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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
 Commission
file number 0-10211
 INTER-TEL (DELAWARE), INCORPORATED
  Delaware
(State or other jurisdiction of incorporation or organization)
    
    86-0220994
(I.R.S. Employer Identification No.)
 1615 S. 52nd Street 
Tempe, Arizona
(Address of principal executive offices)
(Registrants telephone number, including area code)
    
    85281
(Zip Code)
(480) 449-8900
   o þ
 o þ
 þ o
 o þ
  o þ o
 o þ




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##### 



DOCUMENTS INCORPORATED BY REFERENCE
  INTER-TEL (DELAWARE), INCORPORATED
2006 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
 PagePART ISafe Harbor Statement
    
    
    3Item 1
    
    Business
    
    
    3Item 1A
    
    Risk Factors
    
    
    17Item 1B
    
    Unresolved Staff Comments
    
    
    30Item 2
    
    Properties
    
    
    31Item 3
    
    Legal Proceedings
    
    
    31Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    31PART IIItem 5
    
    Market Price of and Dividends on the Registrants Common Equity and Related Stockholder Matters
    
    
    32Item 6
    
    Selected Financial Data
    
    
    34Item 7
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    35Item 7A
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    55Item 8
    
    Financial Statements and Supplementary Data
    
    
    56Item 9
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    88Item 9A
    
    Evaluation of Disclosure Controls and Procedures
    
    
    88Item 9B
    
    Other Information
    
    
    88PART IIIItem 10
    
    Directors and Executive Officers of the Registrant
    
    
    88Item 11
    
    Executive Compensation
    
    
    90Item 12
    
    Security Ownership of Certain Beneficial Owners and Management
    
    
    90Item 13
    
    Certain Relationships and Related Transactions
    
    
    90Item 14
    
    Principal Accountant Fees and Services
    
    
    90PART IVItem 15
    
    Exhibits, Financial Statement Schedule and Reports on Form 8-K
    
    
    90Signatures
    
    
    93Exhibit 21Exhibit 23Exhibit 31.1Exhibit 31.2Exhibit 32.1
  2




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PART I
 
 SAFE HARBOR STATEMENT
   
 ITEM 1. BUSINESS
 The Company
   PRODUCTS AND SERVICES OFFERED TO INTER-TELS DISTRIBUTION NETWORKS
  3




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Ò Ò TM
 Communication Systems and Software
   Standards-based Architecture
    ®
 4




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Axxess ® Converged Communications System
 ®
  ®
  Inter-Tel Ò 5000 Network Communications Solutions
  
 5




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®
 ®
   Inter-Tel 7000 Network Communication Platform
   Lake OfficeLink and Sigma Converged Communications Systems
   TM
 6




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Endpoints
  Ò Ò
 ®
    Presence, Collaboration & Messaging Applications
  7




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Inter-Tel System Manager
  Unified Communicator ®
    Attendant Console
  Connection Assistant ®
  Inter-Tel Personal Communicator
   8




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Telephony Manager
 ®
  Inter-Tel Audio and Web Conferencing
    Web Conferencing
  Remote Support
  Contact Center Suite
  9




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Inter-Tel Enterprise ® Messaging
 ®
 Unified Messaging
 ® ® â â ä â
 Voice Processing
 
 Other Products and Services
 Managed Services
  10




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â
 Network, Local and Long Distance Services
 â â
 
   Networking Technologies Integration
   Inter-Tel Professional Services
  11




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Leasing Services
 SM SM
  Peripheral Products
 â â
 SALES AND DISTRIBUTION
   12




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Distribution Channels
    National, Government and Education Accounts
    13




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Lease Financing Services
 SM
 International Sales
 , Axxess Axxess Axxess
 Customer Service and Support
    14




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RESEARCH AND DEVELOPMENT
   MANUFACTURING
 Axxess
 COMPETITION
  15




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INTELLECTUAL PROPERTY RIGHTS
  EMPLOYEES
  ACCESS TO INFORMATION
 www.inter-tel.com nd
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ITEM 1A. RISK FACTORS
 FORWARD LOOKING STATEMENTS
 This Annual Report on Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange
Act of 1934, as amended. You can identify these statements by the fact that they do not relate
strictly to historical or current facts. They use words such as anticipate, estimate,
expect, project, intend, plan, believe and other words and terms of similar meaning. Any
or all of our forward-looking statements in this report and in any other public statements we make
may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known
or unknown risks and uncertainties. No forward-looking statement can be guaranteed, and you are
cautioned not to place undue reliance on these forward-looking statements. Actual future results
may differ materially.
 Except as may be required under the federal securities laws, we undertake no obligation to
publicly update forward-looking statements, whether as a result of new information, future events
or otherwise. You are advised, however, to consult any further disclosures we may make on related
subjects in our reports to the SEC. We provide the following cautionary discussion of risks,
uncertainties and possibly inaccurate assumptions relative to our business. These are factors that
we think could cause our actual results to differ materially from expected and historical results.
Other factors besides those listed here could also adversely affect us. This discussion is
provided as permitted by the Private Securities Litigation Reform Act of 1995.
 Set forth below is a detailed discussion of certain of these risks and other risks affecting
our business. The categorization of risks set forth below is meant to help you better understand
the risks facing our business and is not intended to limit your consideration of the possible
effects of these risks to the listed categories. Any adverse effects related to the risks
discussed below may, and most likely will, affect many aspects of our business.
 Risks Related to Our Business
 Our operating results have historically depended on a number of factors, and these factors may
cause our operating results to fluctuate in the future.
  
    
    volume and timing of orders received during the quarter;
    
    gross margin fluctuations associated with the mix of products and services sold and the mix
of new and recurring customers;
    
    the mix of distribution channels;
    
    general economic conditions, including interest rates and the condition of the markets our
business addresses;
    
    patterns of capital spending by customers and the relative size of our customers, in
particular at times when we are introducing new systems and software targeted to and designed
for larger customers;
    
    the timing of new product announcements and releases by us and our competitors and other
competitive factors;
    
    pricing pressures;
    
    the cost and effects of acquisitions;
    
    the availability and cost of products and components from our suppliers, including shipping
and manufacturing problems associated with subcontracted vendors;
    
    the impact of the E-Rate settlement, the one year debarment by the FCC of Inter-Tel
Technologies from E-Rate opportunities, and expected fines and penalties associated with our
former GSA variances and noncompliance, which could affect both our government business and
our commercial business;
    
    the impact of settlements, continuing litigation, proceedings and other contingencies,
which could affect our business;
    
    the impact of costs and uncertainties resulting from stockholder actions, including actual
or potential proxy contests or acquisition proposals;
    
    fluctuations in interests rates, and the timing and volume of sales of leases to third
party funding sources;
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
    
    the potential impact of accounting pronouncements, such as FIN 48 or FAS 123R;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances.
    Our market is subject to rapid technological change and to compete successfully, we must
continually introduce new and enhanced products and services that achieve broad market acceptance.
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Our future success largely depends on increased commercial acceptance of our Inter-Tel 5000 series
and Inter-Tel 7000 Network Communications Solutions, the Lake OfficeLink product (branded
EncoreCXâ in North America), the Lake Sigma product (branded Sprint/Embarq Connection
Central TM in North America), speech recognition, Interactive Voice Response, presence
management, collaboration, messaging products, Session Initiation Protocol (SIP) applications,
multi-protocol SIP endpoints, and related computer-telephony products, as well as continued
acceptance of our Axxessâ systems and software.
 ® ®
 We have many competitors and expect new competitors to enter our market, which could increase price
competition and spending on research and development and which may impair our ability to compete
successfully.
  
    
    PABX, converged systems and IP-PBX providers, distributors, or resellers such as Aastra,
Adtran, Alcatel, Altigen, Avaya, Cisco Systems, 3Com, Iwatsu, Interactive
Intelligence/Vonexus, Lucky
Goldstar, Mitel, NEC, Nortel, Panasonic, Samsung, ShoreTel, Siemens, Toshiba, Vertical Networks
(including acquisitions of the former Comdial and Vodavi organizations).
    
    large data routing and convergence companies such as 3Com, Adtran and Cisco Systems;
    
    voice processing applications providers such as ADC, InterVoice-Brite, Active Voice (a
subsidiary of NEC America), Avaya, and Captaris (formerly AVT);
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
    
    web collaboration product and service providers, such as Centra, Citrix, eDial (a division
of Alcatel), IBM, Microsoft, Raindance Communications, and WebEx;
    
    hosting service providers such as AT&T (formerly SBC), Layered Technologies, New Global
Telecom (NGT), and Vonage using servers to host call processing functions that have
traditionally been owned by customers;
    
    long distance services providers such as AT&T, Global Crossing, MCI, Qwest, Sprint and Verizon;
    
    large computer and software corporations such as Dell, IBM, HP, Intel and Microsoft;
    
    peer-to-peer softphone services such as Skype/eBay;
    
    regional Bell operating companies, or RBOCs, competitive local exchange companies, or
CLECs; cable television companies, IP Centrex service providers, VoIP trunk replacement
providers, and satellite and other wireless and wireline broadband service providers offering
IP centrex services such as AccessLine, AT&T (formerly SBC), cBeyond, Covad, Level-3, New
Global Telecom, Qwest, Time-Warner Telecom, and Vonage; and
    
    independent leasing companies that provide telecom equipment financing.
   
    
    offer broader product and service offerings;
    
    develop and expand their product and service offerings more quickly;
    
    offer greater price discounts or make substantial product promotions;
    
    adapt to new or emerging technologies and changing customer needs faster;
    
    take advantage of acquisitions and other opportunities more readily;
    
    negotiate more favorable licensing agreements with vendors;
    
    devote greater resources to the marketing and sale of their products; and
    
    address customers service-related issues more adequately.
  Our products are complex and may contain errors or defects that are detected only after their
release, which may cause us to incur significant unexpected expenses and lost sales.
  20




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
    
    costs associated with the remediation of any problems;
    
    costs associated with design modifications;
    
    loss of or delay in revenues;
    
    loss of customers;
    
    damage to our reputation;
    
    failure to achieve market acceptance or loss of market share;
    
    increased service and warranty costs;
    
    liabilities to our customers; and
    
    increased insurance costs.
 The complexity of our products has caused delays and could cause future delays in the development
and release of new products and services. As a result, customer demand for our products could
decline, which could harm our business. Additionally, changes in technology could render current
inventories obsolete.
  Our founder and former Chief Executive Officer controls approximately 19.3% of our Common Stock,
may be able to exert significant influence over the Company and has signaled his willingness to
engage with the Company with respect to significant matters.
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Business acquisitions, business ventures, and/or dispositions entail numerous risks and may disrupt
our business, dilute stockholder value and distract management attention.
  
    
    unanticipated costs and liabilities;
    
    difficulty of assimilating the operations, products and personnel of the acquired business or business ventures;
    
    difficulties in managing the financial and strategic position of acquired or developed products, services and technologies;
    
    difficulties in maintaining customer relationships;
    
    difficulties in servicing and maintaining acquired products, in particular where a
substantial portion of the targets sales were derived from our competitors products and
services;
    
    difficulty of assimilating the vendors and independent contractors of the acquired business or business venture;
    
    the diversion of managements attention from the core business;
    
    inability to maintain uniform standards, controls, policies and procedures;
    
    potential disagreements and impact on the ongoing acquired operations related to the
computation of earn-outs associated with post-acquisition results; and
    
    impairment of relationships or risk of loss of acquired employees and customers occurring
as a result of integration of the acquired business.
   We may not be able to adequately protect our proprietary technology and may be infringing upon
third-party intellectual property rights.
  22




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® rd
  Our reliance on a limited number of suppliers for key components and our dependence on contract
manufacturers could impair our ability to manufacture and deliver our products and services in a
timely and cost-effective manner.
   23




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We derive a substantial portion of our net sales from our dealer network and if these dealers do
not effectively promote and sell our products, our business and operating results could be harmed.
  We have been the subject of government investigations, which have resulted in convictions and civil
penalties and may cause further competitive and financial harm to our business.
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We have been involved in legal disputes, which have resulted in a jury verdict, legal settlement
and associated legal costs, which may cause further competitive and financial harm to our business.
     Managing our international sales efforts may expose us to additional business risks, which may
result in reduced sales or profitability in our international markets.
  25




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If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may
not be able to achieve our objectives.
  Our IP network products may be vulnerable to viruses, other system failure risks and security
concerns, which may result in lost customers or slow commercial acceptance of our IP network
products.
  We may be unable to achieve or manage our growth effectively, which may harm our business.
  The introduction of new products and services has lengthened our sales cycles, which may result in
significant sales and marketing expenses.
 â
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We rely heavily upon third-party packaged software systems to manage and run our business
processes, to provide certain products and services and to produce our financial statements. From
time to time we upgrade these systems to ensure continuation of support and to expand the
functionality of the systems to meet our business needs. The risks associated with the upgrade
process include disruption of our business processes, which could harm our business.
   Our stock price has been and may continue to be volatile, impairing your ability to sell your
shares at or above purchase price.
  27




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
    
    reactions of investors, competitors, customers or suppliers to the threatened 2007 proxy
contest initiated by Mr. Mihaylo, including the non-binding
proposals submitted Mr. Mihaylo;
    
    announcements of developments relating to our business;
    
    investors reactions to actions of large stockholders;
    
    fluctuations in our operating results;
    
    the impact of our dividend announcements, repurchase program or stock transactions by officers and directors;
    
    shortfalls in revenue or earnings relative to securities analysts expectations or
alternatively, results that exceed such expectations;
    
    announcements of technological innovations or new products or enhancements by us or our
competitors, including product delays;
    
    announcements of acquisitions or planned acquisitions of other companies or businesses;
    
    investors reactions to acquisition or disposition announcements or any forecasts of our future results;
    
    general economic conditions in the telecommunications industry;
    
    the market for Internet-related voice and data products and services;
    
    changes in the national or worldwide economy;
    
    changes in legislation or regulation affecting the telecommunications industry;
    
    developments relating to our intellectual property rights and the intellectual property rights of third parties;
    
    litigation or governmental investigations of our business practices;
    
    the impact on our business of the E-Rate settlement, the one year debarment of Technologies
from the E-Rate program, and expected fines and penalties associated with the GSA variances
and noncompliance which could affect both our government business and our commercial business;
    
    the impact on our business of settlements, continuing litigations, proceedings and other
contingencies, which could affect our business;
    
    changes in our relationships with our customers and suppliers, including shipping and
manufacturing problems associated with subcontracted vendors;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances.
  Changes in stock option accounting rules have adversely impacted our reported operating
results prepared in accordance with generally accepted accounting principles, and may affect our
stock price and our competitiveness in the employee marketplace.
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Risks Related to Our Industry
 Reductions in spending on enterprise communications equipment may materially and adversely affect
our business.
  The emerging market for IP network telephony is subject to market risks and uncertainties that
could cause significant delays and expenses.
 Axxess
  Government regulation of third party long distance and network service entities on which we rely
may harm our business.
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Consolidation within the telecommunications industry could increase competition and adversely
affect our business.
  Terrorist activities and resulting military and other actions could harm our business.
  We Are Exposed To Costs And Risks Associated With Compliance With Changing Laws, Regulations And
Standards In General, and Specifically With Regulation Of Corporate Governance And Disclosure
Standards.
  
 ITEM 1B. UNRESOLVED STAFF COMMENTS
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ITEM 2. PROPERTIES
  
 ITEM 3. LEGAL PROCEEDINGS
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    For:
    
    Against:
    
    Abstain:Proposal that the stockholders
urge the Inter-Tel Board of
Directors to arrange for the
prompt sale of Inter-Tel to the
highest bidder.
    
    
    11,013,912
    
    
    
    11,272,464
    
    
    
    238,159
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PART II
 
 ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
  2006
    
    High
    
    Low
    
    2005
    
    High
    
    LowFirst Quarter
    
    $
    22.83
    
    
    $
    19.03
    
    
    First Quarter
    
    $
    30.00
    
    
    $
    24.36Second Quarter
    
    
    24.18
    
    
    
    19.84
    
    
    Second Quarter
    
    
    24.66
    
    
    
    17.27Third Quarter
    
    
    22.50
    
    
    
    19.37
    
    
    Third Quarter
    
    
    25.34
    
    
    
    18.45Fourth Quarter
    
    
    22.72
    
    
    
    20.16
    
    
    Fourth Quarter
    
    
    21.01
    
    
    
    18.12
 Dividends.
 Period
    
    Q1
    
    Q2
    
    Q3
    
    Q4
    
    Totals1997
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    0.01
    
    
    $
    0.011998
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.041999
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.042000
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.042001
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.02
    
    
    $
    0.052002
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    0.102003
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.182004
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.07
    
    
    $
    0.07
    
    
    $
    0.262005
    
    $
    0.08
    
    
    $
    1.08
    (1)
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    1.322006
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    0.32
 One-Time Special Dividend
 No Sales of Unregistered Securities
  Equity Compensation Plan Information
  32




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Performance Graph (Comparison of Five-Year Cumulative Total Returns)
  COMPARISON OF CUMULATIVE TOTAL RETURNS AMONG
INTER-TEL, NASDAQ U.S. AND NASDAQ TELECOM INDICES
 
 Legend
 Description
    
    
    12/31/01
    
    
    
    12/31/02
    
    
    
    12/31/03
    
    
    
    12/31/04
    
    
    
    12/31/05
    
    
    
    12/30/06Inter-Tel (Delaware), Incorporated
    
    
    
    100.0
    
    
    
    
    109.35
    
    
    
    
    131.70
    
    
    
    
    145.85
    
    
    
    
    110.19
    
    
    
    
    126.62Nasdaq U.S.
    
    
    
    100.0
    
    
    
    
    69.13
    
    
    
    
    103.36
    
    
    
    
    112.49
    
    
    
    
    114.88
    
    
    
    
    126.21Nasdaq Telecommunications Stocks:
    
    
    
    100.0
    
    
    
    
    46.03
    
    
    
    
    76.56
    
    
    
    
    81.63
    
    
    
    
    77.58
    
    
    
    
    102.00(SIC 4800-4899 US & Foreign)
 Notes:
    
    A. The lines represent monthly index levels derived from compounded daily returns that include all dividends.B. The indexes are re-weighted daily, using the market capitalization on the previous trading day.C. If the monthly interval, based on the fiscal year-end, is not a trading day, the preceding trading day is used.D. The index level for all series was set to $100.0 on 12/31/01.
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ITEM 6. SELECTED FINANCIAL DATA
 Financial Summary
   For the years ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002Net sales
    
    $
    458,364
    
    
    $
    442,894
    
    
    $
    416,768
    
    
    $
    373,638
    
    
    $
    381,292Cost of sales
    
    
    230,837
    (1)
    
    
    216,584
    
    
    
    195,318
    
    
    
    176,763
    
    
    
    186,983Research and development
    
    
    33,679
    (1)
    
    
    33,258
    
    
    
    28,815
    
    
    
    21,978
    
    
    
    19,340Selling, general and administrative
    
    
    161,844
    (1)
    
    
    151,586
    
    
    
    139,917
    
    
    
    128,964
    
    
    
    128,284Amortization of purchased intangible assets
    
    
    4,642
    
    
    
    4,194
    
    
    
    1,867
    
    
    
    1,803
    
    
    
    1,122In-process research and development
    
    
    
    
    
    
    2,600
    (2)
    
    
    
    
    
    
    
    
    
    
    Other charges
    
    
    1,314
    (1)
    
    
    11,986
    (2)
    
    
    9,261
    (3)
    
    
    
    
    
    
    Operating income
    
    
    26,048
    
    
    
    22,686
    
    
    
    41,590
    
    
    
    44,130
    
    
    
    45,563Litigation settlement (net of costs except
for taxes)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,516
    (4)Write-down/recovery of investment in
Inter-Tel.NET/Vianet
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    124
    
    
    
    (1,200
    )Interest and other, net
    
    
    6,146
    
    
    
    3,988
    
    
    
    2,536
    
    
    
    1,528
    
    
    
    1,780Foreign currency transaction gains (losses)
    
    
    (203
    )
    
    
    215
    
    
    
    (399
    )
    
    
    18
    
    
    
    330Income before income taxes
    
    
    31,991
    (1)
    
    
    26,889
    (2)
    
    
    43,727
    (3)
    
    
    45,800
    
    
    
    61,989
    (4)Income taxes
    
    
    7,370
    (1)
    
    
    9,035
    
    
    
    16,514
    
    
    
    17,165
    
    
    
    23,454Net income
    
    $
    24,621
    (1)
    
    $
    17,854
    (2)
    
    $
    27,213
    (3)
    
    $
    28,635
    
    
    $
    38,535
    (4)Net income per shareBasic
    
    $
    0.93
    (1)
    
    $
    0.68
    (2)
    
    $
    1.06
    (3)
    
    $
    1.14
    
    
    $
    1.58
    (4)Diluted
    
    $
    0.90
    (1)
    
    $
    0.66
    (2)
    
    $
    1.00
    (3)
    
    $
    1.08
    
    
    $
    1.49
    (4)Weighted average basic common shares
    
    
    26,581
    
    
    
    26,261
    
    
    
    25,767
    
    
    
    25,078
    
    
    
    24,444Weighted average diluted common shares
    
    
    27,226
    
    
    
    27,207
    
    
    
    27,266
    
    
    
    26,473
    
    
    
    25,864BALANCE SHEET DATATotal assets
    
    $
    436,881
    
    
    $
    396,268
    
    
    $
    407,782
    
    
    $
    360,594
    
    
    $
    282,719Working capital
    
    
    201,676
    
    
    
    195,518
    
    
    
    220,397
    
    
    
    199,561
    
    
    
    130,746Long-term liabilities
    
    
    69,573
    
    
    
    91,672
    
    
    
    85,229
    
    
    
    76,600
    
    
    
    35,019Stockholders equity
    
    
    252,656
    
    
    
    220,331
    
    
    
    238,829
    
    
    
    206,544
    
    
    
    173,025OTHER INFORMATIONCurrent ratio (current assets divided by
current liabilities)
    
    
    2.76
    
    
    
    3.32
    
    
    
    3.63
    
    
    
    3.61
    
    
    
    2.78Dividends declared per share (5)
    
    $
    0.32
    
    
    $
    1.32
    
    
    $
    0.26
    
    
    $
    0.18
    
    
    $
    0.10Net cash provided by operating activities
    
    $
    43,287
    
    
    $
    29,487
    
    
    $
    54,550
    
    
    $
    54,060
    
    
    $
    77,151
 Notes to Financial Summary:
  (1)
    
    2006 net income included expenses related to a proxy contest, special stockholders meeting
and related expenses incurred totaling $6.1 million; expenses related to the expensing of
equity awards in accordance with Statement of Financial Accounting Standards (SFAS) No. 123R
totaling $4.6 million;
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legal fees related to a settlement reached in the first quarter of 2006
totaling $1.3 million; and a tax benefit resulting from the reversal of valuation allowances
for certain state operating losses and the release of certain tax reserves totaling $3.0
million. The net effect, after income taxes of these items was $5.4 million. Without the
above items, we would have reported net income of $30.0 million ($1.10 per diluted share) for
the year ended December 31, 2006. See Item 7 Managements Discussion and Analysis of
Financial Condition and Results of Operations and Note B of Notes to the Consolidated
Financial Statements for further discussion of these items.(2)
    
    2005 operating income included pre-tax charges and an in-process research and development
write-off totaling $14.6 million, which reduced net income by $10.5 million, or $0.39 per
diluted share after tax. The pre-tax charges reflected (a) the write-off of in-process
research and development costs of $2.6 million in connection with the Lake acquisition in the
first quarter of 2005, (b) a pre-tax legal judgment, legal settlement and related legal fees
and expenses of $10.4 million in the third quarter of 2005, and (c) a litigation settlement
and related legal fees and expenses of $1.6 million accrued in the fourth quarter of 2005.
Without these charges, we would have reported net income of $28.3 million ($1.04 per diluted
share) for the year ended December 31, 2005. Refer to Notes A and C of Notes to the
Consolidated Financial Statements for additional information regarding these costs.(3)
    
    2004 operating income included a pre-tax charge of $9.3 million, which reduced net income by
$9.0 million, or $0.33 per diluted share after tax. These pre-tax charges reflected the
penalties, fines and legal costs associated with the e-Rate settlement
announced in the fourth quarter. Without this charge, we would have reported net income of
$36.2 million ($1.33 per diluted share) for the year ended December 31, 2004.(4)
    
    2002 income before taxes included $15.5 million of proceeds, net of related expenses from a
binding arbitration settlement, which increased net income by $9.5 million, or $0.37 per share
after tax. Without this settlement, we would have reported net income of $29.0 million ($1.12
per diluted share) for the year ended December 31, 2002.(5)
    
    Includes one-time special dividend of $1.00 per share paid in April 2005 to shareholders of
record on March 31, 2005.
 
 ITEM 7. 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 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 us on the date hereof, and we assume no obligation to update any such forward-looking
statements. Our 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 Future Operating Results and elsewhere in this Form 10-K .
 Overview
  
    
    Inter-Tel 7000, Inter-Tel 5000 and Inter-Tel Axxess Network Communications Solutions
(converged voice and data business communication systems);
    
    Lake Communications converged voice and data business communication systems, including
those sold in the US under the Inter-Tel EncoreCXâ and the Sprint/Embarq Connection
Central brands,
    
    integrated voice mail, voice processing and unified messaging systems,
    
    presence management, collaboration, web conference, and audio conferencing applications,
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
    
    multi-media contact center applications,
    
    managed services, including voice and data network design, traffic provisioning, and financial solutions packages (leasing),
    
    networking applications, including the design and implementation of voice and data networks,
    
    local and long distance calling services, voice circuits, data circuits and other
communications services and peripheral products,
    
    call accounting software, computer-telephone integration (CTI) applications, and
    
    maintenance and support services for our products.
  Ò
   
    
    End-user sales and sales-type leases through our direct sales offices and national,
government and education accounts division. We recognize revenue from sales of systems and
services to end-user customers upon installation of the systems and performance of the
services, respectively, allowing for use by our customers of these systems. We defer
pre-payments for communications services and recognize these pre-payments as revenue as the
communications services are provided. For our sales-type lease accounting, 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 as discussed above for
sales to end user customers, and upon receipt of the executed lease documents. 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 also
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recorded as net sales.
Furthermore, when the initial term of the lease is concluded, customers have the option to
renew the lease at a payment and term less than the original lease.
    
    Dealer and VAR sales. For shipments to dealers, value added resellers and other
distributors, our revenue is recognized as products are shipped and services are rendered,
because at such points the sales process is complete. Title to these products passes when
goods are shipped (free-on-board shipping point). However, shipments to one international
dealer, with whom we established a relationship as a result of our Lake acquisition, are
initially held by that dealer on a consignment basis. Such inventory is owned by Inter-Tel
and reported on Inter-Tels books and records until the inventory is sold through to third
parties, at which time the revenue is recorded.
    
    Resale of long distance. We recognize revenue from long distance resale services as
services are provided.
    
    Software Sales. We generally recognize revenues from sales of software upon shipment to
dealers or upon downloading of such software from the Internet by such dealers, as
applicable, or upon installation at end-user sites, depending on the distribution channel.
    
    Maintenance and software support. Maintenance and software support revenue is recognized
ratably over the term of the maintenance or support agreement.
 Costs and gross margins
   
    
    Customer leases generally expire at the end of the month and commence at the beginning
of the month, which naturally leads to end-of-period sales. These factors apply to both
end-user and dealer sales.
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
    
    Quarterly sales of lease rental streams typically occur near the end of the third month
of the quarter. Additionally interest rate fluctuations may impact the gain or loss on
sale of such rental streams.
    
    Internal sales compensation programs for our sales personnel are linked to revenues and
the sales commissions generally increase at accelerated rates as sales volumes increase.
Sales performance bonuses are also frequently tied to quarter-end and year-end performance
targets, providing incentives to sales personnel to close business before the end of each
quarter.
    
    Historically, some price discounting to our dealer channel occurred during the last
month of a quarter or year, and some dealers have purchased consistently to take advantage
of potential product specific pricing discounts or end-of-quarter promotions. However,
such promotions are subject to change at any time, and discounts have been reduced in
recent periods in an effort to minimize this trend and to focus on more targeted
promotions.
  Cash Flows
    38




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â
 SM â SM
 Results of Operations
  Year Ended December 312006
    
    
    2005
    
    
    2004NET SALESTelecommunications systems, software and related
    
    
    86.9
    %
    
    
    87.5
    %
    
    
    88.3
    %Resale of local, long distance and network services
    
    
    13.1
    
    
    
    12.5
    
    
    
    11.7TOTAL NET SALES
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0COST OF SALESTelecommunications systems, software and related
    
    
    42.1
    
    
    
    41.3
    
    
    
    39.7Resale of local, long distance and network services
    
    
    8.2
    
    
    
    7.6
    
    
    
    7.2TOTAL COST OF SALES
    
    
    50.4
    
    
    
    48.9
    
    
    
    46.9GROSS PROFIT
    
    
    49.6
    
    
    
    51.1
    
    
    
    53.1Research and development
    
    
    7.3
    
    
    
    7.5
    
    
    
    6.9Selling, general and administrative
    
    
    35.3
    
    
    
    34.2
    
    
    
    33.6Amortization of intangible assets
    
    
    1.0
    
    
    
    1.0
    
    
    
    0.4In-process research and development
    
    
    0.0
    
    
    
    0.6
    
    
    
    Other charges
    
    
    0.3
    
    
    
    2.7
    
    
    
    2.2OPERATING INCOME
    
    
    5.7
    
    
    
    5.1
    
    
    
    10.0Interest and other, net
    
    
    1.3
    
    
    
    0.9
    
    
    
    0.6Foreign currency transaction gains (losses)
    
    
    0.0
    
    
    
    0.0
    
    
    
    (0.1
    )INCOME BEFORE INCOME TAXES
    
    
    7.0
    
    
    
    6.0
    
    
    
    10.5INCOME TAXES
    
    
    (1.6
    )
    
    
    (2.0
    )
    
    
    (4.0
    )NET INCOME
    
    
    5.4
    %
    
    
    4.0
    %
    
    
    6.5
    %
 Year Ended December 31, 2006 Versus Year Ended December 31, 2005
 Net Sales.
 39




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â
 Gross Profit
   Research and Development (R&D)
 40




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Selling, General and Administrative (SG&A)
   Amortization of Purchased Intangible Assets
 41




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In-process research and development (IPRD) costs
 Other Charges
     42




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Interest and Other, Net
 Foreign Currency Transaction Gains (Losses).
 Income Taxes
 SM
  Net Income.
  Year Ended December 31, 2005 Versus Year Ended December 31, 2004
 Net Sales.
 43




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â
 Gross Profit
   Research and Development
 44




---



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Selling, General and Administrative
  Amortization of Purchased Intangible Assets
 Write-off of in-process research and development (IPRD) costs
 Other Charges
  45




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Interest and Other, Net
 Foreign Currency Transaction Gains (Losses).
 Interest Expense
 Income Taxes
  SM
 46




---



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Net Income.
  Inflation/Currency Fluctuation
  Liquidity and Capital Resources
 (In thousands)
    
    2006
    
    2005
    
    2004Net cash provided by operating activities
    
    $
    43,287
    
    
    $
    29,487
    
    
    $
    54,550Net cash used in investing activities
    
    
    (8,229
    )
    
    
    (38,027
    )
    
    
    (20,096
    )Net cash provided by/(used in) financing activities
    
    
    853
    
    
    
    (39,056
    )
    
    
    2,780Effect of exchange rate changes
    
    
    2,214
    
    
    
    (960
    )
    
    
    (101
    )Increase/(Decrease) in cash and equivalents
    
    
    38,125
    
    
    
    (48,556
    )
    
    
    37,133Cash and equivalents at beginning of year
    
    
    103,774
    
    
    
    152,330
    
    
    
    115,197Cash and equivalents at end of year
    
    $
    141,899
    
    
    $
    103,774
    
    
    $
    152,330
   47




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SM â SM SM
   48




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49




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Contractual Obligations
   Less Than
    
    
    
    
    
    
    
    
    
    After 5(in thousands)
    
    Total
    
    1 Year
    
    1-3 Years
    
    4-5 Years
    
    YearsDecember 31, 2006Operating lease
obligations,
primarily for
building and
equipment leases
    
    $
    22,480
    
    
    $
    7,933
    
    
    $
    9,573
    
    
    $
    4,345
    
    
    $
    629
 (1)
    
    Total contractual obligations do not include contractual obligations recorded on
the balance sheet as current liabilities, or certain purchase obligations as discussed
below.
    Off-Balance Sheet Arrangements
 SM
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Critical Accounting Policies and Estimates
  Revenue Recognition
 End-user sales through our direct sales offices and government and national accounts division
 Dealer and VAR sales
 Resale of long distance
 Software Sales .
 51




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Maintenance and software support
 Sales-Leases
  Goodwill and Other Intangible Assets. Business Combinations Goodwill and Other Intangible Assets.
   52




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Allowance for Doubtful Accounts
 Share-Based Compensation
  Transition Election Relating to Accounting for the Tax Effects of Share-Based
Payment Awards
 53




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Inventories
 Contingencies
 Income Taxes.
  54




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Recent Accounting Pronouncements
     
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    55




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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 Reports of Independent Registered Public Accounting Firm
    
    
    57Consolidated Balance SheetsDecember 31, 2006 and 2005
    
    
    59Consolidated Statements of Income  Years Ended December 31, 2006,
2005 and 2004
    
    
    60Consolidated Statements of Stockholders Equity  Years Ended
December 31, 2006, 2005 and 2004
    
    
    61Consolidated Statements of Cash Flows  Years Ended December 31,
2006, 2005 and 2004
    
    
    62Notes to Consolidated Financial Statements
    
    
    63Schedule II  Valuation and Qualifying Accounts
    
    
    87
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Report of Independent Registered Public Accounting Firm
 
    Share-Based payme
   
 57




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Report of Independent Registered Public Accounting Firm
         
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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
  (In thousands, except share amounts)2006
    
    2005ASSETSCURRENT ASSETSCash and equivalents
    
    $
    141,899
    
    
    $
    103,774Short-term investments
    
    
    64,388
    
    
    
    63,689TOTAL CASH AND SHORT-TERM INVESTMENTS
    
    
    206,287
    
    
    
    167,463Accounts receivable, net of allowances of $6,323
in 2006 and $6,235 in 2005
    
    
    49,027
    
    
    
    44,072Inventories
    
    
    25,287
    
    
    
    19,644Net investment in sales-leases, net of allowances
of $1,112 in 2006 and $998 in 2005
    
    
    19,617
    
    
    
    19,699Income taxes receivable
    
    
    3,035
    
    
    
    2,062Deferred income taxes
    
    
    599
    
    
    
    12,590Prepaid expenses and other assets
    
    
    12,476
    
    
    
    14,253TOTAL CURRENT ASSETS
    
    
    316,328
    
    
    
    279,783PROPERTY, PLANT & EQUIPMENT
    
    
    25,858
    
    
    
    28,236GOODWILL
    
    
    42,865
    
    
    
    29,840PURCHASED INTANGIBLE ASSETS
    
    
    19,570
    
    
    
    23,651NET INVESTMENT IN SALES-LEASES, net of allowances
of $1,763 in 2006 and $1,926 in 2005
    
    
    31,113
    
    
    
    34,758OTHER ASSETS
    
    
    1,147
    
    
    
    TOTAL ASSETS
    
    $
    436,881
    
    
    $
    396,268LIABILITIES AND STOCKHOLDERS EQUITY
CURRENT LIABILITIESAccounts payable
    
    $
    34,261
    
    
    $
    29,879Acquisition payable
    
    
    13,000
    
    
    
    Deferred tax
liability
    
    
    12,246
    
    
    
    Other current liabilities
    
    
    55,145
    
    
    
    54,386TOTAL CURRENT LIABILITIES
    
    
    114,652
    
    
    
    84,265DEFERRED TAX LIABILITY
    
    
    47,712
    
    
    
    70,439LEASE RECOURSE LIABILITY
    
    
    14,682
    
    
    
    14,199OTHER LIABILITIES
    
    
    7,179
    
    
    
    7,034STOCKHOLDERS EQUITYCommon stock, no par value-authorized 100,000,000
shares; issued  27,161,823 shares; outstanding 
26,895,360 shares at December 31, 2006 and
26,264,458 shares at December 31, 2005.
    
    
    27
    
    
    
    27Additional
paid-in capital
    
    
    127,044
    
    
    
    120,462Retained earnings
    
    
    127,787
    
    
    
    114,653Accumulated other comprehensive income (loss)
    
    
    2,178
    
    
    
    (36
    )257,036
    
    
    
    235,106Less: Treasury stock at cost  266,463 shares in
2006 and 897,365 shares in 2005.
    
    
    (4,380
    )
    
    
    (14,775
    )TOTAL STOCKHOLDERS EQUITY
    
    
    252,656
    
    
    
    220,331TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    436,881
    
    
    $
    396,268
  59




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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF INCOME
  (In thousands, except per share data)2006
    
    2005
    
    2004NET SALESTelecommunications systems, software and related
    
    $
    398,150
    
    
    $
    387,606
    
    
    $
    367,969Resale of local, long distance and network services
    
    
    60,214
    
    
    
    55,288
    
    
    
    48,799TOTAL NET SALES
    
    
    458,364
    
    
    
    442,894
    
    
    
    416,768COST OF SALESTelecommunications systems, software and related
    
    
    193,118
    
    
    
    182,789
    
    
    
    165,345Resale of local, long distance and network services
    
    
    37,719
    
    
    
    33,795
    
    
    
    29,973TOTAL COST OF SALES
    
    
    230,837
    
    
    
    216,584
    
    
    
    195,318GROSS PROFIT
    
    
    227,527
    
    
    
    226,310
    
    
    
    221,450Research and development
    
    
    33,679
    
    
    
    33,258
    
    
    
    28,815Selling, general and administrative
    
    
    161,844
    
    
    
    151,586
    
    
    
    139,917Amortization of purchased intangible assets
    
    
    4,642
    
    
    
    4,194
    
    
    
    1,867In-process research and development
    
    
    
    
    
    
    2,600
    
    
    
    Other charges
    
    
    1,314
    
    
    
    11,986
    
    
    
    9,261201,479
    
    
    
    203,624
    
    
    
    179,860OPERATING INCOME
    
    
    26,048
    
    
    
    22,686
    
    
    
    41,590Interest and other, net
    
    
    6,146
    
    
    
    3,988
    
    
    
    2,536Foreign currency transaction gains (losses)
    
    
    (203
    )
    
    
    215
    
    
    
    (399
    )INCOME BEFORE INCOME TAXES
    
    
    31,991
    
    
    
    26,889
    
    
    
    43,727INCOME TAXESCurrent
    
    
    6,355
    
    
    
    7,136
    
    
    
    5,675Deferred
    
    
    1,015
    
    
    
    1,899
    
    
    
    10,8397,370
    
    
    
    9,035
    
    
    
    16,514NET INCOME
    
    $
    24,621
    
    
    $
    17,854
    
    
    $
    27,213NET INCOME PER SHAREBasic
    
    $
    0.93
    
    
    $
    0.68
    
    
    $
    1.06Diluted
    
    $
    0.90
    
    
    $
    0.66
    
    
    $
    1.00Weighted average basic common shares
    
    
    26,581
    
    
    
    26,261
    
    
    
    25,767Weighted average diluted common shares
    
    
    27,226
    
    
    
    27,207
    
    
    
    27,266
  60




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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
  AccumulatedAdditional
    
    
    
    
    
    OtherOutstanding
    
    Common
    
    Paid-In
    
    Retained
    
    Comprehensive
    
    Treasury(in thousands
    
    Shares
    
    Stock
    
    Capital
    
    Earnings
    
    Income (Loss)
    
    Stock
    
    TotalBalance at December 31, 2003
    
    
    25,430
    
    
    $
    27
    
    
    $
    113,933
    
    
    $
    112,538
    
    
    $
    1,025
    
    
    $
    (20,979
    )
    
    $
    206,544Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,213
    
    
    
    
    
    
    
    
    
    
    
    27,213Loss on currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (101
    )
    
    
    
    
    
    
    (101
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,112Exercise of stock options
    
    
    646
    
    
    
    
    
    
    
    
    
    
    
    380
    
    
    
    
    
    
    
    7,830
    
    
    
    8,210Tax benefit from stock options
    
    
    
    
    
    
    
    
    
    
    2,638
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,638Stock issued under ESPP
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    448
    
    
    
    
    
    
    
    603
    
    
    
    1,051Dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,726
    )
    
    
    
    
    
    
    
    
    
    
    (6,726
    )Balance at December 31, 2004
    
    
    26,126
    
    
    
    27
    
    
    
    116,571
    
    
    
    133,853
    
    
    
    924
    
    
    
    (12,546
    )
    
    
    238,829Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17,854
    
    
    
    
    
    
    
    
    
    
    
    17,854Loss on currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (960
    )
    
    
    
    
    
    
    (960
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,894Stock repurchase
    
    
    (717
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13,777
    )
    
    
    (13,777
    )Exercise of stock options
    
    
    786
    
    
    
    
    
    
    
    
    
    
    
    (1,980
    )
    
    
    
    
    
    
    10,406
    
    
    
    8,426Tax benefit from stock options
    
    
    
    
    
    
    
    
    
    
    3,891
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,891Stock issued under ESPP
    
    
    69
    
    
    
    
    
    
    
    
    
    
    
    54
    
    
    
    
    
    
    
    1,142
    
    
    
    1,196Dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (35,128
    )
    
    
    
    
    
    
    
    
    
    
    (35,128
    )Balance at December 31, 2005
    
    
    26,264
    
    
    
    27
    
    
    
    120,462
    
    
    
    114,653
    
    
    
    (36
    )
    
    
    (14,775
    )
    
    
    220,331Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,621
    
    
    
    
    
    
    
    
    
    
    
    24,621Gain on currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,214
    
    
    
    
    
    
    
    2,214Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,835Exercise of stock options
    
    
    569
    
    
    
    
    
    
    
    
    
    
    
    (3,046
    )
    
    
    
    
    
    
    9,370
    
    
    
    6,324Tax benefit from stock options
    
    
    
    
    
    
    
    
    
    
    1,944
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,944Stock issued under ESPP
    
    
    62
    
    
    
    
    
    
    
    
    
    
    
    88
    
    
    
    
    
    
    
    1,025
    
    
    
    1,113Share-based compensation
    
    
    
    
    
    
    
    
    
    
    4,638
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,638Dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,529
    )
    
    
    
    
    
    
    
    
    
    
    (8,529
    )Balance at December 31, 2006
    
    
    26,895
    
    
    $
    27
    
    
    $
    127,044
    
    
    $
    127,787
    
    
    $
    2,178
    
    
    $
    (4,380
    )
    
    $
    252,656
  61




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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  (In thousands)2006
    
    2005
    
    2004OPERATING ACTIVITIES:Net income
    
    $
    24,621
    
    
    $
    17,854
    
    
    $
    27,213Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation of fixed assets
    
    
    9,376
    
    
    
    9,260
    
    
    
    7,915Amortization of purchased intangibles
    
    
    4,642
    
    
    
    4,194
    
    
    
    1,867Amortization of patents included in research and
development expenses
    
    
    27
    
    
    
    199
    
    
    
    222In-process research and development
    
    
    
    
    
    
    2,600
    
    
    
    Provision for losses on receivables
    
    
    2,274
    
    
    
    1,151
    
    
    
    1,525Provision for losses on leases
    
    
    943
    
    
    
    3,772
    
    
    
    3,839Provision for inventory valuation
    
    
    1,630
    
    
    
    579
    
    
    
    1,377Share based compensation
    
    
    4,638
    
    
    
    
    
    
    
    Excess tax benefits from stock options exercised
    
    
    (1,944
    )
    
    
    
    
    
    
    Decrease in other liabilities
    
    
    (10
    )
    
    
    (1,110
    )
    
    
    (2,380
    )(Gain) loss on sale of property and equipment
    
    
    (27
    )
    
    
    83
    
    
    
    10Deferred income tax expense
    
    
    1,015
    
    
    
    1,899
    
    
    
    10,839Changes in operating assets and liabilities
    
    
    (3,898
    )
    
    
    (10,994
    )
    
    
    2,123NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    43,287
    
    
    
    29,487
    
    
    
    54,550INVESTING ACTIVITIES:Purchases of available for sale short-term investments
    
    
    (78,124
    )
    
    
    (60,832
    )
    
    
    (78,411
    )Maturities and sales of available for sale short-term
investments
    
    
    67,525
    
    
    
    57,687
    
    
    
    87,100Purchases of held-to-maturity investments
    
    
    
    
    
    
    
    
    
    
    (11,900
    )Maturities of held-to-maturity investments
    
    
    9,900
    
    
    
    2,000
    
    
    
    Additions to property and equipment and equipment
held under lease
    
    
    (8,390
    )
    
    
    (8,706
    )
    
    
    (10,705
    )Proceeds from sale of property and equipment
and equipment held under lease
    
    
    869
    
    
    
    32
    
    
    
    25Cash used in acquisitions and other investments
    
    
    (9
    )
    
    
    (28,208
    )
    
    
    (6,205
    )NET CASH USED IN INVESTING ACTIVITIES
    
    
    (8,229
    )
    
    
    (38,027
    )
    
    
    (20,096
    )FINANCING ACTIVITIES:Cash dividends paid
    
    
    (8,479
    )
    
    
    (34,854
    )
    
    
    (6,422
    )Payments on term debt
    
    
    (49
    )
    
    
    (47
    )
    
    
    (59
    )Treasury stock purchases
    
    
    
    
    
    
    (13,777
    )
    
    
    Proceeds from stock issued under the
Employee Stock Purchase Plan
    
    
    1,113
    
    
    
    1,196
    
    
    
    1,051Proceeds from exercise of stock options, including
stockholder loan repayments
    
    
    6,324
    
    
    
    8,426
    
    
    
    8,210Excess tax benefits from stock options exercised
    
    
    1,944
    
    
    
    
    
    
    
    NET CASH PROVIDED BY/(USED IN) FINANCING ACTIVITIES
    
    
    853
    
    
    
    (39,056
    )
    
    
    2,780Effect of exchange rate changes
    
    
    2,214
    
    
    
    (960
    )
    
    
    (101
    )INCREASE/(DECREASE) IN CASH AND EQUIVALENTS
    
    
    38,125
    
    
    
    (48,556
    )
    
    
    37,133CASH AND EQUIVALENTS AT BEGINNING OF YEAR
    
    
    103,774
    
    
    
    152,330
    
    
    
    115,197CASH AND EQUIVALENTS AT END OF YEAR
    
    $
    141,899
    
    
    $
    103,774
    
    
    $
    152,330
  62




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##### Table of Contents



NOTE A SIGNIFICANT ACCOUNTING POLICIES
 Description of Business ®
 Change in Capital.
 Principles of Consolidation.
 Cash and Equivalents, Short-Term Investments
  Allowance for Doubtful Accounts
 Inventories
 63




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##### Table of Contents



Property, Plant and Equipment
 Goodwill and Other Intangible Assets. Business Combinations Goodwill and Other Intangible Assets.
     64




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##### Table of Contents



Sales-Leases
 Income Taxes
 Advertising
 Revenue Recognition
 End-user sales through our direct sales offices and national, government and education
accounts division
 Dealer and VAR sales
 Resale of long distance
 Extended Maintenance.
 Software, software support and maintenance agreements.
 65




---



##### Table of Contents



Sales Returns.
 Warranties.
 Shipping and Handling Costs.
 Stock Based Compensation
 Foreign Currency Translation and Transactions
 Contingencies.
  66




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##### Table of Contents



67




---



##### Table of Contents



Use of Estimates
 Reclassifications
 Recent Accounting Pronouncements
     68




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##### Table of Contents



NOTE B  STOCK BASED COMPENSATION
   Transition Election
Relating to Accounting for the Tax Effects of Share-Based Payment Awards
   Year EndedDecember 31, 2006Cost of sales
    
    $
    254Research and development
    
    
    1,252Selling, General and Administrative
    
    
    3,133Share-based compensation expense before income taxes
    
    
    4,638Related income tax benefits
    
    
    816Share-based compensation expense, net of taxes
    
    $
    3,822
 69




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##### Table of Contents



Year EndedDecember 31, 2006Net share-based compensation expense, per common share:Basic
    
    $
    0.14Diluted
    
    $
    0.14
   Years Ended December 31,2006
    
    2005
    
    2004Weighted-
    
    
    
    
    
    Weighted-
    
    
    
    
    
    Weighted-Average
    
    
    
    
    
    Average
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    Exercise
    
    
    
    
    
    ExerciseShares
    
    Price
    
    Shares
    
    Price
    
    Shares
    
    PriceOutstanding at January 1
    
    
    3,855,988
    
    
    $
    16.36
    
    
    
    4,124,118
    
    
    $
    14.88
    
    
    
    4,416,131
    
    
    $
    13.66Granted
    
    
    725,350
    
    
    
    20.44
    
    
    
    707,300
    
    
    
    19.15
    
    
    
    484,000
    
    
    
    23.75Exercised (1)
    
    
    (587,017
    )
    
    
    11.44
    
    
    
    (788,338
    )
    
    
    10.78
    
    
    
    (649,543
    )
    
    
    12.79Expired or canceled
    
    
    (168,813
    )
    
    
    20.20
    
    
    
    (187,092
    )
    
    
    17.88
    
    
    
    (126,470
    )
    
    
    16.85Outstanding at December 31
    
    
    3,825,508
    
    
    
    18.14
    
    
    
    3,855,988
    
    
    
    16.36
    
    
    
    4,124,118
    
    
    
    14.88Exercisable at December 31
    
    
    2,528,710
    
    
    $
    17.26
    
    
    
    2,462,798
    
    
    $
    16.88
    
    
    
    2,002,768
    
    
    $
    13.97
 (1)
    
    The difference between shares exercised in the table above and shares exercised as
reflected in the Consolidated Statements of Stockholders Equity relates to mature shares
tendered in connection with the shares exercised. The Company permits the tendering of
mature shares to exercise stock options provided that the shares have been held for six
months or more. Mature shares tendered for the years ended December 31, 2006, 2005 and 2004
were 18,372; 2,504; and 3,144 shares, respectively.  AverageWeighted
    
    RemainingAverage
    
    Contractual
    
    AggregateShares
    
    Exercise Price
    
    Term (years)
    
    Intrinsic ValueBalance at December 31, 2006
    
    
    3,825,508
    
    
    $
    18.14
    
    
    
    6.23
    
    
    $
    15,379,000Vested and Expected to Vest at
December 31, 2006
    
    
    3,670,203
    
    
    
    18.33
    
    
    
    5.66
    
    
    
    14,057,000Exercisable at December 31, 2006
    
    
    2,528,710
    
    
    $
    17.26
    
    
    
    4.54
    
    
    $
    12,391,000
  70




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##### Table of Contents



Options Outstanding
    
    Options ExercisableWeighted-Average
    
    Weighted
    
    
    
    
    
    WeightedNumber
    
    Remaining
    
    Average
    
    Number
    
    AverageRange of
    
    Outstanding
    
    Contractual
    
    Exercise
    
    Exercisable
    
    ExerciseExercise Price
    
    at 12-31-06
    
    Life
    
    Price
    
    at 12-31-06
    
    Price$  5.25 - $10.00
    
    
    590,750
    
    
    4.1 years
    
    $
    9.30
    
    
    
    590,750
    
    
    $
    9.30$10.01 - $15.12
    
    
    695,071
    
    
    5.6 years
    
    $
    13.62
    
    
    
    430,591
    
    
    $
    13.56$15.13 - $19.13
    
    
    907,660
    
    
    6.7 years
    
    $
    18.53
    
    
    
    503,962
    
    
    $
    18.09$19.14 - $43.44
    
    
    1,632,027
    
    
    6.8 years
    
    $
    21.97
    
    
    
    1,003,407
    
    
    $
    23.13
  Year Ended December 312006
    
    2005
    
    2004Expected dividend yield
    
    
    1.36% - 1.55
    %
    
    
    1.52% - 1.72
    %
    
    
    .82% - 1.13
    %Expected stock price volatility
    
    
    0.41 - 0.53
    
    
    
    0.48 - 0.58
    
    
    
    0.46  0.51Risk-free interest rate
    
    
    4.76% - 5.04
    %
    
    
    3.77% - 4.01
    %
    
    
    2.81% - 3.81
    %Expected life of options
    
    3-5 Years
    
    3-5 years
    
    5 Years
   Year EndedDecember 31,2005
    
    
    2004Net income, as reported
    
    $
    17,854
    
    
    $
    27,213Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects (1)
    
    
    (8,663
    )
    
    
    (3,340
    )Pro-forma net income
    
    $
    9,191
    
    
    $
    23,873Net income per common share:Basic, as reported
    
    $
    0.68
    
    
    $
    1.06Basic, pro forma
    
    $
    0.35
    
    
    $
    0.93Diluted, as reported
    
    $
    0.66
    
    
    $
    1.00Diluted, pro forma
    
    $
    0.34
    
    
    $
    0.97
 
 (1)
    
    On April 26, 2005, the Compensation Committee of the Board of Directors of Inter-Tel, with
the approval of the board of directors, approved the acceleration of the vesting of certain
unvested stock options previously granted to employees under the Companys 1994 Long Term
Incentive Plan, 1997 Long Term 71




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##### Table of Contents



Employee Stock Purchase Plan
  Performance Shares
  NOTE C  ACQUISITIONS
 Lake.
 ®
 72




---



##### Table of Contents



NOTE D SHORT-TERM INVESTMENTS
    Gross
    
    GrossDecember 31, 2006
    
    
    
    
    
    Unrealized
    
    Unrealized
    
    Gross Fair(in thousands)
    
    Cost
    
    Gains
    
    Losses
    
    ValueShort-term, available-for-sale:Mutual funds
    
    $
    403
    
    
    
    
    
    
    
    
    
    
    $
    403Municipal bonds
    
    
    62,985
    
    
    
    
    
    
    
    
    
    
    
    62,985Commercial paper
    
    
    1,000
    
    
    
    
    
    
    
    
    
    
    
    1,000Totals
    
    $
    64,388
    
    
    $
    
    
    
    $
    
    
    
    $
    64,388
 73




---



##### Table of Contents



Gross
    
    GrossDecember 31, 2005
    
    
    
    
    
    Unrealized
    
    Unrealized
    
    Gross Fair(in thousands)
    
    Cost
    
    Gains
    
    Losses
    
    ValueShort-term, available-for-sale:Equity securities
    
    $
    2,988
    
    
    $
    
    
    
    $
    
    
    
    $
    2,988Mutual funds
    
    
    370
    
    
    
    
    
    
    
    
    
    
    
    370Certificate of deposit
    
    
    1,034
    
    
    
    
    
    
    
    
    
    
    
    1,034Municipal bonds
    
    
    49,397
    
    
    
    
    
    
    
    
    
    
    
    49,397Total available-for-sale
    
    $
    53,789
    
    
    $
    
    
    
    $
    
    
    
    $
    53,789Short-term, held-to-maturity:Federal agency issues (mature in 2006)
    
    $
    9,900
    
    
    $
    
    
    
    $
    72
    
    
    $
    9,828Total held-to-maturity
    
    $
    9,900
    
    
    $
    
    
    
    $
    72
    
    
    $
    9,828
 NOTE E NET INVESTMENT IN SALES-LEASES
 SM
 December 312006
    
    
    2005
    
    
    2004Lease balances included in
consolidated accounts receivable,
net of allocated allowances of
$1,586 in 2006; $980 in 2005; and
$1,177 in 2004.
    
    $
    11,024
    
    
    $
    8,860
    
    
    $
    6,390Net investment in Sales-Leases:Current portion, net of
allowances of $1,112 in 2006;
$998 in 2005; and $886 in 2004
    
    
    19,617
    
    
    
    19,699
    
    
    
    17,151Long-term portion, includes
residual amounts of $803 in
2006; $625 in 2005; and $510
in 2004; net of allowances of
$1,763 in 2006; $1,926 in
2005; $1,810 in 2004
    
    
    31,113
    
    
    
    34,758
    
    
    
    33,877Total investment in Sales-Leases,
net of allowances of $4,461 in
2006; $3,904 in 2005; and $3,873
in 2004
    
    
    61,754
    
    
    
    63,317
    
    
    
    57,418Sold rental payments remaining
unbilled (subject to limited
recourse provisions), net of lease
recourse liability reserves of
$14,682 in 2006; $14,199 in 2005;
and $12,241 in 2004
    
    
    259,003
    
    
    
    256,143
    
    
    
    229,163Total balance of sales-leases and
sold rental payments remaining
unbilled, net of allowances and
reserves
    
    $
    320,757
    
    
    $
    319,460
    
    
    $
    286,581Total allowances and reserves for
entire lease portfolio (including
lease recourse liabilities)
    
    $
    19,143
    
    
    $
    18,103
    
    
    $
    16,114
  74




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##### Table of Contents



Years Ended December 31(In thousands)
    
    2006
    
    
    2005
    
    
    2004Sales of rental payments
    
    $
    101,644
    
    
    $
    119,060
    
    
    $
    113,172Sold payments remaining unbilled at end of year
    
    $
    273,685
    
    
    $
    270,342
    
    
    $
    241,404
     NOTE F PROPERTY, PLANT & EQUIPMENT
 December 31(In thousands)
    
    2006
    
    
    2005Computer systems, data processing and other office equipment
    
    $
    67,935
    
    
    $
    63,572Transportation equipment
    
    
    2,159
    
    
    
    4,026Furniture and fixtures
    
    
    5,456
    
    
    
    5,212Leasehold improvements
    
    
    4,481
    
    
    
    4,341Building
    
    
    7,274
    
    
    
    7,318Land
    
    
    2,499
    
    
    
    2,49989,804
    
    
    
    86,968Less: Accumulated depreciation and amortization
    
    
    (63,946
    )
    
    
    (58,732
    )Net property, plant & equipment
    
    $
    25,858
    
    
    $
    28,236
 NOTE G  GOODWILL AND PURCHASED INTANGIBLE ASSETS
 December 31(In thousands)
    
    2006
    
    
    2005Goodwill
    
    $
    47,890
    
    
    $
    34,865Less: Accumulated amortization
    
    
    (5,025
    )
    
    
    (5,025
    )Net Goodwill
    
    $
    42,865
    
    
    $
    29,840Purchased intangible assets:Acquired developed technology
    
    $
    27,082
    
    
    $
    26,332Customer lists and non-competition agreements
    
    
    9,631
    
    
    
    9,79336,713
    
    
    
    36,125Less: Accumulated amortization
    
    
    (17,143
    )
    
    
    (12,474
    )Net Purchased intangible assets
    
    $
    19,570
    
    
    $
    23,651
 75




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##### Table of Contents



NOTE H OTHER CURRENT LIABILITIES
 December 31(In thousands)
    
    2006
    
    
    2005Compensation and employee benefits
    
    $
    19,855
    
    
    $
    15,703Customer deposits
    
    
    4,504
    
    
    
    4,252Deferred revenues
    
    
    13,945
    
    
    
    8,344Miscellaneous taxes payable
    
    
    5,056
    
    
    
    3,295Legal settlements
    
    
    
    
    
    
    10,081Other accrued expenses
    
    
    11,785
    
    
    
    12,711$
    55,145
    
    
    $
    54,386
 NOTE I CREDIT LINE
  NOTE J LEASES
  (In thousands)
    
    2006
    
    
    2005
    
    
    2004Rental expense, gross
    
    $
    10,658
    
    
    $
    10,329
    
    
    $
    9,926Less: Sublease receipts, gross
    
    
    (397
    )
    
    
    (429
    )
    
    
    (545
    )Net rental expense
    
    $
    10,261
    
    
    $
    9,900
    
    
    $
    9,381
  NOTE K INCOME TAXES
   December 31,(in thousands)
    
    2006
    
    
    2005Deferred tax liabilities:Leasesales and capitalized costs
    
    $
    78,813
    
    
    $
    82,777Foreign Intangibles
    
    
    1,828
    
    
    
    2,325Tax over book depreciation
    
    
    1,159
    
    
    
    2,417
 76




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##### Table of Contents



December 31,(in thousands)
    
    2006
    
    
    2005Other
    
    
    3,031
    
    
    
    3,057Total deferred tax liabilities
    
    
    84,831
    
    
    
    90,576Deferred tax assets:State net operating loss carryforward
    
    
    3,117
    
    
    
    5,259State tax credit carryforward
    
    
    2,420
    
    
    
    2,420Federal tax credit carryforward
    
    
    815
    
    
    
    5,052Insurance reserves
    
    
    601
    
    
    
    672Accounts receivable reserves
    
    
    2,112
    
    
    
    2,196Accrued vacation pay
    
    
    2,261
    
    
    
    2,188Inventory reserve
    
    
    1,425
    
    
    
    982Accrued legal
    
    
    361
    
    
    
    1,425Foreign loss carryforwards
    
    
    2,025
    
    
    
    2,553In-process R&D write-off
    
    
    3,768
    
    
    
    4,354Restructuring/Special Charge
    
    
    
    
    
    
    1,156Lease receivable reserves
    
    
    10,157
    
    
    
    9,655Nonqualified Stock Options
    
    
    777
    
    
    
    Other  net
    
    
    2,690
    
    
    
    3,994Deferred tax assets
    
    
    32,529
    
    
    
    41,906Less valuation reserve
    
    
    6,562
    
    
    
    9,179Net deferred tax assets
    
    
    25,967
    
    
    
    32,727Net deferred tax liabilities (total deferred tax
liabilities less net deferred tax assets)
    
    $
    58,864
    
    
    $
    57,849
 SM
   77




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##### Table of Contents



(In thousands)
    
    2006
    
    
    2005
    
    
    2004CurrentFederal
    
    $
    4,782
    
    
    $
    3,161
    
    
    $
    4,901State
    
    
    472
    
    
    
    1,955
    
    
    
    695Foreign
    
    
    1,101
    
    
    
    2,020
    
    
    
    (79
    )Total Current
    
    $
    6,355
    
    
    $
    7,136
    
    
    $
    5,675DeferredFederal
    
    $
    2,594
    
    
    $
    41
    
    
    $
    9,302State
    
    
    (1,610
    )
    
    
    1,446
    
    
    
    1,773Foreign
    
    
    31
    
    
    
    412
    
    
    
    (236
    )Total Deferred
    
    $
    1,015
    
    
    $
    1,899
    
    
    $
    10,839Total income taxes
    
    $
    7,370
    
    
    $
    9,035
    
    
    $
    16,514
  2006
    
    
    2005
    
    
    2004Federal tax at statutory rates
applied to pre-tax income
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %State tax net of federal benefit
    
    
    4.1
    
    
    
    9.9
    
    
    
    3.7Credit for research activities
    
    
    (4.4
    )
    
    
    (3.7
    )
    
    
    (1.6
    )Write-off of Japan
    
    
    
    
    
    
    
    
    
    
    (3.4
    )E-Rate settlement
    
    
    
    
    
    
    
    
    
    
    6.8Release of reserve
    
    
    
    
    
    
    (5.3
    )
    
    
    State NOL valuation allowance
    
    
    (8.2
    )
    
    
    
    
    
    
    Foreign
    
    
    (1.8
    )
    
    
    2.0
    
    
    
    Share-based compensation
    
    
    2.8
    
    
    
    
    
    
    
    Tax exempt interest
    
    
    (5.4
    )
    
    
    (3.4
    )
    
    
    (1.5
    )Other  net
    
    
    0.9
    
    
    
    (0.9
    )
    
    
    (1.2
    )23.0
    %
    
    
    33.6
    %
    
    
    37.8
    %
    78




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##### Table of Contents



NOTE L EQUITY TRANSACTIONS
 Treasury Stock
  Treasury shares
    
    2006
    
    
    2005
    
    
    2004Balance on January 1
    
    
    897,365
    
    
    
    1,036,024
    
    
    
    1,732,181Stock repurchases, including ESOP
    
    
    
    
    
    
    716,500
    
    
    
    Shares reissued
    
    
    (630,902
    )
    
    
    (855,159
    )
    
    
    (696,157
    )Balance on December 31
    
    
    266,463
    
    
    
    897,365
    
    
    
    1,036,024
 Dividend Policy
 79




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##### Table of Contents



Period
    
    Q1
    
    Q2
    
    Q3
    
    Q4
    
    Totals1998
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.041999
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.042000
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.042001
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.02
    
    
    $
    0.052002
    
    $
    0.02
    
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    0.102003
    
    $
    0.03
    
    
    $
    0.03
    
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.182004
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.07
    
    
    $
    0.07
    
    
    $
    0.262005
    
    $
    0.08
    
    
    $
    1.08
    
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    1.322006
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    0.32
 Stock Option Plans.
     80




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##### Table of Contents



Year
    
    Shares2002
    
    
    604,1612003
    
    
    622,7252004
    
    
    635,7412005
    
    
    653,1452006
    
    
    656,611
      81




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##### Table of Contents



1997 Employee Stock Purchase Plan
 NOTE M  EARNINGS PER SHARE
   Years Ended December 31,(In thousands, except per share amounts)
    
    2006
    
    
    2005
    
    
    2004Numerator:Net income
    
    $
    24,621
    
    
    $
    17,854
    
    
    $
    27,213Denominator:Denominator for basic earnings per
share  weighted average shares
    
    
    26,581
    
    
    
    26,261
    
    
    
    25,767Effect of dilutive securities:Employee and director stock options (1)
    
    
    645
    
    
    
    946
    
    
    
    1,499Denominator for diluted earnings per
share  adjusted weighted average
shares and assumed conversions
    
    
    27,226
    
    
    
    27,207
    
    
    
    27,266Basic income per share
    
    $
    0.93
    
    
    $
    0.68
    
    
    $
    1.06Diluted income per share
    
    $
    0.90
    
    
    $
    0.66
    
    
    $
    1.00Options excluded from diluted net
earnings per share calculations (2)
    
    
    1,122
    
    
    
    669
    
    
    
    201
 (1)
    
    The adoption of FAS123R, effective January 1, 2006 also changed the method of computation
of dilutive shares for 2006. If the same method used to determine dilutive shares in 2005
and 2004 82




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##### Table of Contents



was used in 2006, the dilutive shares would have been 724 year ended December 31,
2006. This did not change the diluted earnings per share for the year ended December 31,
2006.(2)
    
    At December 31, 2006, 2005, and 2004, options to purchase shares 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 periods, and therefore the effect would have been antidilutive. NOTE N  RETIREMENT PLANS
  NOTE O  SEGMENT INFORMATION
  ®
  ProxyExpenses
    
    
    
    
    
    Resale ofand Legal
    
    
    
    
    
    Local, LongCosts
    
    Subtotal
    
    Distance andPrincipal
    
    Related to
    
    Principal
    
    Network(In thousands, except per share amounts)
    
    Segment
    
    Settlement
    
    Segment
    
    Services
    
    Total2006Net sales
    
    $
    398,150
    
    
    $
    
    
    
    $
    398,150
    
    
    $
    60,214
    
    
    $
    458,364Gross profit
    
    
    205,033
    
    
    
    
    
    
    
    205,033
    
    
    
    22,494
    
    
    
    227,527Operating income
    
    
    24,273
    
    
    
    (7,442
    )
    
    
    16,831
    
    
    
    9,217
    
    
    
    26,048Interest and other, net
    
    
    5,957
    
    
    
    
    
    
    
    5,957
    
    
    
    189
    
    
    
    6,146Loss on foreign currency transactions
    
    
    (203
    )
    
    
    
    
    
    
    (203
    )
    
    
    
    
    
    
    (203
    )Income taxes
    
    
    8,132
    
    
    
    (2,881
    )
    
    
    5,251
    
    
    
    2,119
    
    
    
    7,370Net income (loss)
    
    $
    21,895
    
    
    $
    (4,561
    )
    
    $
    17,334
    
    
    $
    7,287
    
    
    $
    24,621Net income (loss) per diluted share (1)
    
    $
    0.81
    
    
    $
    (0.17
    )
    
    $
    0.64
    
    
    $
    0.27
    
    
    $
    0.90Weighted average diluted shares (1)
    
    
    27,226
    
    
    
    27,226
    
    
    
    27,226
    
    
    
    27,226
    
    
    
    27,226Goodwill
    
    $
    40,730
    
    
    $
    
    
    
    $
    40,730
    
    
    $
    2,135
    
    
    $
    42,865Total assets
    
    $
    421,058
    
    
    $
    
    
    
    $
    421,058
    
    
    $
    15,823
    
    
    $
    436,881Depreciation and amortization
    
    $
    13,973
    
    
    $
    
    
    
    $
    13,973
    
    
    $
    73
    
    
    $
    14,046
 83




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##### Table of Contents



Resale ofLocal, LongLegal
    
    Subtotal
    
    Distance andPrincipal
    
    Judgment &
    
    Principal
    
    Network(In thousands, except per share amounts)
    
    Segment
    
    Settlement
    
    Segment
    
    Services
    
    Total2005Net sales
    
    $
    387,606
    
    
    $
    
    
    
    $
    387,606
    
    
    $
    55,288
    
    
    $
    442,894Gross profit
    
    
    204,817
    
    
    
    
    
    
    
    204,817
    
    
    
    21,493
    
    
    
    226,310Operating income
    
    
    24,689
    
    
    
    (11,986
    )
    
    
    12,703
    
    
    
    9,983
    
    
    
    22,686Interest and other, net
    
    
    3,821
    
    
    
    
    
    
    
    3,821
    
    
    
    167
    
    
    
    3,988Gain on foreign currency transactions
    
    
    215
    
    
    
    
    
    
    
    215
    
    
    
    0
    
    
    
    215Income taxes
    
    
    10,300
    
    
    
    (4,135
    )
    
    
    6,165
    
    
    
    2,870
    
    
    
    9,035Net income (loss)
    
    $
    18,425
    
    
    $
    (7,851
    )
    
    $
    10,574
    
    
    $
    7,280
    
    
    $
    17,854Net income (loss) per diluted share (1)
    
    $
    0.68
    
    
    $
    (0.29
    )
    
    $
    0.39
    
    
    $
    0.27
    
    
    $
    0.66Weighted average diluted shares (1)
    
    
    27,207
    
    
    
    27,207
    
    
    
    27,207
    
    
    
    27,207
    
    
    
    27,207Goodwill
    
    $
    27,705
    
    
    $
    
    
    
    $
    27,705
    
    
    $
    2,135
    
    
    $
    29,840Total assets
    
    $
    381,729
    
    
    $
    
    
    
    $
    381,729
    
    
    $
    14,539
    
    
    $
    396,268Depreciation and amortization
    
    $
    13,596
    
    
    $
    
    
    
    $
    13,596
    
    
    $
    57
    
    
    $
    13,653
 Resale ofLocal, LongSubtotal
    
    Distance andPrincipal
    
    
    
    
    
    Principal
    
    Network(In thousands, except per share amounts)
    
    Segment
    
    E-Rate
    
    Segment
    
    Services
    
    Total2004Net sales
    
    $
    367,969
    
    
    $
    
    
    
    $
    367,969
    
    
    $
    48,799
    
    
    $
    416,768Gross profit
    
    
    202,624
    
    
    
    
    
    
    
    202,624
    
    
    
    18,826
    
    
    
    221,450Operating income
    
    
    43,177
    
    
    
    (9,261
    )
    
    
    33,916
    
    
    
    7,674
    
    
    
    41,590Interest and other, net
    
    
    2,354
    
    
    
    
    
    
    
    2,354
    
    
    
    182
    
    
    
    2,536Gain on foreign currency transactions
    
    
    (399
    )
    
    
    
    
    
    
    (399
    )
    
    
    
    
    
    
    (399
    )Income taxes
    
    
    14,371
    
    
    
    (304
    )
    
    
    14,067
    
    
    
    2,447
    
    
    
    16,514Net income (loss)
    
    $
    30,761
    
    
    $
    (8,957
    )
    
    $
    21,804
    
    
    $
    5,409
    
    
    $
    27,213Net income (loss) per diluted share (1)
    
    $
    1.13
    
    
    $
    (0.33
    )
    
    $
    0.80
    
    
    $
    0.20
    
    
    $
    1.00Weighted average diluted shares (1)
    
    
    27,266
    
    
    
    27,266
    
    
    
    27,266
    
    
    
    27,266
    
    
    
    27,266Goodwill
    
    $
    18,923
    
    
    $
    
    
    
    $
    18,923
    
    
    $
    2,135
    
    
    $
    21,058Total assets
    
    $
    399,069
    
    
    $
    
    
    
    $
    399,069
    
    
    $
    8,714
    
    
    $
    407,783Depreciation and amortization
    
    $
    9,897
    
    
    $
    
    
    
    $
    9,897
    
    
    $
    107
    
    
    $
    10,004
 (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. See Note L for additional information.  Year Ended December 31,(in thousands, except percentages)
    
    2006
    
    2005
    
    2004Source of net sales
    
    $
    
    %
    
    $
    
    %
    
    $
    
    %Domestic
    
    
    412,623
    
    
    
    90.0
    
    
    
    405,607
    
    
    
    91.6
    
    
    
    403,620
    
    
    
    96.8Lake Communications
    
    
    28,532
    
    
    
    6.2
    
    
    
    22,996
    
    
    
    5.2
    
    
    
    
    
    
    
    Other International
    
    
    17,209
    
    
    
    3.8
    
    
    
    14,291
    
    
    
    3.2
    
    
    
    13,148
    
    
    
    3.2Total net sales
    
    
    458,364
    
    
    
    100.0
    
    
    
    442,894
    
    
    
    100.0
    
    
    
    416,768
    
    
    
    100.0
 84




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##### Table of Contents



NOTE P FINANCIAL INSTRUMENTS
 Concentration of Credit Risk
 Fair Value of Financial Instruments
 NOTE Q SUPPLEMENTAL CASH FLOW
 Years Ended December 31,(In thousands)
    
    2006
    
    
    2005
    
    
    2004Cash paid for:Interest
    
    $
    65
    
    
    $
    85
    
    
    $
    118Income taxes paid (received)
    
    
    4,711
    
    
    
    1,222
    
    
    $
    (1,156
    )Changes in operating assets and liabilities:Increase in receivables and current net
investment in sales-leases
    
    $
    (7,245
    )
    
    $
    (1,295
    )
    
    $
    (4,494
    )Increase in inventories
    
    
    (7,264
    )
    
    
    (2,988
    )
    
    
    (2,192
    )(Increase) decrease in prepaid expenses
and other assets
    
    
    11,598
    
    
    
    (998
    )
    
    
    5,933(Decrease) increase in long-term net
investment in sales-leases and other
assets
    
    
    2,813
    
    
    
    (1,348
    )
    
    
    (1,809
    )(Decrease) increase in accounts payable
and other current liabilities
    
    
    (3,800
    )
    
    
    (4,365
    )
    
    
    4,685$
    (3,898
    )
    
    $
    (10,994
    )
    
    $
    2,123
 85




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##### Table of Contents



NOTE R QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
   2006
    
    1st Qtr
    
    2nd Qtr
    
    3rd Qtr
    
    4th QtrNet sales
    
    $
    106,923
    
    
    $
    115,925
    
    
    $
    117,034
    
    
    $
    118,481Gross profit
    
    
    53,278
    
    
    
    56,762
    
    
    
    58,028
    
    
    
    59,458Other charges
    
    
    1,314
    
    
    
    
    
    
    
    
    
    
    
    Net income
    
    $
    3,201
    
    
    $
    4,786
    
    
    $
    7,480
    
    
    $
    9,155Net income per shareBasic
    
    $
    0.12
    
    
    $
    0.18
    
    
    $
    0.28
    
    
    $
    0.34Net income per shareDiluted
    
    $
    0.12
    
    
    $
    0.18
    
    
    $
    0.27
    
    
    $
    0.33Weighted average basic common shares
    
    
    26,308
    
    
    
    26,534
    
    
    
    26,674
    
    
    
    26,814Weighted average diluted common shares
    
    
    26,980
    
    
    
    27,227
    
    
    
    27,305
    
    
    
    27,400
 2005
    
    1st Qtr
    
    2nd Qtr
    
    3rd Qtr
    
    4th QtrNet sales
    
    $
    105,618
    
    
    $
    115,265
    
    
    $
    111,335
    
    
    $
    110,676Gross profit
    
    
    53,965
    
    
    
    60,045
    
    
    
    56,260
    
    
    
    56,040Other charges
    
    
    
    
    
    
    
    
    
    
    10,378
    
    
    
    1,608Net income
    
    $
    1,958
    
    
    $
    6,941
    
    
    $
    735
    
    
    $
    8,220Net income per shareBasic
    
    $
    0.07
    
    
    $
    0.26
    
    
    $
    0.03
    
    
    $
    0.31Net income per shareDiluted
    
    $
    0.07
    
    
    $
    0.26
    
    
    $
    0.03
    
    
    $
    0.31Weighted average basic common shares
    
    
    26,373
    
    
    
    26,301
    
    
    
    26,147
    
    
    
    26,222Weighted average diluted common shares
    
    
    27,788
    
    
    
    27,069
    
    
    
    27,056
    
    
    
    26,914
 86




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##### Table of Contents



SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS
 (In Thousands)Col. A
    
    Col. B
    
    Col. C
    
    Col. D
    
    Col. E.Balance
    
    Charged to
    
    
    
    
    
    
    
    
    
    Balanceat
    
    Costs
    
    Charged to
    
    Charged to
    
    at EndBeginning
    
    &
    
    Other
    
    Deductions
    
    ofDESCRIPTION
    
    of Period
    
    Expenses
    
    Accounts
    
    (1)
    
    PeriodYear ended December 31, 2006Deducted from asset accounts:Allowance for Doubtful Accounts
    
    $
    6,235
    
    
    $
    2,274
    
    
    $
    
    
    
    $
    2,187
    
    
    $
    6,323Allowance for Sales-Leases
    
    
    2,924
    
    
    
    250
    
    
    
    
    
    
    
    299
    
    
    
    2,875Lease Recourse Liability
    
    
    14,199
    
    
    
    692
    
    
    
    
    
    
    
    210
    
    
    
    14,682Year ended December 31, 2005Deducted from asset accounts:Allowance for Doubtful Accounts
    
    $
    9,921
    
    
    $
    1,151
    
    
    $
    (405)
    (2)
    
    $
    4,432
    
    
    $
    6,235Allowance for Sales-Leases
    
    
    2,696
    
    
    
    683
    
    
    
    
    
    
    
    455
    
    
    
    2,924Lease Recourse Liability
    
    
    12,241
    
    
    
    3,089
    
    
    
    
    
    
    
    1,131
    
    
    
    14,199Year ended December 31, 2004Deducted from asset accounts:Allowance for Doubtful Accounts
    
    $
    11,010
    
    
    $
    1,525
    
    
    $
    (349)
    (2)
    
    $
    2,265
    
    
    $
    9,921Allowance for Sales-Leases
    
    
    2,734
    
    
    
    711
    
    
    
    
    
    
    
    749
    
    
    
    2,696Lease Recourse Liability
    
    
    12,020
    
    
    
    3,128
    
    
    
    
    
    
    
    2,907
    
    
    
    12,241
 (1)
    
    Uncollectible accounts written off, net of recoveries.(2)
    
    Acquisition related adjustments. 87




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##### Table of Contents



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
  
 ITEM 9A. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
 Controls and Procedures
 Evaluation of Disclosure Controls and Procedures
 Changes in Internal Controls Over Financial Reporting
 Managements Report on Internal Control Over Financial Reporting Internal Control  Integrated Framework Internal Control  Integrated Framework
  
 ITEM 9B. OTHER INFORMATION
  
 PART III
  
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
  Norman Stout; age 49, Director and Chief Executive Officer.
 88




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##### Table of Contents



Craig W. Rauchle; age 51; President and Chief Operating Officer
 Jeffrey T. Ford; age 45; Senior Vice President and Chief Technology Officer.
 John L. Gardner; age 61; General Counsel, Senior Vice President and Assistant Secretary.
 Kurt R. Kneip; age 44; Chief Financial Officer, Senior Vice President and Secretary.
 Code of Business Conduct
 http://www.inter-tel.com
 1.
    
    From our main web page at http://www.inter-tel.com, first click on Company.2.
    
    Then click on About Inter-Tel.3.
    
    Next, click on Code of Business Conduct.
 financialinfo@inter-tel.com nd
 89




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##### Table of Contents



ITEM 11. EXECUTIVE COMPENSATION
  
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
  
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
  
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
  
 PART IV
 
 ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
 (a) The following documents are filed as part of this Report:
 1. Financial Statements
  
    
    Report of Independent Registered Public Accounting Firm
    
    Consolidated Balance Sheets  December 31, 2006 and 2005
    
    Consolidated Statements of Income  Years Ended December 31, 2006, 2005 and 2004
    
    Consolidated Statements of Stockholders Equity  Years Ended December 31, 2006,
2005 and 2004
    
    Consolidated Statements of Cash Flows  Years Ended December 31, 2006, 2005 and 2004
    
    Notes to Consolidated Financial Statements
 2. Financial Statement Schedule
   Schedule IIValuation and Qualifying Accounts
    
    Page No. 87
  90




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##### Table of Contents



3. Exhibits
  3.1(10)
    
    Certificate of
Incorporation, as amended.3.2(22)
    
    By-Laws, as amended.10.15(1)
    
    Registrants form of standard Distributor Agreement.10.16(1)
    
    Registrants form of standard Service Agreement.10.35(3)
    
    Agreement between Registrant and Samsung Semiconductor and Telecommunications Company, Ltd. dated October 17, 1984.10.37(3) *
    
    Tax Deferred Savings Plan.10.51(11) *
    
    1990 Directors Stock Option Plan and form of Stock Option Agreement.10.52(15) *
    
    Inter-Tel, Incorporated 1994 Long-Term Incentive Plan and forms of Stock Option Agreements.10.53(12)
    
    Agreement between Registrant and Maxon Systems, Inc. dated February 27, 1990.10.54(12)
    
    Agreement between Registrant and Varian Tempe Electronics Center dated February 26, 1991.10.55(12)
    
    Agreement between Registrant and Jetcrown Industrial Ltd. dated February 18, 1993.10.56(13) *
    
    Employee Stock Ownership Plan.10.57(14)
    
    Loan and Security Agreement dated March 4, 1997 between Bank One, Arizona, N.A. and Registrant and Modification Agreement dated July 25, 1997.10.58 (16)
    
    Development, Supply and License Agreement between Registrant and QUALCOMM dated January 17, 1996.10.59(17) *
    
    Inter-Tel, Incorporated 1997 Long-Term Incentive Plan.10.60(18) *
    
    Inter-Tel, Incorporated 1997 Employee Stock Purchase Plan.10.61(19) *
    
    Inter-Tel, Incorporated Acquisition Stock Option Plan and form of Stock Option Agreement.10.62(20)
    
    Computer Telephony Asset Purchase Agreement dated as of October 17, 1999 by and between
Executone Information Systems, Inc., Inter-Tel, Incorporated and Executone Inter-Tel
Business Information Systems, Inc.10.63(21) *
    
    Form of Key Employee Tier 1 Change of Control Severance Agreement.10.64(21) *
    
    Form of Key Employee Tier 2 Change of Control Severance Agreement.10.65(23)
    
    Non-Employee Director Non-Qualified Deferred Compensation Plan.10.66 (24)
    
    Employment Agreement for Chief Executive Officer
 
 (1)
    
    Incorporated by reference to Registrants Registration Statement on Form S-1 (File
No. 2-70437).(3)
    
    Incorporated by reference to Registrants Annual Report on Form 10-K for the year
ended November 30, 1984 (File No. 0-10211), Registration Statement on Form S-8 (File No.
333-106868) and Registrants Annual Report on Form 11-K for the year ended December 31,
2002 (File No. 0-10211)(10)
    
    Incorporated by reference to Registrants Report on
Form 8-K filed on July 3, 2006 (File
No. 0-10211).(11)
    
    Incorporated by reference to Registrants Registration Statement on Form S-8 (File
No. 33-40353). 91




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##### Table of Contents



(12)
    
    Incorporated by reference to Registrants Registration Statement on Form S-1 (File
No. 33-70054).(13)
    
    Incorporated by reference to Registrants Registration Statement on Form S-8 (File
No. 33-73620).(14)
    
    Incorporated by reference to Registrants Annual Report on Form 10-K for the year
ended December 31, 1998 (File No. 0-10211).(15)
    
    Incorporated by reference to Registrants Proxy Statement dated March 23, 1994 and to
Registrants Registration Statement on Form S-8 (File No. 33-83826).(16)
    
    Incorporated by reference to Registrants Annual Report on Form 10-K for the year
ended December 31, 1995 (File No. 0-10211).(17)
    
    Incorporated by reference to Registrants Registration Statements on Forms S-8 (File
Nos. 333-41197, 333-85098, 333-104642, 333-113600, and 333-123506).(18)
    
    Incorporated by reference to Registrants Registration Statements on Forms S-8 (File
Nos. 333-41197 and 333-87474).(19)
    
    Incorporated by reference to Registrants Registration Statements on Forms S-8 (File
Nos. 333-56872, 333-67261 and 333-85098).(20)
    
    Incorporated by reference to Registrants Report on Form 8-K (File No. 0-10211, filed
on January 14, 2000).(21)
    
    Incorporated by reference to Registrants Annual Report on Form 10-K for the year
ended December 31, 2003 (File No. 0-10211).(22)
    
    Incorporated by reference to Registrants Report on Form 8-K (File No. 0-10211, filed
on March 11, 2007).(23)
    
    Incorporated by reference to Registrants Annual Report on Form 10-K for the year
ended December 31, 2005 (File No. 0-10211).(24)
    
    Incorporated by reference to Registrants Report on Form 8-K (File No. 0-10211, filed
on October 16, 2006).*
    
    Management contracts or compensatory plan or arrangement required to be filed as an
exhibit to this report on Form 10-K. (b)
    
    Exhibits filed herewith.
 21
    
    Subsidiaries of Inter-Tel, Incorporated.23.0
    
    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.24
    
    Power of Attorney (See signature page of this Annual Report on Form 10-K and
incorporated herein by reference).31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer and Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350,
Chapter 63 of Title 18, United States Code).
 See Item 15(a) 3 also.(c)
    
    Financial Statement Schedule.The response to this portion of Item 15 is submitted as a
separate section of this report. See Item 8.
 92




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##### Table of Contents



SIGNATURES
  Dated: March 15, 2007
    
    INTER-TEL (DELAWARE), INCORPORATEDBY:
    
    /s/ Norman Stout

Norman StoutDirector and Chief Executive Officer
 POWER OF ATTORNEY
 KNOW ALL PERSONS BY THESE PRESENTS
  Signature
    
    Title
    
    Date/s/ Kurt R. Kneip

Kurt R. Kneip
    
    Sr. Vice President and
Chief Financial Officer
    
    March 15, 2007/s/ Alexander L. Cappello

Alexander L. Cappello
    
    Chairman of the Board of
Directors
    
    March 15, 2007/s/ J. Robert Anderson

J. Robert Anderson
    
    Director
    
    March 15, 2007/s/ Gerald W. Chapman

Gerald W. Chapman
    
    Director
    
    March 15, 2007/s/ Gary D. Edens

Gary D. Edens
    
    Director
    
    March 15, 2007/s/ Steven E. Karol

Steven E. Karol
    
    Director
    
    March 15, 2007/s/ Robert Rodin

Robert Rodin
    
    Director
    
    March 15, 2007/s/ Agnieszka Winkler

Agnieszka Winkler
    
    Director
    
    March 15, 2007
 93




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##### Table of Contents



Index to Exhibits
 21
    
    Subsidiaries of Inter-Tel (Delaware), Incorporated.23.0
    
    Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.24
    
    Power of Attorney (See signature page of this Annual Report on Form 10-K and
incorporated herein by reference).31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer and Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350,
Chapter 63 of Title 18, United States Code).