturity  of  three  months  or  less at date of
acquisition.  Excess 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.

         Inventories.  Inventories, consisting principally of telephone systems,
computer  equipment  and  related  components,  are  stated at the lower of cost
(first-in, first-out method) or market.

         Property, Plant and Equipment.  Property, plant and equipment is stated
at cost.  Depreciation  is  computed  using the  straight-line  method  over the
estimated  useful  life of the related  property  which range from 3 years to 12
years.  Leasehold  improvements  are depreciated over the shorter of the related
lease terms or the estimated useful lives of the improvements.

         Excess of Purchase Price Over Net Assets  Acquired.  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 are being amortized over 3 to 40
years. Accumulated amortization through December 31, 1997 was $866,744.

         Sales-Leases.  The discounted present values of minimum rental payments
under sales-type  leases are recorded as sales, net of provisions for continuing
administration  and other  expenses over the lease period.  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.  Gains or losses  resulting from
the sale of rental  income from such leases are recorded as  adjustments  to the
original sales amounts.

         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.  The
Company  incurred  $577,000;  $437,000 and $318,000 in advertising  costs during
1997, 1996, and 1995, respectively.

         Stock Based Compensation.  The Company grants stock options for a fixed
number of shares to  employees  with an exercise  price equal to the fair market
value of the shares at the date of grant.  The company accounts for stock option
grants  in  accordance  with  Accounting   Principles   Board  Opinion  No.  25,
"Accounting  for  Stock  Issued  to  Employees,"  ("APB  25")  and  accordingly,
recognizes no compensation expense for these stock option grants.
<PAGE>
         Recently  Issued  Accounting  Standards.  In 1996, the Company  adopted
Financial  Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards  ("SFAS")  Statement  No.  121,  "Accounting  for  the  Impairment  of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS No. 121"),
which  requires  impairment  losses to be recorded on long-lived  assets used in
operations when indicators of impairment are present and the  undiscounted  cash
flows  estimated  to be  generated  by those  assets  are less than the  assets'
carrying  amount.  SFAS 121 also addresses the accounting for long-lived  assets
that are expected to be disposed  of. The Company  adopted SFAS 121 in the first
quarter  of 1996  and  the  adoption  did  not  have a  material  impact  to the
operations  of the  Company.  During the fourth  quarter  of 1996,  the  Company
decided to replace its management  information  system ("MIS")  software with an
integrated solution from a more established vendor and accordingly wrote off the
software license and implementation  costs relating to the system software being
replaced.  The  special  pre-tax  charge  of $4.5  million  reflects  the  costs
associated  with the  Company's  decision to abandon its current MIS software in
favor of different system software.

         In February  1997,  the FASB issued SFAS No. 128,  "Earnings Per Share"
("SFAS No.  128"),  adopted by the Company on December  31,  1997.  SFAS No. 128
replaced the previously  reported  primary and fully diluted  earnings per share
with basic and diluted  earnings per share.  Unlike primary  earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants, and
convertible  securities.  Diluted  earnings  per  share is very  similar  to the
previously  reported  primary earnings per share. All earnings per share amounts
for all periods have been presented, and where necessary, restated to conform to
the SFAS No. 128 requirements.  The impact of SFAS No. 128 on the calculation of
fully  diluted  earnings  per share for each of the  periods  presented  was not
material.

         In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an  Enterprise  and  Related  Information"  ("SFAS  No.  131").  SFAS No. 131
establishes  standards  for the way  that  public  business  enterprises  report
information about operating segments in annual financial statements and requires
that those enterprises  report selected  information about operating segments in
interim financial reports issued to shareholders.  It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers.  SFAS No. 131 is effective for financial  statements for fiscal years
beginning  after December 15, 1997. The adoption of SFAS 131 will have no impact
on the Company's consolidated results of operations,  financial position or cash
flows.

         Recent  Pronouncements.  In October  1997,  the  American  Institute of
Certified  Public  Accountants  issued  Statement  of Position  97-2,  "Software
Revenue  Recognition"  ("SOP 97-2").  SOP 97-2 provides guidance on when revenue
should be recognized and in what amounts for  licensing,  selling,  leasing,  or
otherwise  marketing  computer  software.  SOP 97-2 is effective  for  financial
statements  for  fiscal  years  beginning  after  December  15,  1997.   Earlier
application for financial  statements or information that has not been issued is
encouraged.  The  Company is in the  process of  evaluating  if the  adoption of
SOP97-2  will  have an  impact,  if any,  on its  software  revenue  recognition
practices.

         Contingencies.  The  Company  is a party to certain  litigation  in the
normal course of business. Management does not anticipate that the resolution of
such matters will have a material  adverse effect on the Company's  consolidated
financial position.

         Use  of  Estimates.  The  preparation  of  the  consolidated  financial
statements in conformity with generally accepted accounting  principles 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 1996
and 1995 financial statements to conform to the 1997 presentation.
<PAGE>
NOTE B --  ACQUISITIONS

         Effective  November 29, 1996, the Company acquired 100% of the stock of
NTL Corporation  ("ComNet") for cash and a short-term  note. The transaction has
been accounted for as a purchase  transaction,  and accordingly,  the results of
its  operations  have been  included in the  consolidated  results of operations
since the transaction  date. The purchase price has been allocated to the assets
and liabilities based on fair values at acquisition. The purchase price over net
assets acquired  (goodwill) is being amortized over 5 to 10 years,  based on the
lives  of the  underlying  assets.  The  acquisition  did  not  include  certain
components of ComNet's  business.  Accordingly,  separate  operating results for
ComNet's    telecommunications    business   are   not    available.    ComNet's
telecommunication revenues for 1996 were approximately $9.0 million.

NOTE C -- NET INVESTMENT IN SALES-LEASES

         Net investment in  sales-leases  represents  the value of  sales-leases
presently  held under the Company's  Totalease  program.  The Company  currently
sells the rental  income from some of the  sales-leases.  The Company  maintains
reserves  against  potential  recourse  following  the  resales  based upon loss
experience and past due accounts. Activity during the years was as follows:

                                          Year Ended December 31
     (In thousands)                    1997          1996         1995

     Sales of rental income           $ 57,812      $ 42,985     $ 25,106
     Sold income remaining
         unbilled at end of year      $ 99,900      $ 65,970     $ 37,256
     Allowance for uncollectible
         minimum lease payments
         and recourse liability at
         end of year                   $ 3,969      $  2,706     $  1,513

         The Company  does not expect any  significant  losses from the recourse
provisions  related to the sale of rental income. The Company is compensated for
administration and servicing of rental income sold.

NOTE D -- PROPERTY, PLANT & EQUIPMENT
                                                    December 31
         (In thousands)                          1997           1996

         Computer systems and equipment        $28,570        $20,236
         Transportation equipment                1,665          1,737
         Furniture and fixtures                  4,043          3,301
         Leasehold improvements                  1,693          1,037
         Land                                    2,619            321
                                                 -----        -------
                                                38,590         26,632
         Less:  Accumulated depreciation
              and amortization                  19,031         15,443
                                                ------         ------
                                               $19,559        $11,189
                                                ======         ======
<PAGE>
NOTE E -- OTHER ASSETS
                                                            December 31
         (In thousands)                                 1997             1996

         Net investment in sales-leases              $13,402          $11,497
         Excess of purchase price over net
              assets acquired, net                     4,380            4,334
         Other assets                                    248              126
                                                      ------          -------
                                                     $18,030          $15,957
                                                     =======          =======


NOTE F-- OTHER CURRENT LIABILITIES
                                                            December 31
         (In thousands)                                1997             1996

         Compensation and employee benefits           $8,163           $6,176
         Deferred revenues                             2,947            2,889
         Other accrued expenses                        7,611            7,776
                                                       -----          -------
                                                     $18,721          $16,841
                                                     =======          =======

NOTE G -- CREDIT LINE

         The Company maintains a $7,000,000  unsecured bank credit line at prime
rate to cover international letters of credit and for other purposes. The credit
agreement matures July 31, 1998 and contains certain  restrictions and financial
covenants. At December 31, 1997, $390,000 of the credit line was committed under
letter of credit arrangements.

NOTE H -- LEASES

         Rental expense amounted to $4,342,000;  $3,538,000;  and $2,995,000; in
1997, 1996 and 1995, respectively. Noncancellable operating leases are primarily
for buildings.  Certain of the leases contain provisions for renewal options and
scheduled rent increases. At December 31, 1997, future minimum commitments under
noncancellable leases, including a five year lease for its headquarters facility
and a 15 year lease for its  distribution  and support  facility,  are:  1998 --
$3,444,000;  1999 -- $2,570,000; 2000 -- $1,788,000; 2001 -- $1,230,000; 2002 --
$733,000; thereafter -- $2,610,000.

NOTE I -- INCOME TAXES

         The Company  accounts  for income taxes under SFAS  Statement  No. 109,
"Accounting for Income Taxes"  ("Statement  No. 109").  Under Statement No. 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 the Company's  deferred tax  liabilities and
assets as of December 31, are as follows:

         (In thousands)                               1997          1996

         Deferred tax liabilities:
              Lease--sales and reserves              $15,624      $ 12,502
              Accelerated depreciation                    --           179
                                                     -------      --------
         Total deferred tax liabilities               15,624        12,681
                                                     -------      --------
<PAGE>
         Deferred tax assets:

              Inventory basis differences              2,580         1,553
              Accounts receivable reserves             1,357         1,135
              Maintenance reserve                        259           317
              Accrued vacation pay                       604           557
              Foreign loss carryforwards               1,047           794
              Other -- net                             1,858         1,223
                                                     -------      --------
         Deferred tax assets                           7,705         5,579
              Less valuation reserve                   1,047           794
                                                     -------      --------
         Net deferred tax assets                       6,658         4,785
                                                     -------      --------
         Net deferred tax liabilities                $ 8,966       $ 7,896
                                                     =======       =======

         During 1997 and 1996,  the  Company  incurred  losses of  $722,000  and
$730,000 with respect to foreign  operations.  At December 31, 1997, the Company
had foreign loss carryforwards of approximately $3,100,000,  which will begin to
expire in 1999.  The  valuation  allowance  increased  by  $253,000  in 1997 and
$248,000 in 1996 due to increases in foreign loss carryforward benefits.

         Federal and state income taxes consisted of the following:

         (In thousands)           1997            1996            1995

              Federal          $ 8,290          $ 5,414         $ 4,789
              State              1,630              850             460
                                 -----              ---             ---
                               $ 9,920          $ 6,264         $ 5,249
                                 =====            =====           =====

         The  principal  reasons for the  difference  between  total  income tax
expense and the amount  computed by applying the  statutory  federal  income tax
rate to income before taxes are as follows:
                                                  1997       1996        1995
         Federal tax at statutory rates
              applied to pre-tax income            35%        34%         34%
         State tax net of federal benefit           4          4           2
         Valuation reserve increase
              for foreign losses                    1          2           2
         Other - net                               --          1          --
                                                  ---        ---         ---
                                                   40%        41%         38%
                                                  ===        ===         ===

NOTE J -- EQUITY TRANSACTIONS

         Stock Split. Retroactive adjustments have been made, as appropriate, to
Common Stock and per share amounts to reflect the 2-for-1  stock split  effected
in the form of a stock dividend in October 1997.

         Treasury  Stock.  During  the  second  quarter  of  1997,  the  Company
initiated  a stock  repurchase  program  under  which  the  Board  of  Directors
authorized the repurchase of up to 1,470,000 shares (on a pre-Stock Split basis)
of the Common Stock. The Company expended  approximately $27.2 million for stock
repurchases  during  1997,  which was funded  primarily  through  existing  cash
balances.  The Company  reissued  shares through  November  through stock option
exercises and issuances.  The proceeds  received for the stock reissued was less
than its cost basis. Accordingly,  the difference was recorded as a reduction to
retained earnings.

         Public  Stock  Offering.  In a public  offering in December  1997,  the
Company sold  3,000,000  shares of Common Stock.  Net proceeds from the offering
were approximately $59,150,000.  In conjunction with the offering, all remaining
treasury  shares  were  reissued  first and the  remaining  shares  issued  from
previously unissued Common Stock.

         Dividend  Policy.  On  September  24,  1997,  the  Company's  Board  of
Directors  declared a cash  dividend  (the "Cash  Dividend")  of $0.01 for every
share of Common  Stock,  payable to
<PAGE>
shareholders  of record as of  December  31,  1997,  with  dividend  payments to
commence on or about January 15, 1998.  Prior to the Cash Dividend,  the Company
had declared no cash dividends on its Common Stock since incorporation.

         Stock  Option  Plans.  Under  the  Company's  1994 and  1997  Long-Term
Incentive  Plans,  selected  officers and key employees  are granted  options to
purchase  Common Stock of the Company at not less than fair market value at date
of grant. The options are exercisable at the end of their ten-year term, but may
become  exercisable in annual  installments.  In some  instances,  predetermined
performance  goals and share  market  value  increases  must be met to allow the
options to be exercised before the end of the option term.

         Under other  previous stock option plans,  directors,  officers and key
employees may purchase  Common Stock of the Company at amounts not less than the
fair market value at the date of grant.  These options  generally have a term of
five to ten years and are  exercisable  over four to five years  commencing  one
year from the date of grant, except for director stock option grants,  which are
exercisable commencing six months from the date 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. Options must be granted at not less than 100% of the fair market
value of the Company's 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 July 1990, the Company  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,  each Eligible
Director  received a one-time  automatic  grant of an option to  purchase  5,000
shares of the Company's Common Stock. In addition,  each Eligible Director shall
be 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 annual  reelection  as  Director.  All  options
granted  have a five-year  term and fully vest at the end of six months from the
grant date.

         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.  Options  must be granted at not less than 100% of the fair
market value of the  Company's  stock at the dates of grant.  Options  generally
vest over four or five years and expire ten years from the date of grant.

         Option activity for the past three years under all plans is as follows:

                                                   Number of Shares
                                           1997           1996          1995

  Outstanding at beginning of year       2,192,300      1,695,000     1,649,000
  Granted                                1,523,000        788,000       321,024
  Exercised                              (511,426)      (205,000)     (217,774)
  Expired or canceled                    (241,350)       (85,700)      (57,250)
                                         ---------       --------      --------
  Outstanding at end of year             2,962,524      2,192,300     1,695,000
                                         ---------      ---------     ---------
  Exercise price range                $2.88-$25.88   $2.88-$10.22   $1.13-$7.25
  Exercisable at end of year               587,774        578,700       334,166
  Weighted-average fair value of
    options granted                          $8.42          $2.36         $1.72

         At December 31,  1997,  the Company has  reserved  4,400,050  shares of
Common Stock for issuance in connection with the stock option plans.
<PAGE>
         For the stock option plans discussed above, the Company has adopted the
disclosure   only  provisions  of  SFAS  No.  123  "Accounting  for  Stock-Based
Compensation,"  ("SFAS No. 123").  Accordingly,  no  compensation  cost has been
recognized in the accompanying financial statements for the stock option plans.

         The  following  table  summarizes   information   about  stock  options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
                                   Options Outstanding                             Options Exercisable

                            Number                                                 Number
                        Outstanding at    Weighted-Average      Weighted       Exercisable at      Weighted
    Range of             December 31,        Remaining           Average        December 31,        Average
 Exercise Price              1997         Contractual Life    Exercise Price        1997         Exercise Price
<S>                      <C>                   <C>               <C>              <C>                <C>
    $2.88 - $4.31           718,579             6 years            $3.01           410,579            $3.01
    $4.81 - $7.06           698,950             7 years            $5.79            74,700            $6.43
   $7.25 - $10.25         1,432,995             8 years            $8.14           102,495            $8.41
  $15.13 - $25.88           112,000             9 years           $22.14                --              N/A
</TABLE>

         During 1997, the weighted  average  exercise price of options  granted,
exercised, and expired or canceled was $8.42, $4.36 and $5.62, respectively.

         Had  compensation  cost  for the  Company's  stock  option  plans  been
determined  based on the fair value at the grant  date for awards in 1997,  1996
and 1995  consistent  with the  provisions of SFAS No. 123, the  estimated  fair
value of the options  would be amortized  to expense  over the option's  vesting
period and the  Company's  net  income and net income per share  would have been
decreased to the pro forma amounts  indicated  below for the year ended December
31:

(in thousands, except per share amounts)     1997          1996         1995

Net income as reported                      $14,682       $9,042       $8,499

Pro forma net income                        $14,345       $8,950       $8,455

Pro forma earnings per diluted share         $0.55        $0.34        $0.36

         Pro forma results disclosed are based on the provisions of SFAS No. 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-Sholes  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 the Company's  employee 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
management's  opinion,  the  estimating  models  do not  necessarily  provide  a
reliable single measure of the fair value of its employee stock options.

         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.  The option  pricing  model  utilized the following  weighted  average
assumptions for 1997, 1996 and 1995,  respectively:  risk free interest rates of
5.0% in each  year;  dividend  yields  of 0.25% in 1997 and 0% in 1996 and 1995;
volatility  factors of the expected market price of the Company's stock averaged
 .30;  and a  weighted  average  expected  life of the  option  of 3.0  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 Company  director  options
which vest at the end of six months from the grant date.
<PAGE>
         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.
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, the Company sold 36,018 shares for  approximately  $256,000 ($7.12 per
share) to employees  in 1997.  At December 31,  1997,  463,982  shares  remained
authorized under the Plan.

NOTE K - EARNINGS PER SHARE

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

(in thousands, except per share amounts)
                                                  1997        1996       1995
Numerator:
  Net Income                                   $14,682      $9,042     $8,499
                                                ------       -----      -----

Denominator:
  Denominator for basic earnings per
    share - weighted average shares             24,836      25,780     23,056

  Effect of dilutive securities:
    Employee and director stock options          1,147         792        710
                                                 -----         ---        ---

  Denominator for diluted earnings per
    share - adjusted weighted average
    shares and assumed conversions              25,983      26,572     23,766
                                                ------      ------     ------

Basic earnings per share                        $ 0.59      $ 0.35     $ 0.37
                                                ======      ======     ======

Diluted earnings per share                      $ 0.57      $ 0.34     $ 0.36
                                                ======      ======     ======

         Options which 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.  The number of options to purchase
shares of Common Stock that were outstanding  during 1997 that were antidilutive
were  immaterial,  because the market price of the Company's stock was generally
higher  during  the  course of the year than the  prices at which  options  were
granted.

NOTE L -- RETIREMENT PLANS

         The  Company  has two  retirement  plans for the  benefit of all of its
employees.  Under its 401(k)  Retirement  Plan,  participants  may contribute an
amount not exceeding 15 percent of compensation received during participation in
the Plan. The Company makes voluntary annual  contributions to the Plan based on
a percentage of contributions  made by Plan  participants of up to 10 percent of
compensation.  Contributions to the Plan totaled $491,000; $394,000 and $328,000
in 1997, 1996 and 1995, respectively.

         In 1992, the Company 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 the Company's Common Stock
in July 1992. The loan was paid in full during 1997. As the principal  amount of
the loan was repaid to the Company  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; 69,424 and 64,580
in 1997, 1996 and 1995, respectively.  Contributions to the ESOP totaled $62,500
in 1997, and $125,000 each 1996 and 1995 and are based upon the historic cost of
the shares  purchased by the ESOP. After the final
<PAGE>
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
the Company does not  anticipate  making future  allocations of shares from this
plan.

NOTE M -- FINANCIAL INSTRUMENTS

         Concentration  of Credit Risk.  Financial  instruments that potentially
subject  the  Company  to  significant  concentrations  of credit  risk  consist
principally of cash investments,  trade accounts receivable,  and net investment
in  sales-leases.  The Company  maintains cash and  equivalents  not invested in
money market funds with a major bank in its  marketplace.  The Company  performs
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 the Company's 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.

NOTE N -- SUPPLEMENTAL CASH FLOW
(In thousands)                                   1997        1996        1995

Cash paid for:
   Interest                                    $     47    $     77    $    106
   Income taxes                                $  5,914    $  4,213    $  1,885
                                               --------    --------    --------
Changes in operating assets and liabilities:
   Increase in receivables                     $ (7,294)   $ (8,569)   $(16,368)
   Increase in inventories                       (4,280)     (1,309)     (5,997)
   (Increase) decrease in prepaid
      expenses and other assets                   4,407      (6,268)       (500)
   Increase in long-term other assets            (2,028)     (4,024)     (1,676)
   Increase in accounts payable
      and other current liabilities               7,562       4,466       6,400
                                               --------    --------    --------
                                               $ (1,633)   $(15,704)   $(18,141)
                                               ========    ========    ========

NOTE O -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

         A summary of the quarterly  results of  operations  for the years ended
December 31, 1997 and 1996 follows: (In thousands, except per share amounts)
<TABLE>
<CAPTION>
         1997                                       1st Qtr        2nd Qtr        3rd Qtr        4th Qtr
<S>                                                 <C>            <C>            <C>            <C>
         Net sales                                  $50,322        $54,823        $56,915        $61,508
         Gross margin                                22,170         24,401         26,298         28,336
         Net income                                   2,670          3,424          3,978          4,610
         Net income per share
              Basic                                   $0.10          $0.13          $0.17          $0.19
              Diluted                                 $0.10          $0.13          $0.16          $0.18
         Average number of common
           shares outstanding -- Basic               25,901         25,438         23,397         24,606
         Average number of common
           shares outstanding -- Diluted             26,450         26,623         24,682         26,179
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
         1996                                       1st Qtr        2nd Qtr        3rd Qtr        4th Qtr
<S>                                                 <C>            <C>            <C>            <C>
         Net sales                                  $42,213        $43,736        $47,435        $52,500
         Gross margin                                19,312         19,108         19,616         22,882
         Net income                                   2,899          2,784          2,689            670
         Net income per share
              Basic                                   $0.11          $0.11          $0.10          $0.03
              Diluted                                 $0.11          $0.10          $0.10          $0.03
         Average number of common
           shares outstanding -- Basic               25,546         25,748         25,858         25,885
         Average number of common
           shares outstanding -- Diluted             26,341         26,567         26,607         26,579
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

         This  Management's  Discussion and Analysis of Financial  Condition and
Results of Operations and other parts of this Annual Report to  Shareholders  on
Form  10-K  contain   forward-looking   statements   that   involve   risks  and
uncertainties. The words "expects," "anticipates," "believes," "intends," "will"
and similar expressions identify  forward-looking  statements which are based on
information available to the Company on the date hereof, and the Company assumes
no  obligation  to update any such  forward-looking  statements.  The  Company's
actual  results  could  differ   materially  from  those  anticipated  in  these
forward-looking  statements as a result of certain factors,  including those set
forth in "Factors That May Affect Results of Future  Operations"  and else where
in this 10-K.

General

         Inter-Tel  is a single  point of  contact,  full  service  provider  of
digital business telephone  systems,  IP telephony  products,  CTI applications,
voice  processing  software  and long  distance  calling  services.  Inter-Tel's
products and services  include the AXXESS and Inter-Tel  Axxent digital business
communication  platforms,  the AXXESSORY  Talk voice  processing  platform,  the
Inter-Tel  Vocal'Net  IP  telephony  gateway  and the  Inter-Tel.net  private IP
telephony network.  The Company also provides  maintenance,  leasing and support
services for its products.  The  Company's  Common Stock is quoted on the NASDAQ
National Market System under the symbol INTL.

         The Company has developed networks of direct sales offices, dealers and
value  added  resellers  (VARs)  which sell the  Company's  products.  In recent
periods,  the Company has focused on expanding its direct sales capabilities and
its dealer and VAR  network.  The Company has  acquired a number of resellers of
telephony  products and integrated  these  operations  with its existing  direct
sales operations in the same geographic areas and in other strategic markets.

         Sales of systems  through  the  Company's  dealers  and VARs  typically
generate  lower gross  margins  than sales  through the  Company's  direct sales
organization,  although direct sales typically require higher levels of selling,
general and administrative  expenses.  In addition,  the Company's long distance
and  network  services  typically  generate  lower gross  margins  than sales of
software and system products.  Accordingly,  the Company's margins may vary from
period to period  depending  upon  distribution  channel and product mix. In the
event that sales through dealers or sales of long distance  services increase as
a percentage of net sales, the Company's overall gross margin could decline.

         The  Company's  operating  results  depend  upon a variety of  factors,
including the volume and timing of orders received  during a period,  the mix of
products sold and the mix of distribution channels, general economic conditions,
patterns  of  capital   spending  by  customers,   the  timing  of  new  product
announcements  and  releases  by  the  Company  and  its  competitors,   pricing
pressures,  the cost and effect of acquisitions and the availability and cost of
products  and  components  from  the  Company's   suppliers.   Historically,   a
substantial  portion of the  Company's  net sales in a given  quarter  have been
recorded in the third month of the  quarter,  with a  concentration  of such net
sales in the last two weeks of the quarter. In addition,  the Company is subject
to seasonal  variations in its operating results, as net sales for the first and
third quarters are frequently less than those experienced  during the fourth and
second quarters, respectively.
<PAGE>
         The markets  served by the  Company  have been  characterized  by rapid
technological  changes and  increasing  customer  requirements.  The Company has
sought to  address  these  requirements  through  the  development  of  software
enhancements  and  improvements to existing  systems and the introduction of new
products and applications.  The Company's research and development  efforts over
the last several years have been focused  primarily on  developing  new products
such as the Inter-Tel  Vocal'Net  Server,  Inter-Tel Axxent system and Inter-Tel
VisualMail;  enhancing the CTI capabilities of the AXXESS digital communications
platform;  and expanding the capacity of the Company's AXXESS and AXXESSORY Talk
systems.  Current  efforts are related to the support of industry  standard  CTI
interfaces,  the  development  of  additional  applications  and  features,  the
enhancement  of the  Inter-Tel  Vocal'Net  Gateway  Server and Service  Provider
Package, and the development of a LAN-based  Communications Server incorporating
the Company's Call Processing and Voice  Processing  software.  New applications
under   development   also  include  Basic  Rate  ISDN,  PBX   networking,   the
Inter-Tel.net  private IP telephony service and enhanced unified messaging.  The
software-based  architecture  of the AXXESS system  facilitates  maintenance and
support, upgrades, and incorporation of additional features and functionality.

         The Company  offers to its  customers a package of lease  financing and
other services under the name Totalease.  Totalease  provides to customers lease
financing,  maintenance  and support  services,  fixed price  upgrades and other
benefits. The Company finances this program through the periodic resale of lease
rental streams to financial institutions.

         Net sales of the Company have  increased  substantially  in each of the
past three years. Such increases were 20.3%,  23.5%, and 21.5% in 1997, 1996 and
1995, respectively, over the preceding year.
<PAGE>
Results of Operations

         The following table sets forth certain  statement of operations data of
the Company expressed as a percentage of net sales for the periods indicated:

                                                 Year Ended December 31
                                                1997        1996       1995
                                                ----        ----       ----
      Net sales                                100.0%      100.0%     100.0%
      Cost of sales                             54.7        56.5       58.3
                                                ----        ----       ----
      Gross margin                              45.3        43.5       41.7
      Research and development                   3.6         3.5        3.8
      Selling, general and administrative       31.3        30.3       28.9
      Special charge                              --         2.5        0.9
                                                ----        ----       ----
      Operating income                          10.4         7.2        8.1
      Interest and other income                  0.6         1.1        1.1
      Interest expense                           0.0         0.0        0.1
      Income taxes                               4.4         3.4        3.5
                                                ----        ----       ----
      Net income                                 6.6%        4.9%       5.6%
                                                ----        ----       ----


Year Ended December 31, 1997 Versus Year Ended December 31, 1996

         Net Sales.  Net sales  increased  20.3% to $223.6  million in 1997 from
$185.9 million in 1996.  Sales from the Company's  direct sales offices and from
wholesale   distribution  accounted  for  approximately  $26.3  million  of  the
increase.  The remaining  increases  occurred in long  distance  sales and other
operations.

         Gross Profit. Gross profit increased to $101.2 million, or 45.3% of net
sales in 1997 from $80.9 million,  or 43.5% of net sales in 1996.  This increase
was primarily a result of higher sales,  as a percentage of total net sales,  of
AXXESS  digital  communication  platforms,  call  processing  software and voice
processing software.  In addition,  gross margin increased based on a percentage
increase in sales  through the Company's  direct sales  offices  compared to its
dealer network.

         Research and Development.  Research and development  expenses increased
to $8.0 million,  or 3.6% of net sales in 1997 from $6.6 million, or 3.5% of net
sales, in 1996.  These expenses in both 1997 and 1996 were directed  principally
toward the continued development of the AXXESS and Inter-Tel Axxent software and
systems,  unified messaging and voice processing  software,  Inter-Tel Vocal'Net
and certain CTI applications.  The Company expects that research and development
expenses will continue to increase in absolute dollars as the Company  continues
to develop  and  enhance  existing  and new  technologies  and  products.  These
expenses may vary, however, as a percentage of net sales.

         Selling,    general   and   administrative.    Selling,   general   and
administrative  expenses  increased to $69.9  million,  or 31.3% of net sales in
1997  from  $56.4  million,  or 30.3% of net  sales,  in  1996.  This  reflected
increased selling, incentive, training and other compensation costs attributable
to the increased  sales through the Company's  direct sales offices,  additional
personnel to support the direct  dealer  network and  expansion of long distance
operations,  development of the  Inter-Tel.net  network and expenses  associated
with international operations.  Such increase is also attributable to the hiring
of  additional  sales and  technical  training  staff,  expansion  of its credit
management group, and increases in reserves for accounts receivable. The Company
expects that  selling,  general and  administrative  expenses  will  increase in
absolute dollars, but may vary as a percentage of net sales.

         Interest  and  Other  Income.  Other  income  decreased   approximately
$591,000 in 1997  principally  as a result of lower levels of cash available for
investment.

         Net Income.  Net income  increased 62.4% to $14.7 million,  or $.57 per
diluted  share,  in 1997  compared  to net income of $9.0  million,  or $.34 per
diluted  share,  in 1996.  Excluding  the
<PAGE>
special charge in 1996 related to the write-off of its MIS software,  net income
would have been $11.8 million, or $.44 per diluted share.

Year Ended December 31, 1996 Versus Year Ended December 31, 1995

         Net Sales.  Net sales  increased  23.5% to $185.9  million in 1996 from
$150.5  million  in  1995.  Sales  from  direct  sales  offices   accounted  for
approximately $14.7 million of the increase,  with wholesale  distribution sales
increasing approximately $12.2 million. The remaining increases occurred in long
distance sales and other operations.

         Gross Profit.  Gross profit increased to $80.9 million, or 43.5% of net
sales in 1996 from $62.8 million,  or 41.7% of net sales in 1995. This reflected
the transition to the direct dealer network and the expansion of AXXESS software
and systems sales.

         Research and Development.  Research and development  expenses increased
to $6.6 million,  or 3.5% of net sales in 1996 from $5.8 million, or 3.8% of net
sales, in 1995.  These expenses in both 1996 and 1995 were directed  principally
to the continued  development  of the AXXESS and Inter-Tel  Axxent  software and
systems,  unified messaging and voice processing  software,  Inter-Tel Vocal'Net
and Inter-Tel Vocal'Net server, and certain CTI applications.

         Selling,    general   and   administrative.    Selling,   general   and
administrative  expenses  increased to $56.4  million,  or 30.3% of net sales in
1996,  from  $43.6  million,  or 28.9% of net  sales,  in 1995.  This  reflected
increased   incentive  and  other   compensation,   costs  associated  with  the
implementation of the Company's  information  systems,  additional  personnel to
support the direct dealer  network and expanded long  distance  operations,  and
expenses associated with the expansion of international operations.

         Special Charge.  During the fourth quarter of 1996, the Company decided
to replace  its MIS system  software  with an  integrated  solution  from a more
established   vendor  and  accordingly   wrote  off  the  software  license  and
implementation costs relating to the system software being replaced. The special
pre-tax  charge of $4.5 million  ($.10 per share after tax),  reflects the costs
associated  with the  Company's  decision to abandon its current MIS software in
favor of different system software.

         Interest and Other Income.  Other income  increased in 1996 principally
from the investment of the funds  received from the August 1995 public  offering
and funds generated through operating cash flow.

         Net Income.  Net income  increased  6.4% to $9.0  million,  or $.34 per
diluted share,  in 1996  including the special  charge  recognized in the fourth
quarter compared to $8.5 million, or $.36 per diluted share, in 1995.  Excluding
the special  charges in both periods,  net income would have been $11.8 million,
or $.44 per  diluted  share,  for 1996  compared  to $9.3  million,  or $.39 per
diluted  share for 1995.  In addition,  net income per diluted share in 1996 was
based on additional average shares outstanding in 1996, primarily reflecting the
public stock offering of 4.0 million shares of Common Stock in August 1995.

Inflation/Currency Fluctuation

         Inflation and currency  fluctuations have not previously had a material
impact on Inter-Tel's  operations.  International  procurement  agreements  have
traditionally been denominated in U.S. currency.  Moreover, a significant amount
of  contract  manufacturing  has been or is  expected  to be  moved to  domestic
sources.  The expansion of  international  operations in the United  Kingdom and
Europe  and  increased  sales,  if any,  in Japan and other  parts of Asia could
result in higher international sales as a percentage of total revenues; however,
international revenues are currently not significant.
<PAGE>
Liquidity and Capital Resources

         At  December  31,  1997,  the  Company  had $88.8  million  in cash and
equivalents,  which  represents a increase of  approximately  $49.9 million from
December 31, 1996. The Company maintains a $7.0 million unsecured revolving line
of credit with Bank One, Arizona, NA. This credit facility is annually renewable
and is available  through July 31, 1998. Under the credit facility,  the Company
has the  option to borrow  at a prime  rate or  adjusted  LIBOR  interest  rate.
Historically,   the  credit   facility  has  been  used   primarily  to  support
international  letters of credit to  suppliers.  In December  1997,  the Company
received  net  proceeds  of  approximately  $59.2  million  from a public  stock
offering of  3,000,000  shares.  The  proceeds may be used to develop and expand
Inter-Tel.net  and for  potential  acquisitions,  strategic  alliances,  working
capital and general corporate purposes.

         Net cash provided by operating activities totaled $28.2 million for the
year ended  December 31,  1997,  compared to $7.3 million for the same period in
1996.  The  increase  in cash  generated  in 1997 was  primarily  the  result of
profitable operations including non cash depreciation charges. In addition, cash
used in operating assets and liabilities declined  significantly in 1997 to $1.6
million,  compared to cash used of $15.7 million in 1996. During 1997, increases
in  accounts  receivable  and  inventory  were  principally  funded by  accounts
payable. The Company continues to expand its dealer network,  which has required
and is expected to continue to require  working  capital for increased  accounts
receivable and inventories.

         Net cash used in investing activities, primarily in the form of capital
expenditures,  totaled  $12.5  million  and  $7.0  million  in  1997  and  1996,
respectively. These capital expenditures were related primarily to the expansion
of facilities, equipment and management information systems used in operations.

         Net cash provided by financing activities totaled $34.1 million in 1997
compared to $611,000 for the same period in 1996.  During the second  quarter of
1997, the Company initiated a stock repurchase  program under which the Board of
Directors  authorized the  repurchase of up to 1,470,000  shares (on a pre-Stock
Split  basis) of the Common  Stock.  The Company  expended  approximately  $27.2
million for stock  repurchases  during 1997, which was funded primarily  through
existing cash balances.  The Company  reissued shares through  November  through
stock  option  exercises  and  issuances.  The  proceeds  received for the stock
reissued was less than its cost basis. Accordingly,  the difference was recorded
as a  reduction  to  retained  earnings.  The  Company  reissued  all  remaining
authorized,  but then  unissued  shares  upon the  completion  of the  Company's
offering  of  3,000,000  shares of Common  Stock in December  1997.  The Company
received  net  proceeds  of $59.2  million  from the  offering.  Such  stock was
reissued from the offering at greater than the cost basis.  The  difference  was
recorded as an increase to Common Stock.

         The Company offers to its customers lease financing and other services,
including its Totalease program,  through its Inter-Tel Leasing subsidiary.  The
Company  funds its  Totalease  program  in part  through  the sale to  financial
institutions of rental income streams under the leases. Resold Totalease rentals
totaling  $99.9  million  remain  unbilled at December 31, 1997.  The Company is
obligated to  repurchase  such income  streams in the event of defaults by lease
customers and, accordingly, maintains reserves based on loss experience and past
due  accounts.  Although  the Company to date has been able to resell the rental
streams  from  leases  under  the  Totalease   program   profitably   and  on  a
substantially current basis, the timing and profitability of lease resales could
impact  the  Company's  business  and  operating  results,  particularly  in  an
environment  of  fluctuating  interest  rates and economic  uncertainty.  If the
Company is required to repurchase  rental streams and realizes losses thereon in
amounts  exceeding  its  reserves,  its  operating  results  will  be  adversely
affected.

         The Company believes that the net proceeds from the Company's  offering
of  3,000,000  shares of Common  Stock  completed  on  December  1, 1997 and its
working  capital  and  credit  facilities,  together  with cash  generated  from
operations,  will be sufficient to develop and expand its Inter-Tel.net network,
to finance  acquisitions of additional resellers of telephony products and other
strategic  acquisitions or corporate alliances,  and to provide adequate working
capital  for at least  the next  twelve  months.  However,  to the  extent  that
additional funds are required in the future to address working capital needs and
to provide  funding for capital  expenditures,  expansion of the business or
<PAGE>
the Inter-Tel.net network or additional acquisitions,  the Company will seek, if
at  all,  additional  financing.  There  can  be no  assurance  that  additional
financing will be available when required or on acceptable terms.

Impact of Recently Issued Accounting Standards

         In February 1997, the Financial Accounting Standards Board (the "FASB")
issued SFAS No.  128,  "Earnings  Per Share"  ("SFAS No.  128"),  adopted by the
Company on December 31, 1997.  Statement  128 replaced the  previously  reported
primary and fully diluted earnings per share with basic and diluted earnings per
share.  Unlike primary earnings per share, basic earnings per share excludes any
dilutive  effects of options,  warrants,  and  convertible  securities.  Diluted
earnings per share is very similar to the previously  reported  primary earnings
per share.  All earnings per share amounts for all periods have been  presented,
and where necessary, restated to conform to the Statement 128 requirements.  The
impact of SFAS No. 128 on the  calculation  of fully diluted  earnings per share
for each of the periods presented was not material.

         In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an  Enterprise  and  Related  Information"  ("SFAS  No.  131").  SFAS No. 131
establishes  standards  for the way  that  public  business  enterprises  report
information about operating segments in annual financial statements and requires
that those enterprises  report selected  information about operating segments in
interim financial reports issued to shareholders.  It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers.  SFAS No. 131 is effective for financial  statements for fiscal years
beginning  after December 15, 1997. The adoption of SFAS 131 will have no impact
on the Company's consolidated results of operations,  financial position or cash
flows.