##### 



EXHIBIT 13.0 ANNUAL REPORT TO SECURITY HOLDERS FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm Shareholders and Board of Directors
Inter-Tel, Incorporated We have audited the accompanying consolidated balance sheets of Inter-Tel, Incorporated and
subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income,
stockholders equity, and cash flows for each of the three years in the period ended December 31,
2004. Our audits also included the financial statement schedule listed in the Index to consolidated
financial statement and schedule. These financial statements and the schedule are the
responsibility of the Companys management. Our responsibility is to express an opinion on the
financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Inter-Tel, Incorporated and subsidiaries at
December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for
each of the three years in the period ended December 31, 2004, in conformity with U.S. generally
accepted accounting principles. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole, presents fairly in
all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of Inter-Tel, Incorporateds internal control over
financial reporting as of December 31, 2004, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 10, 2005 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Phoenix, Arizona
March 10, 2005




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##### 



INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003 (In thousands, except share amounts)2004
    
    
    2003ASSETSCURRENT ASSETSCash and equivalents
    
    $
    152,330
    
    
    $
    115,197Short-term investments
    
    
    52,644
    
    
    
    59,334TOTAL CASH AND SHORT-TERM INVESTMENTS
    
    
    204,974
    
    
    
    174,531Accounts receivable, net of allowances of $9,921
in 2004 and $11,010 in 2003
    
    
    45,176
    
    
    
    43,434Inventories, net of allowances of $6,712 in 2004
and $6,952 in 2003
    
    
    16,055
    
    
    
    14,648Net investment in sales-leases, net of allowances
of $886 in 2004 and $749 in 2003
    
    
    17,151
    
    
    
    15,502Income taxes receivable
    
    
    4,017
    
    
    
    8,196Deferred income taxes
    
    
    9,905
    
    
    
    13,789Prepaid expenses and other assets
    
    
    7,194
    
    
    
    6,432TOTAL CURRENT ASSETS
    
    
    304,472
    
    
    
    276,532LONG-TERM INVESTMENTS
    
    
    9,900
    
    
    
    PROPERTY, PLANT & EQUIPMENT
    
    
    27,840
    
    
    
    24,657GOODWILL
    
    
    19,890
    
    
    
    17,967PURCHASED INTANGIBLE ASSETS
    
    
    10,987
    
    
    
    8,191NET INVESTMENT IN SALES-LEASES, net of allowances
of $1,810 in 2004 and $1,985 in 2003
    
    
    33,877
    
    
    
    32,529TOTAL ASSETS
    
    $
    406,966
    
    
    $
    359,876LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    30,801
    
    
    $
    28,386Other current liabilities
    
    
    52,196
    
    
    
    47,585TOTAL CURRENT LIABILITIES
    
    
    82,997
    
    
    
    75,971DEFERRED TAX LIABILITY
    
    
    65,234
    
    
    
    57,996LEASE RECOURSE LIABILITY
    
    
    12,241
    
    
    
    12,020OTHER LIABILITIES
    
    
    7,063
    
    
    
    6,584SHAREHOLDERS EQUITYCommon stock, no par value-authorized 100,000,000
shares; issued  27,161,823 shares; outstanding 
26,125,799 shares at December 31, 2004 and
25,429,642 shares at December 31, 2003.
    
    
    116,598
    
    
    
    113,960Retained earnings
    
    
    134,455
    
    
    
    113,299Accumulated other comprehensive income
    
    
    924
    
    
    
    1,025251,977
    
    
    
    228,284Less: Treasury stock at cost  1,036,024 shares
in 2004 and 1,732,181 shares in 2003.
    
    
    (12,546
    )
    
    
    (20,979
    )TOTAL SHAREHOLDERS EQUITY
    
    
    239,431
    
    
    
    207,305TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    406,966
    
    
    $
    359,876
 See accompanying notes.




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##### 



INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2004, 2003 and 2002 (In thousands, except per share data)  2004
    
    
    2003
    
    
    2002NET SALESTelecommunications systems, software and related
    
    $
    367,969
    
    
    $
    330,014
    
    
    $
    344,876Resale of local, long distance and network services
    
    
    48,924
    
    
    
    43,822
    
    
    
    36,580TOTAL NET SALES
    
    
    416,893
    
    
    
    373,836
    
    
    
    381,456Cost of salesTelecommunications systems, software and related
    
    
    165,345
    
    
    
    150,237
    
    
    
    165,006Resale of local, long distance and network services
    
    
    29,973
    
    
    
    26,526
    
    
    
    21,977TOTAL COST OF SALES
    
    
    195,318
    
    
    
    176,763
    
    
    
    186,983GROSS PROFIT
    
    
    221,575
    
    
    
    197,073
    
    
    
    194,473Research and development
    
    
    28,815
    
    
    
    21,978
    
    
    
    19,340Selling, general and administrative
    
    
    139,917
    
    
    
    128,964
    
    
    
    128,284Amortization of purchased intangible assets
    
    
    1,867
    
    
    
    1,803
    
    
    
    1,122Other charge  E-Rate settlement
    
    
    9,261
    
    
    
    
    
    
    
    179,860
    
    
    
    152,745
    
    
    
    148,746OPERATING INCOME
    
    
    41,715
    
    
    
    44,328
    
    
    
    45,727Litigation settlement (net of costs except for taxes)
    
    
    
    
    
    
    
    
    
    
    15,516(Write-down)/recovery of investment in Inter-Tel.NET
/ Vianet
    
    
    
    
    
    
    124
    
    
    
    (1,200
    )Interest and other income
    
    
    2,654
    
    
    
    1,683
    
    
    
    1,936Foreign currency transaction gains (losses)
    
    
    (399
    )
    
    
    18
    
    
    
    330Interest expense
    
    
    (118
    )
    
    
    (155
    )
    
    
    (156
    )INCOME BEFORE INCOME TAXES
    
    
    43,852
    
    
    
    45,998
    
    
    
    62,153INCOME TAXES (BENEFIT)Current
    
    
    5,676
    
    
    
    (12,784
    )
    
    
    18,495Deferred
    
    
    11,122
    
    
    
    30,264
    
    
    
    5,02116,798
    
    
    
    17,480
    
    
    
    23,516NET INCOME
    
    $
    27,054
    
    
    $
    28,518
    
    
    $
    38,637NET INCOME PER SHAREBasic
    
    $
    1.05
    
    
    $
    1.14
    
    
    $
    1.58Diluted
    
    $
    0.99
    
    
    $
    1.08
    
    
    $
    1.49DIVIDENDS PER SHARE
    
    $
    0.26
    
    
    $
    0.18
    
    
    $
    0.10Weighted average basic common shares
    
    
    25,767
    
    
    
    25,078
    
    
    
    24,444Weighted average diluted common shares
    
    
    27,266
    
    
    
    26,473
    
    
    
    25,864
 See accompanying notes.




---



##### 



INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
Years Ended December 31, 2004, 2003 and 2002 (in thousands)  AccumulatedShare-
    
    
    
    
    
    
    OtherOutstanding
    
    
    Common
    
    
    holder
    
    
    Retained
    
    
    Comprehensive
    
    
    TreasuryShares
    
    
    Stock
    
    
    Loans
    
    
    Earnings
    
    
    Income (loss)
    
    
    Stock
    
    
    TotalBalance at December 31, 2001
    
    
    24,166
    
    
    $
    108,968
    
    
    $
    (942
    )
    
    $
    54,877
    
    
    $
    151
    
    
    $
    (36,217
    )
    
    $
    126,837Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38,637
    
    
    
    
    
    
    
    
    
    
    
    38,637Gain on currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44
    
    
    
    
    
    
    
    44Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38,681Stock repurchase
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16
    )
    
    
    
    
    
    
    3
    
    
    
    (13
    )Exercise of stock options
    
    
    682
    
    
    
    
    
    
    
    
    
    
    
    (1,626
    )
    
    
    
    
    
    
    8,234
    
    
    
    6,608Tax benefit from stock options
    
    
    
    
    
    
    2,671
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,671Shareholder loan repayments
    
    
    
    
    
    
    
    
    
    
    604
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    604Stock issued under ESPP
    
    
    62
    
    
    
    
    
    
    
    
    
    
    
    228
    
    
    
    
    
    
    
    744
    
    
    
    972Dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,457
    )
    
    
    
    
    
    
    
    
    
    
    (2,457
    )Balance at December 31, 2002
    
    
    24,910
    
    
    
    111,639
    
    
    
    (338
    )
    
    
    89,643
    
    
    
    195
    
    
    
    (27,236
    )
    
    
    173,903Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    28,518
    
    
    
    
    
    
    
    
    
    
    
    28,518Gain on currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    830
    
    
    
    
    
    
    
    830Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,348Stock repurchase
    
    
    (8
    )
    
    
    
    
    
    
    
    
    
    
    (58
    )
    
    
    
    
    
    
    (149
    )
    
    
    (207
    )Exercise of stock options
    
    
    470
    
    
    
    
    
    
    
    
    
    
    
    (465
    )
    
    
    
    
    
    
    5,701
    
    
    
    5,236Tax benefit from stock options
    
    
    
    
    
    
    2,321
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,321Shareholder loan repayments
    
    
    
    
    
    
    
    
    
    
    338
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    338Stock issued under ESPP
    
    
    58
    
    
    
    
    
    
    
    
    
    
    
    210
    
    
    
    
    
    
    
    705
    
    
    
    915Dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,549
    )
    
    
    
    
    
    
    
    
    
    
    (4,549
    )Balance at December 31, 2003
    
    
    25,430
    
    
    
    113,960
    
    
    
    
    
    
    
    113,299
    
    
    
    1,025
    
    
    
    (20,979
    )
    
    
    207,305Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,054
    
    
    
    
    
    
    
    
    
    
    
    27,054Loss on currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (101
    )
    
    
    
    
    
    
    (101
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    26,953Exercise 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
    
    
    $
    116,598
    
    
    $
    
    
    
    $
    134,455
    
    
    $
    924
    
    
    $
    (12,546
    )
    
    $
    239,431
 See accompanying notes.




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##### 



INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2004, 2003 and 2002 (In thousands)2004
    
    
    2003
    
    
    2002OPERATING ACTIVITIES:Net income
    
    $
    27,054
    
    
    $
    28,518
    
    
    $
    38,637Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation of fixed assets
    
    
    7,915
    
    
    
    7,109
    
    
    
    7,310Amortization of goodwill and purchased intangibles
    
    
    1,867
    
    
    
    1,803
    
    
    
    1,122Amortization of patents included in research and
development expenses
    
    
    222
    
    
    
    222
    
    
    
    222Non-cash portion of other charges (recoveries)
    
    
    
    
    
    
    (124
    )
    
    
    1,200Provision for losses on receivables
    
    
    1,525
    
    
    
    3,164
    
    
    
    4,177Provision for losses on leases
    
    
    3,839
    
    
    
    4,528
    
    
    
    6,356Provision for inventory valuation
    
    
    1,378
    
    
    
    991
    
    
    
    1,526Decrease in other liabilities
    
    
    (2,380
    )
    
    
    (3,564
    )
    
    
    (3,937
    )Loss on sale of property and equipment:
    
    
    10
    
    
    
    118
    
    
    
    37Deferred income tax expense
    
    
    11,122
    
    
    
    30,264
    
    
    
    5,021Changes in operating assets and liabilities
    
    
    1,998
    
    
    
    (18,969
    )
    
    
    15,480NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    54,550
    
    
    
    54,060
    
    
    
    77,151INVESTING ACTIVITIES:Purchases of available for sale short-term investments
    
    
    (78,411
    )
    
    
    (170,464
    )
    
    
    (67,682
    )Maturities and sales of available for sale short-term
investments
    
    
    87,100
    
    
    
    152,046
    
    
    
    29,766Purchases of held-to-maturity investments
    
    
    (11,900
    )
    
    
    
    
    
    
    Additions to property and equipment and equipment
held under lease
    
    
    (10,705
    )
    
    
    (7,048
    )
    
    
    (7,600
    )Proceeds from sale of property and equipment
and equipment held under lease
    
    
    25
    
    
    
    76
    
    
    
    328Proceeds from investment in Inter-Tel.NET/Vianet
    
    
    
    
    
    
    1,450
    
    
    
    Cash used in acquisitions and other investments
    
    
    (6,205
    )
    
    
    (3,100
    )
    
    
    (11,377
    )NET CASH USED IN INVESTING ACTIVITIES
    
    
    (20,096
    )
    
    
    (27,040
    )
    
    
    (56,565
    )FINANCING ACTIVITIES:Cash dividends paid
    
    
    (6,422
    )
    
    
    (3,756
    )
    
    
    (2,192
    )Payments on term debt
    
    
    (59
    )
    
    
    (102
    )
    
    
    (481
    )Treasury stock purchases
    
    
    
    
    
    
    (207
    )
    
    
    (13
    )Proceeds from stock issued under the
Employee Stock Purchase Plan
    
    
    1,051
    
    
    
    915
    
    
    
    972Proceeds from exercise of stock options, including
shareholder loan repayments
    
    
    8,210
    
    
    
    5,574
    
    
    
    7,212NET CASH PROVIDED BY FINANCING ACTIVITIES
    
    
    2,780
    
    
    
    2,424
    
    
    
    5,498Effect of exchange rate changes
    
    
    (101
    )
    
    
    830
    
    
    
    44INCREASE IN CASH AND EQUIVALENTS
    
    
    37,133
    
    
    
    30,274
    
    
    
    26,128CASH AND EQUIVALENTS AT BEGINNING OF YEAR
    
    
    115,197
    
    
    
    84,923
    
    
    
    58,795CASH AND EQUIVALENTS AT END OF YEAR
    
    $
    152,330
    
    
    $
    115,197
    
    
    $
    84,923
 See accompanying notes.




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##### 



INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003 and 2002 NOTE A  SIGNIFICANT ACCOUNTING POLICIES Description
of Business. Inter-Tel, incorporated in 1969, is a single point of contact,
full-service provider of converged voice and data business communications systems; related
networking applications; and presence management, collaboration, and messaging applications. Our
diverse suite of applications includes unified communications; voice processing and unified
messaging software; audio, video and Web conferencing applications; workgroup and call center
management solutions; Internet Protocol (IP) telephony software; Computer Telephony Integration
(CTI) applications; and other communications services. Our communications platforms include
Inter-Tel 5000 Network Communications Solutions, Inter-Tel Axxess® and EncoreCX® business
communication systems. We also provide managed services such as, local and long distance calling
services; networking; maintenance; leasing; and support services for our products. Our customers
include business enterprises, government agencies and non-profit organizations. Our common stock is
quoted on the Nasdaq National Market under the symbol INTL. Principles of Consolidation. The consolidated financial statements include the accounts of
Inter-Tel, Incorporated and all significant subsidiaries. Intercompany accounts and transactions
have been eliminated in consolidation. Cash and Equivalents, Short-Term Investments and Long-term Investments. Cash and equivalents
include all highly liquid investments with a remaining maturity of three months or less at date of
acquisition. Cash and equivalents are primarily invested in mutual funds comprised of foreign and
domestic high quality dollar denominated money market instruments rated A-1 by Standard & Poors
Ratings Group, or equivalent. The Company accounts for short-term and long-term investments in accordance with Financial
Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities.
The Companys short-term investments are classified as available-for-sale, and have been recorded
at fair value, which approximates cost. The Companys long-term investments in debt securities
have been classified as held-to-maturity and are carried at cost. Allowance
for Doubtful Accounts.  We maintain allowances for doubtful accounts for estimated
losses resulting from the inability of our customers to make required payments. Additional
reserves or allowances for doubtful accounts are recorded for our sales-type leases, discussed
below in Sales-Leases. We establish and maintain reserves against estimated losses based upon
historical loss experience, past due accounts and specific account analysis. Management reviews
the level of the allowances for doubtful accounts on a regular basis and adjusts the level of the
allowances as needed. In evaluating our allowance we consider accounts in excess of 60 days old as
well as other risks in the more current portions of the accounts included. At December 31, 2004,
our allowance for doubtful accounts for accounts receivable was $9.9 million of our $55.1 million
in gross accounts receivable. Inventories.
 We value our inventories at the lower of cost (principally on a standard cost
basis, which approximates the first-in, first-out (FIFO) method) or market. Significant management
judgment is required to determine the reserve for obsolete or excess inventory and we make our
assessment primarily on a significant product-by-product basis and whether such products turned in
the immediately preceding twelve-month period, adjusted for expected changes in projected sales or
marketing demand. Inventory on hand may exceed future demand either because the product is
outdated or obsolete, or because the amount on hand is more than can be used to meet estimated
future needs. We consider criteria such as customer demand, product life-cycles, changing
technologies, slow moving inventory and market conditions. We write down our excess and obsolete
inventory equal to the difference between the cost of inventory and the estimated market value. In
estimating our reserves for obsolescence, we primarily evaluate estimates of demand over a 12-month
period and provide reserves for inventory on hand in excess of the estimated 12-month demand, as
well as evaluating reserves for specific classifications of inventory, including new, used and
staged inventory for specific customers. At December 31, 2004, our inventory reserves were $6.7
million of our $22.8 million gross inventories. Sales of scrap have not been significant for the
years ended December 31, 2004, 2003 and 2002. We do not generally offer rights of return privileges to
dealers or end users.




---



##### 



Property,
Plant and Equipment. Property, plant and equipment is stated at cost. Depreciation
is computed using the straight-line method over the estimated useful lives of the related real and
personal property, which range from 3 years to 30 years. Leasehold improvements are depreciated
over the shorter of the related lease terms or the estimated useful lives of the improvements.
Within the category computer systems and equipment, including database and enterprise software,
WAN and LAN equipment and software, personal computers, servers and related software, the range for
estimated useful lives is 3 years to 7 years. Goodwill
and Other Intangible Assets. On January 1, 2002, Inter-Tel adopted SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. Purchase prices of
acquired businesses that are accounted for as purchases have been allocated to the assets and
liabilities acquired based on the estimated fair values on the respective acquisition dates. Based
on these values, the excess purchase prices over the fair value of the net assets acquired were
allocated to goodwill. Prior to January 1, 2002, Inter-Tel amortized goodwill over the useful life of the underlying
asset, not to exceed 40 years. On January 1, 2002, Inter-Tel began accounting for goodwill under
the provisions of SFAS Nos. 141 and 142 and discontinued the amortization of goodwill after January
1, 2002. As of December 31, 2004, Inter-Tel had gross goodwill of $24.9 million and accumulated
amortization of $5.0 million. Inter-Tel completed five acquisitions in 2004 and one in 2003 and
has not recorded any amortization for these acquisitions on amounts allocated to goodwill in
accordance with SFAS No. 141. The Company performs an annual impairment test on Goodwill using the two-step process
prescribed in SFAS No. 142. The first step is a screen for potential impairment, while the second
step measures the amount of the impairment, if any. In addition, the Company will perform
impairment tests during any reporting period in which events or changes in circumstances indicate
that an impairment may have incurred. Inter-Tel performed the first step of the required impairment
tests for goodwill as of December 31, 2004 and determined that goodwill is not impaired and it is
not necessary to record any impairment losses related to goodwill. In 2004, $17.8 million of the
Companys goodwill, net of amortization, relates to the Companys principal segment and $2.1
million relates to the Network Services segment. There is only one reporting unit (i.e., one
component) as defined in paragraph 30 of SFAS 142 within each of the Companys two operating
segments as defined in paragraph 10 of SFAS 131. Therefore the reporting units are identical to
the segments. Fair value has been determined for each segment in order to determine the
recoverability of the recorded goodwill. At December 31, 2004, the Company primarily considered an
allocated portion of the market capitalization for the entire Company using average common stock
prices in determining that no impairment has occurred. This allocated market capitalization value
far exceeded the net carrying value of the goodwill included in the financial statements.
Therefore, the second step for potential impairment was unnecessary. The Company evaluates the remaining useful lives of its purchased intangible assets, all of
which are subject to amortization, each reporting period. Any changes to estimated remaining lives
prospectively effect the remaining period of amortization. In addition, the purchased intangible
assets are reviewed for possible impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. A loss would be recognized for any
excess of the carrying amount over the estimated fair value. As of December 31, 2004, Inter-Tel
had gross purchased intangible assets of $19.1 million and accumulated amortization of $8.1
million. At December 31, 2004 and December 31, 2003, goodwill, net of accumulated amortization, totaled
$19.9 million and $18.0 million, respectively. Other acquisition-related intangibles, net of
accumulated amortization, totaled $11.0 million at December 31, 2004 and $8.2 million at December
31, 2003. Accumulated amortization through December 2004 was $13.1 million, including $5.0 million
of accumulated amortization attributable to goodwill and $8.1 million of accumulated amortization
of other acquisition-related intangibles. Accumulated amortization through December 31, 2003 was
$11.0 million, including $5.0 million of accumulated amortization attributable to goodwill and $6.0
million of accumulated amortization of other acquisition-related intangibles. Other
acquisition-related intangibles, comprised primarily of developed technology (5-10 year lives),
customer lists (5 year lives) and non-competition agreements (2-5 year lives), are amortized on a
straight-line basis. The useful lives for developed technology are based on the remaining lives of
patents acquired or the estimated useful life of the
technology, whichever is shorter. The useful lives of the customer lists are based on the
expected period of value for such lists. The useful lives for non-competition agreements are based
on the contractual terms of the agreements.




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##### 



Sales-Leases.
 For our sales-type lease accounting, we follow the guidance provided by FASB
Statement No. 13, Accounting for Leases and FASB Statement No. 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities  A Replacement of FASB Statement
No. 125. We record the discounted present values of minimum rental payments under sales-type
leases as sales, net of provisions for continuing administration and other expenses over the lease
period. We record the lease sales at the time of system sale and installation pursuant to Staff
Accounting Bulletin No. 104, as discussed below for sales to end user customers, and upon receipt
of the executed lease documents. The costs of systems installed under these sales-leases are
recorded as costs of sales. The net rental streams are sold to funding sources on a regular basis
with the income streams discounted by prevailing like-term rates at the time of sale. Gains or
losses resulting from the sale of net rental payments from such leases are recorded as net sales.
We establish and maintain reserves against potential recourse following the resales based upon
historical loss experience, past due accounts and specific account analysis. The allowance for
uncollectible minimum lease payments and recourse liability at the end of the year represents
reserves against the entire lease portfolio. Management reviews the adequacy of the allowance on a
regular basis and adjusts the allowance as required. These reserves are either netted in the
accounts receivable, current and long-term components of Net investments in Sales-Leases on the

balance sheet, or included in long-term liabilities on our balance sheet for off-balance sheet
leases. Income
Taxes.  Deferred income taxes result from temporary differences in the recognition of
revenues and expenses for financial reporting and income tax purposes. Advertising.  The cost of advertising is expensed as incurred. We incurred $373,000;
$331,000; and $443,000 in advertising costs during 2004, 2003, and 2002, respectively. Revenue
Recognition.  In December 2003, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition. The Company applies the
provisions of SAB 104 to all revenue transactions. SAB 104 supercedes SAB 101, Revenue Recognition
in Financial Statements. The primary purpose of SAB 104 is to rescind accounting guidance
contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of
the issuance of EITF 00-21. Additionally, SAB 104 rescinds the SECs Revenue Recognition in
Financial Statements Frequently Asked Questions and Answers (the FAQ) issued with SAB 101 that
had been codified in SEC Topic 13, Revenue Recognition. Selected portions of the FAQ have been
incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF
00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of
SAB 104. The issuance of SAB 104 did not have a material impact on the Companys financial
position, results of operations or cash flows. Accordingly, revenue is recognized when all four of the following criteria are met: (i)
persuasive evidence that arrangement exists; (ii) delivery of the products and/or services has
occurred; (iii) the selling price is both fixed and determinable and; (iv) collectibility is
reasonably probable. Revenue derived from sales of systems and services to end-user customers is
recognized upon installation of the systems and performance of the services, respectively, allowing
for use by our customers of these systems. Pre-payments for communications services are deferred
and recognized as revenue as the communications services are provided. For shipments to dealers and other distributors, our revenues are recorded as products are
shipped and services are rendered, because the sales process is complete. These shipments are
primarily to third-party dealers and distributors and title passes when goods are shipped
(free-on-board shipping point). Long distance services revenues are recognized as service is
provided. We provide a number of incentives, promotions and awards to certain dealers and other
distributors. These incentives primarily represent discounts (which are recognized as a reduction
of sales), advertising allowances and awards (which are recognized as marketing expense) and
management assistance (which is expensed as incurred). Revenues for sales of software to dealers or end-users are generally recognized upon
shipment. Revenues related to software support and maintenance agreements are recognized ratably
over the life of the support or maintenance agreements. Sales
Returns.  We do not generally allow sales returns either by the terms of our contracts
or in practice, except for returns related to warranty provisions. Once a product has been
installed or delivered, such that revenue recognition requirements have been met, it would be very
unusual to take back a system. This would likely happen in the case of a collection problem, where
we attempt to recover assets to reduce a




---



##### 



bad debt, or in a dispute where we ultimately decide to
take back the system rather than proceed to possible litigation. However, we allow returns for our
errors (shipping the wrong product or wrong volume). Such returns have not been significant during
the last 3 years. We may accept, but are under no obligation to accept a return where a customer
ordered a part in error. In these unusual cases, we would charge a restocking fee, typically 25
percent of the original invoiced price. Warranties. We do not have a provision or accrual for warranties for either end-users or
dealers since we do not manufacture our own products. Any warranties are generally passed through
from our third-party manufacturers and vendors, and are generally for periods of up to 2 years. Extended
Maintenance. End-user customers can purchase extended maintenance agreements from us
beyond the 1-year warranty provided by the manufacturers. In these cases, we defer and amortize
the revenue related to the extended maintenance agreement over the term of the extended agreement. Shipping
and Handling Costs. EITF 00-10 Accounting for Shipping and Handling Fees and
Costs, addresses the accounting for shipping and handling fees and costs. Our policy is
primarily not to bill customers for shipping costs, unless the customer requests priority shipping.
Such amounts are not significant to our operations. Shipping and handling costs recorded in 2004,
2003 and 2002 were approximately $1.3 million, $1.4 million, and $1.1 million, respectively, and
are included in cost of sales. Stock
Based Compensation. In 2002, the Financial Accounting Standards Board (FASB) issued
Statement No. 148 Accounting for Stock-Based CompensationTransition and Disclosure, an amendment
of FASB Statement No. 123 (SFAS No. 148), which provides alternative methods of transition for
an entity that voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require
prominent disclosure about the effects on reported net income of an entitys accounting policy
decisions with respect to stock-based employee compensation. Finally, this statement amends APB
Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim
financial information. We adopted SFAS No. 148 in the fourth quarter of 2002. Since we have not
changed to a fair value method of stock-based compensation, the applicable portion of this
statement only affects our footnote disclosures. We do not recognize compensation expense relating to employee stock options because we only
grant options with an exercise price equal to the fair value of the stock on the effective date of
grant. At December 31, 2004, the Company has four stock-based employee and director incentive
plans and an employee stock purchase plan. The Company accounts for these plans under the
recognition and measurement principles of APB No. 25, Accounting for Stock Issued to Employees,
and related interpretations. Stock-based employee compensation costs are not reflected in net
income, as all options granted under the plans had an exercise price equal to the market value of
the underlying common stock on the date of grant. If we had elected to recognize compensation
expense using a fair value approach, and therefore determined the compensation based on the value
as determined by the modified Black-Scholes option pricing model, the pro forma net income and
earnings per share would have been as follows and in Note K: Years Ended December 31,(in thousands, except per share data)
    
    2004
    
    
    2003
    
    
    2002Net income, as reported
    
    $
    27,054
    
    
    $
    28,518
    
    
    $
    38,637Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all
awards, net of related tax effects
    
    
    (3,340
    )
    
    
    (3,007
    )
    
    
    (3,062
    )Pro forma net income
    
    $
    23,714
    
    
    $
    25,511
    
    
    $
    35,575Earnings per share:Basic  as reported
    
    $
    1.05
    
    
    $
    1.14
    
    
    $
    1.58Basic  pro forma
    
    $
    0.92
    
    
    $
    1.02
    
    
    $
    1.46Diluted  as reported
    
    $
    0.99
    
    
    $
    1.08
    
    
    $
    1.49Diluted  pro forma
    
    $
    0.87
    
    
    $
    0.96
    
    
    $
    1.38
 Pro forma results disclosed are based on the provisions of SFAS 123 using the Black-Scholes
option valuation model and are not likely to be representative of the effects on pro forma net
income for future years.




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##### 



In addition, the Black-Scholes option valuation model was developed for
use in estimating the fair value of traded options, which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because our stock options have
characteristics significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in our opinion, the
estimating models do not necessarily provide a reliable single measure of the fair value of our
stock options. See Note K for further discussion of the Companys stock-based employee
compensation. Foreign Currency Translation and Transactions. For our foreign operations, the local currency
is the functional currency. All assets and liabilities are translated at period-end exchange rates
and all income statement amounts are translated at an average of month-end rates. Adjustments
resulting from this translation are recorded in accumulated other comprehensive income. Foreign
currency transaction gains and losses also result from transactions denominated in a currency other
than U.S. dollars; gains and losses resulting from remeasuring monetary assets and liability
accounts that are denominated in currencies other than a subsidiarys functional currency are
included in other income under the caption Foreign currency transaction gains (losses). See Note
R for additional information regarding the Lake acquisition completed subsequent to year-end. Contingencies. We are a party to various claims and litigation in the normal course of
business. Managements current estimated range of liability related to various claims and pending
litigation is based on claims for which our management can estimate the amount and range of loss,
or can estimate a minimum amount of a loss. Because of the uncertainties related to both the
amount and range of loss on the remaining pending claims and litigation, management is unable to
make a reasonable estimate of the liability that could result from an unfavorable outcome. As
additional information becomes available, we will assess the potential liability related to our
claims and pending litigation, revise our estimates and accrue for any losses to the extent that
they are probable and the amount is estimable. Such revisions in our estimates of the potential
liability could materially impact our results of operations and financial position. However, at
December 31, 2004, management did not believe that the ultimate impact of various claims and
pending litigation would have a materially adverse impact on the Company. On January 5, 2005, the Company received court approval of a civil settlement agreement (the
Civil Settlement) and a criminal plea agreement (the Plea Agreement) with the United States of
America, each dated as of December 8, 2004 and disclosed on that same date. The court approval of
the Civil Settlement and Plea Agreement resolves the investigation of the Department of Justice
into the participation of Inter-Tel Technologies, Inc., the Companys wholly-owned subsidiary
(Technologies) in a federally administered E-Rate program to connect schools and libraries to
the Internet. In connection with the Civil Settlement, Technologies agreed to pay a penalty of
$6,740,450 and forego the collection of certain accounts receivable of $259,540 related to
Technologies participation in the E-Rate program. In connection with the Plea Agreement,
Technologies entered guilty pleas to charges of mail fraud and an antitrust violation. Under the
Plea Agreement, Technologies agreed to pay a fine of $1,721,000 and observe a three-year
probationary period, which will, among other things, require Technologies to implement a
comprehensive corporate compliance program. The resolution is currently expected to cost
Inter-Tel approximately $9.5 million in total, including criminal fines, civil settlement and
restitution, uncompensated E-Rate work, accounts receivable forgiveness, and related remaining
attorneys fees and other expenses. The payments constituting the primary components of the
settlement are not tax deductible. The effect of the resolution on fourth quarter results of
operations was a reduction to net income by approximately $9.0 million, after considering (1)
accounts receivable reserves previously accrued and (2) an income tax benefit of approximately $0.3
million related to attorneys fees and other expenses. In addition, on January 21, 2005, Inter-Tel Technologies received notification from the
Federal Communications Commission that the Technologies subsidiary was temporarily suspended from
participation in the E-Rate program pending a proposed debarment. Technologies has contested the
scope and length of the proposed debarment from the E-Rate program, but there can be no assurance
that Technologies will be successful in this regard. Revenues in 2004
relating to Inter-Tel Technologies participation in the E-Rate
program were not significant. Use of Estimates. The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ from those estimates.




---



##### 



Reclassifications. Certain reclassifications have been made to the 2003 and 2002 financial
statements to conform to the 2004 presentation. Recent Accounting Pronouncements In
December 2004, the FASB issued SFAS No. 123R  Share Based Payment. This statement is a
revision to SFAS No. 123, supersedes APB No. 25,Accounting for Stock Issued to Employees, and
amends SFAS No. 95, Statement of Cash Flows. This statement will require us to expense the cost
of employee services received in exchange for an award of equity instruments. This statement also
provides guidance on valuing and expensing these awards, as well as disclosure requirements, and is
effective for the first interim reporting period that begins after June 15, 2005. SFAS No. 123R
permits public companies to choose between the following two adoption methods:  1.
    A modified prospective method in which compensation cost is recognized beginning with
the effective date (a) based on the requirements of SFAS No. 123R for all share-based
payments granted after the effective date and (b) based on the requirements of SFAS No. 123
for all awards granted to employees prior to the effective date of SFAS No. 123R that remain
unvested on the effective date, or3.
    A modified retrospective method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based on the
amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures
either (a) all prior periods presented or (b) prior interim periods of the year of adoption. As permitted by SFAS No. 123, we currently account for share-based payments to employees using
the APB No. 25 intrinsic value method and recognize no compensation cost for employee stock options
or the employee stock purchase plan shares. As proposed, companies would be required to recognize
an expense for compensation costs related to share-based payment arrangements, including stock
options and employee stock purchase plans. The impact of the adoption of SFAS No. 123R cannot be
predicted at this time because it will depend on levels of share-based payments granted in the
future. However, valuation of employee stock options under SFAS No. 123R is similar to SFAS No.
123, with some exceptions. For information about what our reported results of operations and
earnings per share would have been had we adopted SFAS No. 123, see the discussion under the
heading Stock Based Compensation in Note A to the Consolidated Financial Statements. The adoption
of SFAS No. 123Rs fair value method will have a significant impact on our results of operations,
although it will have no impact on our overall financial position. Due to timing of the release of
SFAS No. 123R, we have not yet completed the analysis of the ultimate impact that this new
pronouncement will have on the results of operations, nor the method of adoption for this new
standard. NOTE B  ACQUISITIONS, TECHNOLOGY INVESTMENTS, DISPOSITIONS AND RESTRUCTURING CHARGES New Sales Offices in 2004. In January, July and October 2004, we acquired certain
assets and assumed certain liabilities relating to the customer bases of former dealers in
Nashville and Memphis, Tennessee; Greenville, South Carolina; Pittsburgh, Pennsylvania and Las
Vegas, Nevada. The total assets acquired and liabilities assumed from these acquisitions were
approximately $1.7 million and $0.4 million, respectively. Purchased intangibles and goodwill
recorded as a result of the transactions totaled $0.9 million and $2.7 million, respectively. The
goodwill is non-amortizable. The balances included in other purchased intangible assets will be
amortized over a period of five years from the date of each acquisition. New Technology Investments in 2004. In October 2004, the Company acquired certain
assets and assumed certain liabilities of Converging Technologies, Inc. The acquired assets
primarily include Web-based conferencing solutions, notably Linktivity® software. Tangible assets
acquired, liabilities assumed and purchased intangibles (all technology related) acquired were $0.5
million, $0.3 million and $3.0 million, respectively. The purchased intangible is being amortized
over five years. Also in October 2004, the Company obtained a license of intellectual property
from eDial, a division of Alcatel USA Marketing, Inc. for a total price of $1.0 million. The eDial
intangible is being amortized over five years. New Sales Office in 2003. In connection with opening a new sales office in
Philadelphia, Pennsylvania during December 2003, we acquired certain assets and assumed certain
liabilities relating to a customer




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##### 



base of a former dealer. The total assets acquired and
liabilities assumed were approximately $0.6 million and $0.9 million, respectively. Total goodwill
and purchased intangibles recorded as a result of the transaction were $0.2 million and $0.1
million, respectively. The goodwill balance is non-amortizable. The balance included in the $0.1
million in other purchased intangible assets is being amortized over a period of five years. Technology Investment in 2003. In connection with the acquisition of the rights to
certain developed technology for a capitalized purchase price of $2.25 million (included in
purchased intangible assets) during the year ended December 31, 2003, the Company entered into an
arrangement with the selling entity under which the selling entity would perform additional
development activities on a cost reimbursement basis through August 15, 2004. Under the terms of
the arrangement, the selling entity could also earn bonus payments totaling up to $1,000,000 for
meeting certain development milestones. Milestone bonuses totaling $750,000 for the year ended
December 31, 2004 were achieved and expensed as research and development costs. Technological
feasibility of the underlying technology has not yet been achieved to provide for viable product
sales. As of December 31, 2004, the remaining milestone bonus of $250,000 is dependent on future
events and is not considered to be probable or reasonably estimable. The following table
summarizes details of the expenses in connection with this technology investment recorded during
the respective periods: (In thousands)
    
    2004
    
    
    2003
    
    
    2002Milestone bonus payments
    
    $
    750
    
    
    $
    
    
    
    $
    Development activities on a cost
reimbursement basis
    
    
    665
    
    
    
    525
    
    
    
    Totals
    
    $
    1,415
    
    
    $
    525
    
    
    $
    
 Swan. On December 3, 2002, Inter-Tel Integrated Systems, Inc., our wholly owned
subsidiary, acquired 100% of the capital stock of Swan Solutions Limited (Swan) in England and
Wales, for $4.0 million in cash. $3.0 million was paid at closing, $250,000 was paid in June 2003
and $250,000 was paid in December 2003. The remaining $500,000 was subject to the achievement of
five performance milestones at $100,000 each. As of June 30, 2004, portions of all five $100,000
milestones had been achieved for which $450,436 was paid to the Swan shareholders. Of this amount,
the final $100,000 milestone achievement was paid during the second quarter of 2004. Payments
relating to the achievement of performance milestones were capitalized and are being amortized as
purchased intangible assets. In total, the Company recorded amortizable intangible technology
assets totaling $3.9 million in connection with this acquisition. These technology assets are
being amortized over five years. During the years ended December 31, 2004, 2003 and 2002, the
amortization of purchased intangible assets from Swan was approximately $788,000, $796,000 and
57,000, respectively. The values for acquired developed technology were determined based on the negotiated prices
paid to acquire the technology. Each of our technology acquisitions was made primarily to acquire
a specific technology, rather than for the purpose of acquiring an operating company. The
technologies acquired have been used to add additional features/applications to our current
products, sold separately as new products or obtained primarily for use with our next generation of
products. The weighted-average amortization period for total purchased intangibles as of December 31,
2004 and December 31, 2003 was approximately 6.8 years and 7.0 years for each period, respectively.
The weighted-average amortization period as of December 31, 2004 and December 31, 2003 for
developed technology was approximately 7.0 and 7.5 years for each period, respectively, and 5.0 and
4.8 years as of December 31, 2004 and 2003, respectively, for customer lists and non-compete
agreements. Each of the acquisitions discussed above were not material business acquisitions either
individually or collectively and has been accounted for using the purchase method of accounting.
The results of operations of each of these acquisitions have been included in our accompanying
consolidated statements of operations from the date of acquisitions. Inter-Tel.NET/Comm-Services/Vianet. Inter-Tels management has not participated in
the management of Inter-Tel.NET since its partial sale in July 2001. As a result, since July 24,
2001, we have accounted for the remaining Inter-Tel.NET/Comm-Services investment using the cost
method of accounting. On December 30, 2001, Comm-Services entered into a merger agreement with
Vianet. Inter-Tels 17% investment in Comm-Services was converted to approximately 10% of Vianet
stock and as a result, Vianet




---



##### 



assumed the loan for the purchase and Inter-Tel continued to hold collateral from the
former shareholders of Comm-Services until March 2003. During 2002, the net investment in the
notes receivable and 10% interest in Vianet (formerly Comm-Services) was written down by $1.2
million and was recorded in other assets at a carrying value of approximately $2.5 million as of
December 31, 2002, which approximated managements estimate of the related collateral value at that
time. During 1999, 2000 and 2001, Inter-Tel.NET entered into operating lease agreements totaling
approximately $6.5 million from an equipment vendor for network equipment and software. The lease
agreements required Inter-Tel.NET to purchase vendor maintenance on their products. Inter-Tel
originally guaranteed the indebtedness. In February 2003, we executed an agreement with Vianet and
this vendor releasing Inter-Tel from its guarantee of any and all of these obligations, and
Inter-Tel and Vianet released the vendor from claims arising from the failure of the network
equipment and software previously leased. As part of this agreement, Inter-Tel also received
payment from the Vianet shareholders of $1.45 million, in exchange for the release of the remaining
collateral and as payment of the loan. Inter-Tel had also retained a collateral interest in a
Vianet shareholders variable forward option contract that matured in April and May of 2003, and
for which we received no value for the collateral interest. After an adjustment of $124,000 in
2003 related to a recovery of our investment and adjustment of projected costs to actual costs
associated with the 2002 write-down in the Vianet investment, the estimated value received in this
transaction was equivalent to our remaining investment value, less accruals for potential
obligations to the vendor discussed above. Inter-Tel retains its ownership interest in Vianet and will account for the remaining
investment interest of approximately 10% in Vianet using the cost method of accounting. At
December 31, 2004 and 2003, our net investment in Vianet was recorded at no value. Executone. On January 1, 2000 Inter-Tel purchased certain computer telephony assets
and assumed certain liabilities of Executone Information Systems, Inc. (Executone). The Executone
transaction was accounted for using the purchase method of accounting. The aggregate purchase
price was allocated to the fair value of the assets and liabilities acquired, of which $5.4 million
($3.4 million after taxes) was written-off as purchased in-process research and development. In
connection with the Executone acquisition, we sold Executones manufacturing assets and liabilities
to Varian of Tempe, Arizona at a net book value of $6.6 million. During the second quarter of 2000, we decided to close the primary Executone facility in
Milford, Connecticut and to recognize a restructuring charge related to our exit plan and closure
of the Executone operations. We have accounted for the restructuring of the Executone operations,
including severance and related costs, the shut down and consolidation of the Milford facility and
the impairment of assets associated with the restructuring. We finalized our plan for the exiting
of activities and the involuntary termination or relocation of the employees. Accrued costs
associated with this plan were estimates, although the original estimates made for the second
quarter of 2000 for reserve balances have not changed significantly as of December 31, 2004. Exit costs associated with the closure of the Milford facility also included liabilities for
building, furniture and equipment lease, and other contractual obligations. We are liable for the
lease on the Milford buildings through January 14, 2005. Various other furniture, computer and
equipment leases terminated on varying dates through September 2002. To date, we have entered into
sublease agreements with third parties to sublease portions of the facility. The reserve for lease
and other contractual obligations is identified in the table below. The total restructuring charge from this event totaled $50.9 million. The following table
summarizes details of the restructuring charge in connection with the Executone acquisition,
including the description of
the type and amount of liabilities assumed, and activity in the reserve balances from the date
of the charge through December 31, 2004. Activity represents payments made or amounts written off.




---



##### 



(In thousands)Cash/
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ReserveNon-
    
    
    Restructuring
    
    
    2000 and 2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    BalanceDescription
    
    Cash
    
    
    Charge
    
    
    Activity
    
    
    Activity
    
    
    Activity
    
    
    Activity
    
    
    At 12/31/04Personnel Costs:Severance and termination costs
    
    Cash
    
    $
    (1,583
    )
    
    $
    1,560
    
    
    $
    20
    
    
    $
    3
    
    
    $
    
    
    
    $
    Other Plant closure costs
    
    Cash
    
    
    (230
    )
    
    
    230
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Lease termination and other
contractual obligations (net
of anticipated recovery):Building and equipment leases
    
    Cash
    
    
    (7,444
    )
    
    
    2,837
    
    
    
    2,594
    
    
    
    767
    
    
    
    1,238
    
    
    
    (8
    )Other contractual obligations
    
    Cash
    
    
    (1,700
    )
    
    
    1,700
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment of Assets:Inventories
    
    Non-Cash
    
    
    (3,454
    )
    
    
    1,585
    
    
    
    1,869
    
    
    
    
    
    
    
    
    
    
    
    Prepaid inventory and other expenses
    
    Non-Cash
    
    
    (2,485
    )
    
    
    2,485
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Accounts receivable
    
    Non-Cash
    
    
    (1,685
    )
    
    
    766
    
    
    
    88
    
    
    
    831
    
    
    
    
    
    
    
    Fixed assets
    
    Non-Cash
    
    
    (3,151
    )
    
    
    2,942
    
    
    
    53
    
    
    
    14
    
    
    
    26
    
    
    
    (116
    )Net intangible assets
    
    Non-Cash
    
    
    (29,184
    )
    
    
    29,184
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    
    
    
    $
    (50,916
    )
    
    $
    43,289
    
    
    $
    4,624
    
    
    $
    1,615
    
    
    $
    1,264
    
    
    $
    (124
    )
 Included in the total Executone restructuring costs of $50.9 million is a $43.3 million
restructuring charge for exit costs and asset impairment included in other charges, and $7.6
million associated with the impairment of inventories, which has accordingly been recorded as
additional costs of sales. NOTE C SHORT-TERM AND LONG-TERM INVESTMENTS The Company accounts for its investments in accordance with Financial Accounting Standard No.
115, Accounting for Certain Investments in Debt and Equity Securities. Most of the Companys
short-term investments are classified as available-for-sale, and have been recorded at fair value,
which approximates cost. Fair value has been determined to approximate cost based on broker
statements. We have also historically purchased and sold similar investments at face value. The
short-term investments that are classified as held-to-maturity have been recorded at cost and
amortized to face value. The long-term investments, which are all classified as held-to-maturity,
have been recorded at cost and amortized to face value. At December 31, 2004 and December 31,
2003, $50.6 million and $59.3 million, respectively, were recorded as short-term investments,
available-for-sale. At December 31, 2004 $2.0 million were recorded as short-term investments,
held-to-maturity. The Company had no assets classified as short-term investments, held-to-maturity
at December 31, 2003. Short-term investments include certificates of deposit, auction rate
certificates, auction rate preferred securities, municipal preferred securities, federal agency
issues and mutual funds. The auction rate securities are adjustable-rate securities with dividend
rates that are reset periodically by bidders through periodic Dutch auctions generally conducted
every 7 to 49 days by a trust company or broker/dealer on behalf of the issuer. The Company
believes these securities are highly liquid investments through the related auctions; however, the
collateralizing securities have stated terms of up to thirty-one (31) years. At December 31, 2004,
$9.9 million were recorded as long-term investments, held-to-maturity. The Company had no assets
classified as long-term investments, held-to-maturity at December 31, 2003. All investment
instruments are rated A or higher by Standard & Poors Ratings Group, or equivalent. The Companys investments are intended to establish a high-quality portfolio that preserves
principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate
yield in relationship to the Companys investment guidelines and market conditions.




---



##### 



The following is a summary of available-for-sale and held-to-maturity securities: Gross
    
    
    GrossDecember 31, 2004
    
    
    
    
    
    Unrealized
    
    
    Unrealized
    
    
    Gross Fair(in thousands)
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueShort-term, available-for-sale:Equity securities
    
    $
    42,148
    
    
    $
    
    
    
    $
    
    
    
    $
    42,148Mutual funds
    
    
    6,662
    
    
    
    
    
    
    
    
    
    
    
    6,662Certificate of deposit
    
    
    1,008
    
    
    
    
    
    
    
    
    
    
    
    1,008Municipal bonds
    
    
    826
    
    
    
    
    
    
    
    
    
    
    
    826Totals
    
    $
    50,644
    
    
    $
    
    
    
    $
    
    
    
    $
    50,644Short-term, held-to-maturity:Federal agency issues (mature in 2005)
    
    $
    2,000
    
    
    $
    
    
    
    $
    18
    
    
    $
    1,982Totals
    
    $
    2,000
    
    
    $
    
    
    
    $
    18
    
    
    $
    1,982Long-term, held-to-maturity:Federal agency issues (mature in 2006)
    
    $
    9,900
    
    
    $
    
    
    
    $
    140
    
    
    $
    9,760Totals
    
    $
    9,900
    
    
    $
    
    
    
    $
    140
    
    
    $
    9,760
 Gross
    
    
    GrossDecember 31, 2004
    
    
    
    
    
    Unrealized
    
    
    Unrealized
    
    
    Gross Fair(in thousands)
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueShort-term,  available-for-sale:Equity securities
    
    $
    57,855
    
    
    $
    
    
    
    $
    
    
    
    $
    57,855Mutual funds
    
    
    1,479
    
    
    
    
    
    
    
    
    
    
    
    1,479Totals
    
    $
    59,334
    
    
    $
    
    
    
    $
    
    
    
    $
    59,334
 NOTE D NET INVESTMENT IN SALES-LEASES Net investment in sales-leases represents the value of sales-leases presently held under our
Total Solution program. We currently sell the rental payments due to us from some of the
sales-leases. We maintain reserves against our estimate of potential recourse for the balance of
sales-leases and for the balance of sold rental payments remaining unbilled. The following table
provides detail on the total net balances in sales-leases (In thousands): December 312004
    
    
    2003
    
    
    2002Lease balances included in
consolidated accounts receivable,
net of allowances of $1,177 in
2004; $1,774 in 2003; and $2,562
in 2002
    
    $
    6,390
    
    
    $
    7,240
    
    
    $
    6,470Net investment in Sales-Leases:Current portion, net of
allowances of $886 in 2004;
$749 in 2003; and $516 in 2002
    
    
    17,151
    
    
    
    15,502
    
    
    
    13,344Long-term portion, includes
residual amounts of $510 in
2004; $652 in 2003; and $518
in 2002, net of allowances of
$1,810 in 2004; $1,985 in
2003; and $1,411 in 2002
    
    
    33,877
    
    
    
    32,529
    
    
    
    24,692Total investment in Sales-Leases,
net of allowances of $3,873 in
2004; $4,508 in 2003; and $4,489
in 2002
    
    
    57,418
    
    
    
    55,271
    
    
    
    44,506Sold rental payments remaining
unbilled (subject to limited
recourse provisions), net of
allowances of $12,241 in 2004;
$12,020 in 2003; and $11,125 in
2002
    
    
    229,163
    
    
    
    198,091
    
    
    
    194,684




---



##### 



December 312004
    
    
    2003
    
    
    2002Total balance of sales-leases and
sold rental payments remaining
unbilled, net of allowances
    
    $
    286,581
    
    
    $
    253,362
    
    
    $
    239,190Total allowances for entire lease
portfolio (including limited
recourse liabilities)
    
    $
    16,114
    
    
    $
    16,528
    
    
    $
    15,614
 Reserve levels are established based on portfolio size, loss experience, levels of past due
accounts and periodic, detailed reviews of the portfolio. Recourse on the sold rental payments is
contractually limited to a percentage of the net credit losses in a given annual period as compared
to the beginning portfolio balance for a specific portfolio of sold leases. While our recourse is
limited, we maintain reserves at a level sufficient to cover all anticipated credit losses. The
aggregate reserve for uncollectible lease payments and recourse liability represents the reserve
for the entire lease portfolio. These reserves are either netted from consolidated accounts
receivable, netted against current or long-term investment in sales-leases or included in
long-term liabilities for sold rental payments remaining unbilled. Sales of rental payments per
period: Years Ended December 31(In thousands)
    
    2004
    
    
    2003
    
    
    2002Sales of rental payments
    
    $
    113,172
    
    
    $
    88,352
    
    
    $
    83,141Sold payments remaining unbilled at end of year
    
    $
    241,404
    
    
    $
    210,111
    
    
    $
    205,809
 Sales of rental payments represents the gross selling price or total present value of the
payment stream on the sale of the rental payments to third parties. Sold payments remaining
unbilled at the end of the year represents the total balance of leases that are not included in our
balance sheet. We do not expect to incur any significant losses in excess of reserves from the
recourse provisions related to the sale of rental payments. Inter-Tel is compensated for
administration and servicing of rental payments sold. At December 31, 2004, future minimum lease payments related to the sold rental streams
remaining unbilled are: 2005  $73.4 million, 2006  $65.0 million, 2007  $50.2 million, 2008 
$35.6 million, 2009  $16.6 million, thereafter  $215,000. At December 31, 2004, future minimum lease receipts due from customers related to the lease
portfolio included in our December 31, 2004 balance sheet are: 2005  $18.9 million, 2006  $12.9
million, 2007  $9.1 million, 2008  $6.9 million, 2009  $5.4 million, thereafter  $30,000. NOTE E PROPERTY, PLANT & EQUIPMENT December 31(In thousands)
    
    2004
    
    
    2003Computer systems, data processing and other office equipment
    
    $
    46,397
    
    
    $
    38,906Transportation equipment
    
    
    3,820
    
    
    
    3,761Furniture and fixtures
    
    
    4,221
    
    
    
    3,899Leasehold improvements
    
    
    4,673
    
    
    
    4,501Building
    
    
    7,318
    
    
    
    7,297Land
    
    
    2,499
    
    
    
    2,49968,928
    
    
    
    60,863Less: Accumulated depreciation and amortization
    
    
    (41,088
    )
    
    
    (36,206
    )Net property, plant & equipment
    
    $
    27,840
    
    
    $
    24,657
 NOTE F  GOODWILL AND PURCHASED INTANGIBLE ASSETS December 31(In thousands)
    
    2004
    
    
    2003Goodwill
    
    $
    24,915
    
    
    $
    22,992Less: Accumulated amortization
    
    
    (5,025
    )
    
    
    (5,025
    )Net Goodwill
    
    $
    19,890
    
    
    $
    17,967




---



##### 



Purchased intangible assets:Acquired developed technology
    
    $
    15,517
    
    
    $
    11,765Customer lists and non-competition agreements
    
    
    3,550
    
    
    
    2,41819,067
    
    
    
    14,183Less: Accumulated amortization
    
    
    (8,080
    )
    
    
    (5,992
    )Net Purchased intangible assets
    
    $
    10,987
    
    
    $
    8,191
 For the years ending December 31, 2005, 2006, 2007, 2008 and 2009, the estimated amortization
expense on purchased intangible assets is $2.6 million, $2.5 million, $2.1 million, $1.3 million
and $1.0 million, respectively. NOTE G OTHER CURRENT LIABILITIES December 31(In thousands)
    
    2004
    
    
    2003Compensation and employee benefits
    
    $
    17,378
    
    
    $
    18,118Customer deposits
    
    
    4,641
    
    
    
    4,451Restructuring charge
    
    
    8
    
    
    
    1,194Deferred revenues
    
    
    6,937
    
    
    
    7,641Miscellaneous taxes payable
    
    
    2,842
    
    
    
    3,331E-Rate settlement
    
    
    9,261
    
    
    
    Other accrued expenses
    
    
    11,129
    
    
    
    12,850$
    52,196
    
    
    $
    47,585
 NOTE H CREDIT LINE We maintain a $10 million unsecured bank credit line at prime rate to cover international
letters of credit and for other purposes. The credit agreement matures June 1, 2006 and contains
certain restrictions and financial covenants. At December 31, 2004, none of the credit line was
committed under letter of credit arrangements. NOTE I LEASES Noncancellable operating leases are primarily for buildings. Certain of the leases contain
provisions for renewal options and scheduled rent increases. Rental expense amounted to
$9,381,000; $9,590,000; and $9,931,000; in 2004, 2003, and 2002, respectively, as follows: (In thousands)
    
    2004
    
    
    2003
    
    
    2002Rental expense, gross (1)
    
    $
    9,926
    
    
    $
    9,811
    
    
    $
    10,081Less: Sublease receipts, gross
    
    
    (545
    )
    
    
    (221
    )
    
    
    (150
    )Net rental expense
    
    $
    9,381
    
    
    $
    9,590
    
    
    $
    9,931
 (1) The amounts in the table above do not include rental expense in connection with the
Milford, Connecticut building, which we leased in connection with our acquisition in 2000 of
selected assets and assumption of certain liabilities of Executone. The Milford lease expired on
January 14, 2005 and we did not renew the lease. In connection with the Executone charge taken in
2000, we included in the charge the anticipated lease costs through the lease termination date,
offset by expected sublease receipts. The net rental payments in Milford (offset by sublease
receipts) were $1.3 million, $2.2 million, and $2.3 million in 2004, 2003, and 2002 respectively.
The total costs excluded from the gross rental expense above associated with the Milford lease
totaled $2.3 million in 2004, $2.9 million in 2003 and $3.0 million 2002, offset in part by
sublease receipts totaling $1.0 million, $0.8 million and $0.7 million in 2004, 2003, and 2002
respectively. Refer to Note B  Acquisitions, Technology Investments, Dispositions and
Restructuring Charges for additional information regarding the Executone charge and building
lease. At December 31, 2004, future minimum commitments under noncancellable leases are as follows:
2005  $7,584,000; 2006  $5,811,000; 2007  $4,070,000; 2008  $1,782,000; 2009  $665,000.




---



##### 



NOTE J INCOME TAXES We account for income taxes under Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes (SFAS 109). Under SFAS 109, the liability method is used in
accounting for income taxes. Under this method, deferred tax assets and liabilities are determined
(and classified as current or long-term) based on differences between financial reporting and tax
bases of assets and liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. Significant components of our deferred tax liabilities and assets as of December 31 are as follows: December 31(in thousands)
    
    2004
    
    
    2003Deferred tax liabilities:Leasesales and capitalized costs
    
    $
    80,921
    
    
    $
    73,823Write-off of Japan intercompany receivables
    
    
    1,051
    
    
    
    Tax over book depreciation
    
    
    2,986
    
    
    
    199Other
    
    
    3,579
    
    
    
    5,642Total deferred tax liabilities
    
    
    88,537
    
    
    
    79,664Deferred tax assets:Net operating loss carryforward
    
    
    2,905
    
    
    
    7,916Tax credit carryforward
    
    
    4,026
    
    
    
    3,421Insurance reserves
    
    
    1,559
    
    
    
    906Accounts receivable reserves
    
    
    3,457
    
    
    
    3,758Accrued vacation pay
    
    
    1,906
    
    
    
    1,652Foreign loss carryforwards
    
    
    1,051
    
    
    
    880In-process R&D write-off
    
    
    4,852
    
    
    
    5,428Restructuring reserves
    
    
    1,167
    
    
    
    1,968Lease receivable reserves
    
    
    8,047
    
    
    
    5,169Other  net
    
    
    4,238
    
    
    
    5,239Deferred tax assets
    
    
    33,208
    
    
    
    36,337Less valuation reserve
    
    
    
    
    
    
    (880
    )Net deferred tax assets
    
    
    33,208
    
    
    
    35,457Net deferred tax liabilities (total deferred tax
liabilities less net deferred tax assets)
    
    $
    55,329
    
    
    $
    44,207
 The net deferred tax liabilities increased in 2004 due primarily to acceleration of fixed
asset depreciation, temporary differences relating to leases in our Total Solution program and
reduction of the net operating loss carryforward deferred tax asset. Effective May 6, 2003, the
bonus depreciation increased from a 30% to a 50% bonus which favorably impacted the depreciation
deduction for 2004 and 2003. The Company filed a change in accounting method with the Internal Revenue Service for the 2002
tax year to utilize accelerated depreciation for dealer leases. This depreciation deduction
generated a net operating loss in 2002 that was carried back to 2001 and carried forward to 2003
and 2004. We expect the net operating loss carryforward to be fully utilized in 2005. The net
operating loss created deferred tax assets, not only for the loss, but also for research credits
and minimum tax credits. The company was in a slight minimum tax credit filing position for 2004
and 2003 and anticipates full utilization of the credits in 2005. During 2004, 2003 and 2002, we recorded income of $1,718,000; $1,037,000; and $295,000;
respectively, from foreign operations. At December 31, 2004, we had foreign loss carryforwards of
approximately $2,627,000 and expired losses of $235,000. In the fourth quarter of 2004, the
Companys management decided to shut down the operations in Japan. Due to the anticipated
recognition of income by Japan for forgiveness of debt in 2005, Japan will utilize its net
operating losses. The 2004 valuation allowance was reduced to zero and the tax benefit was
recognized. The Company also recognized a tax benefit for the write-off of the Japanese investment
in the amount of $550,000 in 2004.




---



##### 



Federal and state income taxes consisted of the following: (In thousands)
    
    2004
    
    
    2003
    
    
    2002Federal
    
    $
    14,247
    
    
    $
    15,126
    
    
    $
    20,206State
    
    
    2,472
    
    
    
    1,620
    
    
    
    2,584Foreign
    
    
    79
    
    
    
    734
    
    
    
    726$
    16,798
    
    
    $
    17,480
    
    
    $
    23,516
 The principal reasons for the difference between total income tax expense (benefit) and the
amount computed by applying the statutory federal income tax rate to income before taxes are as
follows: 2004
    
    
    2003
    
    
    2002Federal tax at statutory rates
applied to pre-tax income
    
    
    35.0
    %
    
    
    35.0
    %
    
    
    35.0
    %State tax net of federal benefit
    
    
    3.7
    
    
    
    2.3
    
    
    
    2.1Credit for research activities
    
    
    (1.6
    )
    
    
    (1.1
    )
    
    
    (1.2
    )Write-off of Japan
    
    
    (3.4
    )
    
    
    
    
    
    
    E-rate settlement
    
    
    6.8
    
    
    
    
    
    
    
    Tax exempt interest
    
    
    (1.5
    )
    
    
    (1.4
    )
    
    
    Other  net
    
    
    (0.7
    )
    
    
    3.2
    
    
    
    2.138.3
    %
    
    
    38.0
    %
    
    
    38.0
    %
 The E-rate settlement of $9.5 million, further described in Note A to the Consolidated
Financial Statements, consisted primarily of nondeductible fines and penalties. The
non-deductibility of these fines and penalties also unfavorably impacted the state effective tax
rate. The write off of Japan consists of the recognition of the valuation allowance and 2004
Japanese loss as well as a tax benefit for the write off of the investment. The company will write
off an estimated $2.8 million of intercompany receivables for which the Japanese subsidiary will
have corresponding income for the forgiveness of debt. This income will be offset by net operating
loss carryforwards. The tax benefit is 3.4% or approximately $1.5 million. In prior years the tax
benefit of the Japanese operations were offset by a valuation allowance due to historical losses
and an inability to project future income by management. Undistributed earnings of the Companys foreign subsidiaries totaling approximately $4.3
million and $1.9 million as of December 31, 2004 and 2003, respectively, are considered by the
Company to be permanently reinvested; accordingly, deferred income taxes have not been provided on
these earnings. Determining the tax liability that would arise if these earnings were remitted is
not practicable. The amount would depend on a number of factors, including the amount of the
earnings distributed and whether the U.S. operations were generating profits or losses. The Company believes that it maintains adequate tax reserves to offset the potential
liabilities that may arise upon audit. If such reserves ultimately prove to be unnecessary, the
resulting reversal of such reserves would result in tax benefits being recorded in the period the
reserves are no longer deemed necessary. If such reserves ultimately prove to be less than the
ultimate assessment, a future charge to expense would result. The Company has included reserves
for potential losses in deferred income tax liabilities. NOTE K EQUITY TRANSACTIONS Treasury Stock. During the first quarter of 2001, we initiated a stock repurchase program
under which the Board of Directors authorized the repurchase of up to 4,000,000 shares of Inter-Tel
Common Stock. We did not repurchase shares during 2004. However, under this and prior
authorizations, we repurchased 8,271 and 662 shares during 2003 and 2002, respectively, expending
$207,000 and $13,000 to repurchase shares for cash pay-outs to former employees in place of ESOP
share distributions during 2003 and 2002, respectively. During 2001, we expended approximately
$28.9 million for stock repurchases, which was funded primarily through existing cash balances. We
reissued approximately 696,000, 529,000 and 743,000 shares in 2004, 2003 and 2002, respectively,
through stock option and employee stock purchase
plan exercises and issuances. The proceeds received for the stock reissued were greater than
our total cost




---



##### 



basis. Accordingly, the difference was recorded as an increase to retained
earnings. Attached below is a summary of treasury share activity for the past three years. Treasury shares
    
    2004
    
    
    2003
    
    
    2002Balance on January 1
    
    
    1,732,181
    
    
    
    2,252,840
    
    
    
    2,995,393Stock repurchases, including ESOP
    
    
    
    
    
    
    8,271
    
    
    
    662Shares reissued
    
    
    (696,157
    )
    
    
    (528,930
    )
    
    
    (743,215
    )Balance on December 31
    
    
    1,036,024
    
    
    
    1,732,181
    
    
    
    2,252,840
 Board Authorization to Repurchase up to $75 Million of Inter-Tel Stock.In February 2005,
Inter-Tel announced that its board of directors approved a stock repurchase program, with no stated
expiration date, in which Inter-Tel may purchase up to $75 million of its Common Stock in the open
market from time to time, depending upon general market conditions, the Companys share price, the
level of employee stock option exercises, the level of employee stock purchase plan purchases, the
availability of funds and other factors. Dividend Policy. Since December 31, 1997, we have paid quarterly cash dividends (the cash
dividend) for every share of Common Stock to shareholders of record. Dividend payments commence
on or about 15 days after the end of each fiscal quarter. Our Board of Directors has periodically
increased the cash dividend and attached below is a summary of our dividends accrued and paid since
December 31, 1997, the date we first declared cash dividends on our Common Stock. 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
    
    
    $
    0.26
 Increase to Quarterly Dividend and One-Time Special Dividend. Inter-Tels board of directors
also made two dividend announcements in February 2005 affecting dividends:  
    Increase of Inter-Tels quarterly dividend by 14.3% from $0.07 per share per quarter
(total of $0.28 per share per year) to $0.08 per share per quarter (total of $0.32 per share
per year). The increase will be effective beginning the first dividend payment made in
April 2005 for shareholders of record at March 31, 2005, and will continue in effect unless
canceled or revised by the board of directors.
    One-time special dividend of $1.00 per share effective for shareholders of record at
March 31, 2005 and paid on or about April 15, 2005. Stock Option Plans.In July 1990, we adopted the Director Stock Option Plan (the Director
Plan) and reserved a total of 500,000 shares of Common Stock for issuance thereunder. Commencing
with the adoption of the Plan through 2001, each Eligible Director received a one-time automatic
grant of an option to purchase 5,000 shares of our Common Stock. In addition, through 2001 each
Eligible Director was granted an option to purchase 5,000 shares upon the date five (5) days after
such person became Director, and an additional option to purchase 5,000 shares five (5) days after
the date of the regularly scheduled board meeting following the close of our third quarter. All
options granted through 2001 had a five-year term and fully vested at the end of six months from
the grant date. In July 2001, as approved by shareholders at the annual shareholders meeting in April 2002,
the board of directors extended the term of the Director Plan to 2010. Our shareholders also
approved amendments to change the date of the annual grant to directors under the Director Plan to
five (5) business days after the re-election of directors at the annual meeting of shareholders,
increased the initial automatic option grant and each annual option grant from 5,000 to 7,500
shares. The term of options granted under the Director Plan was also increased from five (5) years
to ten (10) years. These amendments did not
increase the number of shares authorized for the Director Plan. In each instance, Director
Plan options must be granted at not less than 100% of the fair market value of our stock at the
dates of grant.




---



##### 



In November 1993, the Board of Directors authorized the Inter-Tel, Incorporated Long-Term
Incentive Plan (the 1994 Long Term Plan). 2,000,000 shares of Common Stock have been reserved
for issuance under the 1994 Long Term Plan to selected officers and key employees. Options must be
granted at not less than 100% of the fair market value of our stock at the dates of grant. Options
generally vest over four or five years and expire five to ten years from the date of grant. The
1994 Long Term Plan does not allow incentive stock options to be granted after November 19, 2003,
but other forms of awards, as defined in the plan, may be continue to be granted to participants. In February 1997, the Board of Directors authorized the Inter-Tel, Incorporated 1997 Long-Term
Incentive Plan (the 1997 Long Term Plan). Option must be granted at not less than 100% of the
fair market value of our stock at the dates of grant. Options generally vest over four or five
years and expire ten years from the date of grant. In March 2000, the Board of Directors
authorized an amendment to the 1997 Long Term Plan to limit our ability to reprice options under
the 1997 Long Term Plan. Prior to January 1, 2002, a total of 3,650,000 shares of Common Stock had
been reserved for issuance under the 1997 Long Term Plan to selected officers and key employees. On February 27, 2001 our Board of Directors authorized an amendment to the 1997 Long Term
Plan, approved by the stockholders, that provides for an automatic increase in the number of shares
of Common Stock reserved thereunder on the first day of each fiscal year equal to the lesser of (a)
2.5% of the outstanding shares on that date, (b) 750,000 shares (subject to appropriate adjustment
for all stock splits, dividends, subdivisions, combinations, recapitalizations and like
transactions) or (c) a lesser amount as determined by the Board of Directors (the Renewal
Feature). Based on shares outstanding at January 1 and as approved each year by our Board of
Directors for each of the respective periods noted below, the Renewal Feature provided for
increases in the number of shares available for issuance under the 1997 Long Term Plan, as follows: Year
    
    Shares2002
    
    
    604,1612003
    
    
    622,7252004
    
    
    635,7412005
    
    
    653,145
 Under the 1994 and 1997 Long Term Plans, in some instances, predetermined share market value
increases must be met to allow acceleration of option vesting provisions before the end of the
option term. In April 1998, the Board of Directors authorized the Inter-Tel, Incorporated Acquisition Stock
Option Plan (the Acquisition Plan). A total of 82,428 shares of Common Stock was reserved for
issuance under the Acquisition Plan to selected key employees hired as a result of the acquisition
of TMSI. New options must be granted at not less than 100% of the fair market value of our stock at
the dates of grant. Options generally vest over four or five years and expire ten years from the
date of grant. A portion of the options granted were replacements for options held to purchase
shares of stock of the selling company; such replacement grants retained the original terms,
including grant dates for vesting purposes and the original grant prices, adjusted using the
applicable conversion ratio of the fair value of Inter-Tels stock compared to that of the selling
company. In March 2000, the Board of Directors authorized an additional 216,000 shares of Common Stock
for issuance under the Acquisition Plan to selected employees hired as a result of the acquisition
of selected assets of Executone. In February 2001, the Board of Directors authorized an additional
300,000 shares of Common Stock for issuance under the Acquisition Plan to selected employees hired
as a result of the acquisition of selected assets of Convergent. In addition, in October 2001, the
Board of Directors authorized an additional 150,000 shares of Common Stock for issuance under the
Acquisition Plan to selected employees hired as a result of the acquisition of Mastermind
Technologies. Options in each instance must be granted at not less than 100% of the fair market
value of our stock at the dates of grant. Options vest over five years and expire ten years from
the date of grant.




---



##### 



Option activity for the past three years under all plans is as follows: (Number of shares)
    
    Years Ended December 31,(Number of shares)
    
    2004
    
    
    2003
    
    
    2002Outstanding at beginning of year
    
    
    4,416,131
    
    
    
    4,188,641
    
    
    
    4,567,945Granted
    
    
    484,000
    
    
    
    879,950
    
    
    
    608,000Exercised (1)
    
    
    (649,543
    )
    
    
    (476,410
    )
    
    
    (710,304
    )Expired or canceled
    
    
    (126,470
    )
    
    
    (176,050
    )
    
    
    (277,000
    )Outstanding at end of year
    
    
    4,124,118
    
    
    
    4,416,131
    
    
    
    4,188,641Exercisable at end of year
    
    
    2,002,768
    
    
    
    1,877,151
    
    
    
    1,628,533Weighted-average grant price of
options granted
    
    $
    14.88
    
    
    $
    13.66
    
    
    $
    13.40Weighted-average fair value
(FAS 123) of options granted
during the year
    
    $
    10.38
    
    
    $
    7.04
    
    
    $
    9.32
   (1)
    
    The difference between shares exercised in the table above and shares exercised as
reflected in the Consolidated Statements of Shareholders 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, 2004, 2003 and 2002
were 3,144, 5,722 and 29,349 shares, respectively. At December 31, 2004, we have reserved 4,957,805 shares of Common Stock for issuance in
connection with the stock option plans. As permitted under Statement of Financial Accounting Standards No. 123 (FAS 123) Accounting
for Stock-Based Compensation, we have elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, and related Interpretations, in accounting for
stock based awards to employees. Under APB 25, we generally recognize no compensation expense with
respect to such awards. The following table summarizes information about stock options outstanding at December 31,
2004: Number
    
    
    Weighted-Average
    
    
    WeightedRange of
    
    Outstanding
    
    
    Remaining
    
    
    AverageExercise Price
    
    at 12-31-04
    
    
    Contractual Life
    
    
    Exercise Price$2.24 - $5.24
    
    
    379
    
    
    1 years
    
    $
    2.24$5.25 - $7.68
    
    
    67,250
    
    
    2 years
    
    $
    6.38$7.69 - $15.12
    
    
    2,518,870
    
    
    6 years
    
    $
    11.01$15.13 - $43.44
    
    
    1,537,619
    
    
    7 years
    
    $
    21.59
 The following table summarizes information about stock options exercisable at December 31,
2004: Number
    
    
    Weighted-Average
    
    
    WeightedRange of
    
    Exercisable
    
    
    Remaining
    
    
    AverageExercise Price
    
    at 12-31-04
    
    
    Contractual Life
    
    
    Exercise Price$2.24 - $5.24
    
    
    379
    
    
    1 years
    
    $
    2.24$5.25 - $7.68
    
    
    67,250
    
    
    2 years
    
    $
    6.38$7.69 - $15.12
    
    
    1,252,570
    
    
    6 years
    
    $
    10.32$15.13 - $43.44
    
    
    682,569
    
    
    7 years
    
    $
    21.41
 During 2004, the weighted average exercise price of options granted, exercised, and expired or
canceled was $23.75, $12.79 and $16.85, respectively. Pro forma information regarding net income and net income per share, as disclosed in Note A,
has been determined as if the Company had accounted for its employee stock-based compensation plans
under the fair value method of SFAS No. 123.




---



##### 



The fair value for these options was estimated at the date of grant using a Black-Scholes
option pricing model using the low end of reasonable assumptions for input variables rather than
attempting to identify a best-point estimate. The option pricing model utilized the following
weighted average assumptions for 2004, 2003 and 2002, respectively: risk free interest rates of
3.29% for 2004, 3.05% for 2003 and 2.73% for 2002; dividend yields of 0.93% for 2004, 1.2% for 2003
and 0.75% for 2002; volatility factors of the expected market price of our stock averaged 0.478 for
2004, 0.560 for 2003 and 0.576 for 2002. Employee stock options vest over four to five year
periods and director options vest at the end of six months from the grant date. 1997 Employee Stock Purchase Plan. In April 1997, the Board of Directors and stockholders
adopted the Employee Stock Purchase Plan (the Purchase Plan) and reserved 500,000 shares for
issuance to eligible employees. In April 2002, the Board of Directors and stockholders approved an
amendment to the Plan to increase the number of authorized shares by 500,000 shares for a total of
1,000,000 authorized thereunder. Under the Purchase Plan, employees are granted the right to
purchase shares of Common Stock at a price per share that is 85% of the lesser of the fair market
value of the shares at: (i) the participants entry date into each six-month offering period, or
(ii) the end of each six-month offering period. Employees may designate up to 10% of their
compensation for the purchase of stock. Under the Plan, we sold 49,758 shares for approximately
$1,051,000 ($21.13 per share) to employees in 2004, 58,242 shares for approximately $915,000
($15.71 per share) to employees in 2003, and 61,562 shares for approximately $972,000 ($15.80 per
share) to employees in 2002. At December 31, 2004, 466,584 shares remained authorized under the
Plan. Stock Option Loans. During 1999, selected officers and employees of Inter-Tel were offered
loans to acquire Inter-Tel common stock. Promissory Notes were established to cover the cost of
exercise of stock options, including applicable taxes, or the cost of Inter-Tel common stock
purchased in the open market during May and June of 1999. The loans were interest-only notes with
balloon payments due on or before March 15, 2004. Interest was charged on the loans at the
mid-term applicable federal interest rate, compounded annually. Interest payments were due on or
before March 15 of each anniversary beginning on March 15, 2000. The loans were recorded in our
balance sheet as reductions to shareholders equity. The notes were full recourse loans and we
retained the common stock certificates as collateral. All of the loans were paid in full prior to
the end of 2003. NOTE L  EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share: Years Ended December 31,(In thousands, except per share amounts)
    
    2004
    
    
    2003
    
    
    2002Numerator:Net income
    
    $
    27,054
    
    
    $
    28,518
    
    
    $
    38,637Denominator:Denominator for basic earnings per
share  weighted average shares
    
    
    25,767
    
    
    
    25,078
    
    
    
    24,444Effect of dilutive securities:Employee and director stock options
    
    
    1,499
    
    
    
    1,395
    
    
    
    1,420Denominator for diluted earnings per
share  adjusted weighted average
shares and assumed conversions
    
    
    27,266
    
    
    
    26,473
    
    
    
    25,864Basic income per share
    
    $
    1.05
    
    
    $
    1.14
    
    
    $
    1.58Diluted income per share
    
    $
    0.99
    
    
    $
    1.08
    
    
    $
    1.49
 In 2004, 2003 and 2002, options to purchase 201,000; 227,150; and 280,580 shares,
respectively, of Inter-Tel stock were excluded from the calculation of diluted net earnings per
share because the exercise price of these options was greater than the average market price of the
common shares for the respective fiscal years, and therefore the effect would have been
antidilutive.




---



##### 



NOTE M  RETIREMENT PLANS Inter-Tel maintains retirement plans for the benefit of our employees. Under our 401(k)
Retirement Plan, participants may contribute on an annual basis up to the maximum amount allowed by
the Internal Revenue Service. We make voluntary annual contributions to the Plan of 50% of
contributions made by Plan participants of up to 6 percent of each participants compensation. Our
matching contributions to the Plan totaled $1,861,000; $1,627,000; and $1,567,000; in 2004, 2003
and 2002, respectively. In 1992, we initiated an Employee Stock Ownership Plan (ESOP), advancing $500,000 to the ESOP
Trust for the purpose of purchasing Common Stock of the Company. The Trust purchased 307,000
shares of Inter-Tel Common Stock in July 1992 and the loan was paid in full during 1997. As the
principal amount of the loan was repaid to Inter-Tel through Company annual contributions, the
equivalent number of shares released was allocated to employees accounts to be held until
retirement. Total shares so allocated were 32,380 in 1997. After the final allocation of shares
in 1997, the ESOP plan was frozen, so that all eligible participants as of July 1, 1997 became
100% vested in their accounts, regardless of length of service. In October 2002, our Board of
Directors authorized the termination of this plan, requiring the shares in the ESOP to be
distributed as one-time rollover contributions to accounts in our 401(k) Retirement Plan, or to
other qualified plans or as early taxable distributions. With the exception of a few of our former
employees whom we could not locate, the Plan assets were distributed in their entirety during 2003,
as allowed pursuant to a favorable determination letter that was issued by the Internal Revenue
Service on January 16, 2003. NOTE N  SEGMENT INFORMATION Inter-Tel follows Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information (SFAS 131). SFAS 131 established standards
for reporting information regarding operating segments in annual financial statements and requires
selected information for those segments to be presented in interim financial reports issued to
stockholders. SFAS 131 also established standards for related disclosures about products and
services and geographic areas. Operating segments are identified as components of an enterprise
about which separate discrete financial information is available for evaluation by the chief
operating decision maker, or decision-making group, in making decisions as to how to allocate
resources and assess performance. The Companys chief decision maker, as defined under SFAS 131, is
the Chief Executive Officer. We view our operations as primarily composed of two segments: (1) our principal segment, which
includes sales of telephone systems, telecommunications software, hardware and related services,
and (2) network services, including resale of local and long distance calling services, voice
circuits and data circuits through NetSolutions®, as well as commissions earned by Network Services
Agency, our division serving as an agent selling local and network services such as T-1 access,
frame relay and other voice and data circuit services on behalf of Regional Bell Operating
Companies (RBOCs) and local exchange carriers (collectively, Network Services). Sales of these
systems, software, related services and Network Services are provided through the Companys direct
sales offices and dealer network to business customers in North America, and in parts of Europe,
South Africa and Asia. As a result, financial information disclosed represents substantially all
of the financial information related to the Companys two principal operating segments. Results of
operations for the Network Services segment, if the operations were not included as part of the
consolidated group, could differ materially, as the operations are integral to the total telephony
solution offered by us to our customers.




---



##### 



For the years ended December 31, we generated income from business segments, including
charges, as follows: Principal
    
    
    
    
    
    
    
    
    
    
    Resale ofSegment
    
    
    
    
    
    
    
    
    
    
    Local,Long(excluding
    
    
    
    
    
    
    Subtotal
    
    
    Distance and(In thousands, except
    
    E-Rate
    
    
    E-Rate
    
    
    Principal
    
    
    Networkper share amounts)
    
    Settlement)
    
    
    Settlement
    
    
    Segment
    
    
    Services
    
    
    Total2004Net sales
    
    $
    367,969
    
    
    $
    
    
    
    $
    367,969
    
    
    $
    48,924
    
    
    $
    416,893Gross profit
    
    
    202,624
    
    
    
    
    
    
    
    202,624
    
    
    
    18,951
    
    
    
    221,575Operating income
    
    
    43,177
    
    
    
    (9,261
    )
    
    
    33,916
    
    
    
    7,799
    
    
    
    41,715Interest and other income
    
    
    2,463
    
    
    
    
    
    
    
    2,463
    
    
    
    191
    
    
    
    2,654Loss on foreign currency
transactions
    
    
    (399
    )
    
    
    
    
    
    
    (399
    )
    
    
    
    
    
    
    (399
    )Interest expense
    
    
    (109
    )
    
    
    
    
    
    
    (109
    )
    
    
    (9
    )
    
    
    (118
    )Net income
    
    $
    30,525
    
    
    $
    (8,957
    )
    
    $
    21,568
    
    
    $
    5,486
    
    
    $
    27,054Net income per diluted share
(1)
    
    $
    1.12
    
    
    $
    (0.33
    )
    
    $
    0.79
    
    
    $
    0.20
    
    
    $
    0.99Weighted average diluted
shares (1)
    
    
    27,266
    
    
    
    27,266
    
    
    
    27,266
    
    
    
    27,266
    
    
    
    27,266Goodwill
    
    
    17,755
    
    
    
    
    
    
    
    17,755
    
    
    
    2,135
    
    
    
    19,890Total assets
    
    $
    397,901
    
    
    $
    
    
    
    $
    397,901
    
    
    $
    9,065
    
    
    $
    406,966Depreciation and amortization
    
    $
    9,897
    
    
    $
    
    
    
    $
    9,897
    
    
    $
    107
    
    
    $
    10,004
 Principal Segment(excluding
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Resale of Local,(In thousands, except per
    
    Litigation
    
    
    Litigation
    
    
    Subtotal Principal
    
    
    Inter-Tel.NET
    
    
    Long Distance andshare amounts)
    
    Settlement)
    
    
    Settlement
    
    
    Segment
    
    
    /Vianet
    
    
    Network Services
    
    
    Total2003Net sales
    
    $
    330,014
    
    
    $
    
    
    
    $
    330,014
    
    
    $
    
    
    
    $
    43,822
    
    
    $
    373,836Gross profit
    
    
    179,777
    
    
    
    
    
    
    
    179,777
    
    
    
    
    
    
    
    17,296
    
    
    
    197,073Operating income
    
    
    37,379
    
    
    
    
    
    
    
    37,379
    
    
    
    
    
    
    
    6,949
    
    
    
    44,328Interest and other income
    
    
    1,526
    
    
    
    
    
    
    
    1,526
    
    
    
    124
    
    
    
    157
    
    
    
    1,807Gain on foreign currency
transactions
    
    
    18
    
    
    
    
    
    
    
    18
    
    
    
    
    
    
    
    
    
    
    
    18Interest expense
    
    
    (153
    )
    
    
    
    
    
    
    (153
    )
    
    
    
    
    
    
    (2
    )
    
    
    (155
    )Net income
    
    $
    24,009
    
    
    $
    
    
    
    $
    24,009
    
    
    $
    77
    
    
    $
    4,432
    
    
    $
    28,518Net income per diluted share
(1)
    
    $
    0.91
    
    
    $
    
    
    
    $
    0.91
    
    
    $
    
    
    
    $
    0.17
    
    
    $
    1.08Weighted average diluted
shares (1)
    
    
    26,473
    
    
    
    26,473
    
    
    
    26,473
    
    
    
    26,473
    
    
    
    26,473
    
    
    
    26,473Goodwill
    
    
    15,832
    
    
    
    
    
    
    
    15,832
    
    
    
    
    
    
    
    2,135
    
    
    
    17,967Total assets
    
    $
    338,637
    
    
    $
    
    
    
    $
    338,637
    
    
    $
    
    
    
    $
    21,239
    
    
    $
    359,876Depreciation and amortization
    
    
    8,973
    
    
    
    
    
    
    
    8,973
    
    
    
    
    
    
    
    161
    
    
    
    9,134
 Principal Segment(excluding
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Resale of Local,(In thousands, except per
    
    Litigation
    
    
    Litigation
    
    
    Subtotal Principal
    
    
    Inter-Tel.NET
    
    
    Long Distance andshare amounts)
    
    Settlement)
    
    
    Settlement
    
    
    Segment
    
    
    /Vianet
    
    
    Network Services
    
    
    Total2002Net sales
    
    $
    344,876
    
    
    $
    
    
    
    $
    344,876
    
    
    $
    
    
    
    $
    36,580
    
    
    $
    381,456Gross profit
    
    
    179,869
    
    
    
    
    
    
    
    179,869
    
    
    
    
    
    
    
    14,604
    
    
    
    194,473Operating income
    
    
    40,356
    
    
    
    
    
    
    
    40,356
    
    
    
    
    
    
    
    5,371
    
    
    
    45,727Interest and other income
    
    
    1,772
    
    
    
    15,516
    
    
    
    17,288
    
    
    
    (1,200
    )
    
    
    164
    
    
    
    16,252Gain on foreign currency
transactions
    
    
    330
    
    
    
    
    
    
    
    330
    
    
    
    
    
    
    
    
    
    
    
    330Interest expense
    
    
    (155
    )
    
    
    
    
    
    
    (155
    )
    
    
    
    
    
    
    (1
    )
    
    
    (156
    )Net income (loss)
    
    $
    25,891
    
    
    $
    9,492
    
    
    $
    35,383
    
    
    $
    (746
    )
    
    $
    4,000
    
    
    $
    38,637




---



##### 



Principal Segment(excluding
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Resale of Local,(In thousands, except per
    
    Litigation
    
    
    Litigation
    
    
    Subtotal Principal
    
    
    Inter-Tel.NET
    
    
    Long Distance andshare amounts)
    
    Settlement)
    
    
    Settlement
    
    
    Segment
    
    
    /Vianet
    
    
    Network Services
    
    
    TotalNet income (loss) per
diluted share (1)
    
    $
    1.00
    
    
    $
    0.37
    
    
    $
    1.37
    
    
    $
    (0.03
    )
    
    $
    0.15
    
    
    $
    1.49Weighted average diluted
shares (1)
    
    
    25,864
    
    
    
    25,864
    
    
    
    25,864
    
    
    
    25,864
    
    
    
    25,864
    
    
    
    25,864Goodwill
    
    
    15,511
    
    
    
    
    
    
    
    15,511
    
    
    
    
    
    
    
    2,135
    
    
    
    17,646Total assets
    
    $
    263,405
    
    
    $
    
    
    
    $
    263,405
    
    
    $
    
    
    
    $
    18,657
    
    
    $
    282,062Depreciation and amortization
    
    
    8,464
    
    
    
    
    
    
    
    8,464
    
    
    
    
    
    
    
    190
    
    
    
    8,654
   (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. Our revenues are generated predominantly in the United States. Total revenues generated from
U.S. customers totaled $403.7 million, $362.8 million and $371.3 million, of total revenues for the
years ended December 31, 2004, 2003 and 2002, respectively. Revenues from international sources
were primarily generated from customers located in the United Kingdom, Europe, Asia, and Mexico.
In 2004, 2003 and 2002, revenues from customers located internationally accounted for 3.2%, 3.0%
and 2.7% of total revenues, respectively. Our applicable long-lived assets at December 31, 2004,
included Property, Plant & Equipment; Goodwill; and Purchased Intangible Assets. The net amount
located in the United States was $56.1 million and the amount in foreign countries was $2.6 million
at December 31, 2004. The net amount located in the United States was $47.3 million and the amount
in foreign countries was $3.5 million at December 31, 2003. NOTE O FINANCIAL INSTRUMENTS Concentration of Credit Risk. Financial instruments that potentially subject Inter-Tel to
significant concentrations of credit risk consist principally of cash investments, trade accounts
receivable, and net investment in sales-leases. We maintain cash and equivalents not invested in
money market funds with a major bank in our marketplace. We perform periodic evaluations of the
relative credit standing of the financial institution. Concentrations of credit risk with respect
to trade accounts receivable and net investment in sales-leases are limited due to the large number
of entities comprising our customer base. Fair Value of Financial Instruments. The carrying amount of cash and equivalents, accounts
receivable, net investment in sales-leases, and accounts payable reported in the consolidated
balance sheets approximate their fair value. NOTE P SUPPLEMENTAL CASH FLOW  Years Ended December 31,(In thousands)
    
    2004
    
    
    2003
    
    
    2002Cash paid for:Interest
    
    $
    118
    
    
    $
    155
    
    
    $
    156Income taxes paid (received)
    
    $
    (1,156
    )
    
    $
    (9,384
    )
    
    $
    15,424Additional disclosure of cash flow information:Tax benefit from stock options
    
    $
    (2,638
    )
    
    $
    (2,321
    )
    
    $
    (2,671
    )Changes in operating assets and liabilities:(Increase) decrease in receivables and
current net investment in sales-leases
    
    $
    (4,444
    )
    
    $
    (6,096
    )
    
    $
    1,907(Increase) decrease in inventories
    
    
    (2,192
    )
    
    
    (4,069
    )
    
    
    9,759(Increase) decrease in prepaid expenses and
other assets
    
    
    5,933
    
    
    
    (2,935
    )
    
    
    4,248Increase in long-term net investment in
sales-leases and other assets
    
    
    (1,809
    )
    
    
    (6,962
    )
    
    
    (3,448
    )Increase in accounts payable and other
current liabilities
    
    
    4,510
    
    
    
    1,093
    
    
    
    3,014$
    1,998
    
    
    $
    (18,969
    )
    
    $
    15,480




---



##### 



NOTE Q QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) A summary of the quarterly results of operations for the years ended December 31, 2004 and
2003 follows (quarterly amounts may not add to the year-end totals due to rounding): (In thousands, except per share amounts) 2004
    
    1st Qtr
    
    
    2nd Qtr
    
    
    3rd Qtr
    
    
    4th QtrNet sales
    
    $
    98,031
    
    
    $
    102,908
    
    
    $
    105,506
    
    
    $
    110,448Gross profit
    
    $
    52,098
    
    
    $
    54,299
    
    
    $
    55,934
    
    
    $
    59,244ERate settlement (pre-tax)
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    9,261Net income
    
    $
    6,820
    
    
    $
    8,117
    
    
    $
    9,206
    
    
    $
    2,911Net income per shareBasic
    
    $
    0.27
    
    
    $
    0.32
    
    
    $
    0.36
    
    
    $
    0.11Net income per shareDiluted
    
    $
    0.25
    
    
    $
    0.30
    
    
    $
    0.34
    
    
    $
    0.11Weighted average basic common shares
    
    
    25,543
    
    
    
    25,715
    
    
    
    25,816
    
    
    
    25,994Weighted average diluted common shares
    
    
    27,350
    
    
    
    27,262
    
    
    
    26,944
    
    
    
    27,509
 2003
    
    1st Qtr
    
    
    2nd Qtr
    
    
    3rd Qtr
    
    
    4th QtrNet sales
    
    $
    84,169
    
    
    $
    95,102
    
    
    $
    94,545
    
    
    $
    100,020Gross profit
    
    $
    44,074
    
    
    $
    50,250
    
    
    $
    49,244
    
    
    $
    53,505Net income
    
    $
    4,672
    
    
    $
    7,269
    
    
    $
    7,218
    
    
    $
    9,359Net income per shareBasic
    
    $
    0.19
    
    
    $
    0.29
    
    
    $
    0.29
    
    
    $
    0.37Net income per shareDiluted
    
    $
    0.18
    
    
    $
    0.28
    
    
    $
    0.27
    
    
    $
    0.35Weighted average basic common shares
    
    
    24,920
    
    
    
    24,947
    
    
    
    25,107
    
    
    
    25,338Weighted average diluted common shares
    
    
    26,039
    
    
    
    25,970
    
    
    
    26,865
    
    
    
    27,020
 NOTE R  SUBSEQUENT EVENT On February 28, 2005, Inter-Tel Lake Ltd, a wholly owned Irish subsidiary of Inter-Tel
Incorporated (Inter-Tel) executed an agreement for the purchase of 100% of the issued share
capital of Lake Communications Limited and certain affiliated entities (collectively, Lake) for
$28.0 million, plus an earn-out of up to $17.6 million based upon certain targets relating to
operating results for Lake through the first eighteen months following the closing date of the
transaction. The transaction closed out of escrow on March 4, 2005 upon the release from escrow of
closing documentation. Lake, based in Dublin, Ireland, is a provider of converged communications
products in the under 40 user market, including EncoreCXÒ products currently being
distributed by Inter-Tel in the United States. Lake designs and develops its products for sale
through a distribution network of telecom operators and distributors, including Inter-Tel in the
United States. Lake outsources its manufacturing to third-party suppliers. For more than a year,
Lake has sold certain communications products to the Company in the ordinary course of its
business.