UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                         -------------------------------

                                    FORM 10-K
                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended                           Commission File Number:
     December 31, 1997                                       0-10211

                             INTER-TEL, INCORPORATED

Incorporated in the State of Arizona                 I.R.S. No. 86-0220994

                        120 North 44th Street, Suite 200
                           Phoenix, Arizona 85034-1822

                                 (602) 302-8900

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

           Securities registered pursuant to Section 12(g) of the Act:

                                  Common Stock
              (26,796,272 shares outstanding as of March 13, 1998)

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes X No

         Indicate by check mark if disclosure of delinquent  filers  pursuant to
Item 405 of Regulation S-K (S 229.405 of this chapter) is not contained  herein,
and will not be contained,  to the best of registrant's knowledge, in definitive
proxy or information  statements  incorporated  by reference in Part III of this
Form 10-K or any amendment to this Form 10-K - [ ].

         The aggregate  market value of the voting stock held by  non-affiliates
of the  registrant,  based upon the last reported sales price in NASDAQ National
Market  System on March 13,  1998,  was  approximately  $543,688,355.  Shares of
Common Stock held by each  executive  officer and director have been excluded in
that such persons may be deemed to be affiliates.
<PAGE>
         Materials have been incorporated by reference into this Report from the
following  documents:  (1)  materials  from  the  registrant's  Proxy  Statement
relating to its 1998 Annual Meeting of  Shareholders  have been  incorporated by
reference into Part III and Part IV and (2) documents from the registrant's Form
S-1 Registration  Statements (Nos. 2-70437 and 33-70054),  Form S-3 Registration
Statements (Nos. 33-58161, 33-61437,  333-01735,  333-12433 and 333-39221), Form
S-8 Registration  Statements (Nos. 2-94805,  33-40353,  33-73620 and 333-41197),
Annual Reports on Form 10-K for the years December 31, 1984,  1988 and 1994, and
current  reports  on Form 8-K  dated  July 17,  1987,  August  3, 1988 have been
incorporated  by reference into Part IV, Item 14.  Portions of the Annual Report
to  Shareholders  for the year  ended  December  31,  1996 are  incorporated  by
reference into Part II.

                             INTER-TEL, INCORPORATED
                          1997 FORM 10-K ANNUAL REPORT

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                     PART I
                                                                                                 Page
<S>          <C>                                                                                 <C>
Item 1        Business                                                                              3
Item 2        Properties                                                                           25
Item 3        Legal Proceedings                                                                    26
Item 4        Submission of Matters to a Vote of Security Holders                                  26

                                     PART II

Item 5        Market for the Registrant's Common Stock
              and Related Stockholder Matters                                                      26
Item 6        Selected Financial Data                                                              26
Item 7        Management's Discussion and Analysis of
              Financial Condition and Results of Operations                                        27
Item 7A       Quantitative and Qualitative Disclosures About Market Risk                           27
Item 8        Financial Statements and Supplementary Data                                          27
Item 9        Changes in and Disagreements with Accountants
              on Accounting and Financial Disclosure                                               27

                                    PART III

Item 10       Directors and Executive Officers of the Registrant                                   27
Item 11       Executive Compensation                                                               27
Item 12       Security Ownership of Certain Beneficial Owners and Management                       27
Item 13       Certain Relationships and Related Transactions                                       27

                                     PART IV

Item 14       Exhibits, Financial Statement Schedules and Reports on Form 8-K                      28
                                       2
</TABLE>
<PAGE>
                                     PART I

ITEM 1.  BUSINESS

The Company

         This  Annual  Report to  Shareholders  on Form 10-K  ("10-K")  contains
forward-looking statements that involve risks and uncertainties.  The statements
contained  in this 10-K  that  are not  purely  historical  are  forward-looking
statements  within the meaning of Section 27A of the  Securities Act of 1933, as
amended,  and Section 21E of the  Securities  Exchange Act of 1934,  as amended,
including without limitation  statements  regarding the Company's  expectations,
beliefs,  intentions or strategies  regarding  the future.  All  forward-looking
statements  included in this document are based on information  available to the
Company on the date hereof,  and the Company assumes no obligation to update any
such  forward-looking  statements.  The cautionary  statements made in this 10-K
should be read as being  applicable  to all related  forward-looking  statements
wherever they appear in this document. The Company's actual results could differ
materially  from those  anticipated  in these  forward-looking  statements  as a
result of certain  factors,  including  those set forth under  "Factors That May
Affect Results of Future  Operations"  below and elsewhere in this document.  In
evaluating the Company's business, shareholders and prospective investors should
consider  carefully the following  factors in addition to the other  information
set forth in this document.

         Inter-Tel,  incorporated  in  Arizona  in 1969,  is a  single  point of
contact,  full service  provider of digital  business  telephone  systems,  call
processing  software,  voice  processing  software,  call  accounting  software,
Internet  Protocol  (IP)  telephony  software,  computer  telephone  integration
("CTI")  applications and long distance calling services.  Inter-Tel's  products
and  services   include  the  AXXESS  and  Inter-Tel   Axxent  digital  business
communication software platforms,  the AXXESSORY Talk voice processing platform,
the Inter-Tel  Vocal'Net IP telephony gateway,  the Inter-Tel  Vocal'Net Service
Provider Software and Centralized  Accounting Software and Inter-Tel.net,  an IP
telephony  packet  switched  long  distance  service.  The Company also provides
maintenance, leasing and support services for its products. The Company's Common
Stock is quoted on the Nasdaq National Market System under the symbol INTL.

         The  Company  has  developed  a  distribution  network of direct  sales
offices,  dealers  and value added  resellers  (VARs)  which sell the  Company's
products to  small-to-medium-size  organizations and to divisions or departments
of  larger  organizations,   including  Fortune  500  companies,  large  service
organizations and governmental agencies. The Company has 30 direct sales offices
in the United States,  one in the United Kingdom,  one in Japan and a network of
hundreds of dealers and VARs who purchase directly from the Company.

Industry Background

         In recent  years,  advances  in  telecommunications  technologies  have
facilitated the development of increasingly  sophisticated telephone systems and
applications.  Users rely upon a variety of applications,  including  conference
calling,  speaker  phones,  automated  attendant,  voice  processing and unified
messaging (the  integration of voice mail,  facsimile and electronic  mail),  to
improve  communications  within  their  organizations  and  with  customers  and
vendors.  Digital  technology has  facilitated  the integration of computing and
telecommunications  technologies,  which  has  made  possible  a  number  of new
applications that further enhance  productivity.  Examples of these applications
include   automatic   call   distribution   (which   provides  for  queuing  and
prioritization of incoming calls), call accounting (which permits accounting for
telephone usage and toll calls), unified messaging,  electronic data interchange
between  customers  and vendors and the use of automatic  number  identification
coupled  with  database   look-up  (where  customer   information  is  retrieved
automatically from a computerized database when the customer calls).
                                       3
<PAGE>
         The emergence of high-performance, low-cost computers and the growth of
the  Internet  and other  digital  IP  networks  have  enabled  real-time  voice
communications to be transmitted on digital packet switched networks rather than
over traditional circuit switched telephone networks.  This development of voice
applications  for  the  Internet  and  other  IP  networks  reflects  a  broader
convergence  of standard  voice  communications  and data  networks.  Because IP
network telephony  converts all transmissions to the same type of packets,  both
voice and data can use the same data circuits, thereby increasing efficiency and
maximizing the use of available  bandwidth.  The lowering of federal  regulatory
barriers  to  competition   across   traditionally   distinct   sectors  of  the
telecommunications industry has opened new markets for and increased competitive
pressures  on  telecommunications  companies.  In  response  to  these  factors,
telecommunications  companies have begun to establish a presence in Internet and
other IP network voice communications services.

         Following  the  breakup  of the  Bell  system  in 1984,  which  removed
restrictions  on  the  ability  of  the  RBOCs  to  purchase  telecommunications
equipment from independent  suppliers and to resell such equipment to end users,
the market for  telecommunications  systems and applications became increasingly
fragmented.   The  number  of   independent   suppliers  and   distributors   of
telecommunications  equipment  initially  increased,  but  increased  levels  of
competition  subsequently led to consolidation among suppliers and distributors.
In addition,  different  telecommunications  systems and applications were often
available  from  only one or a  limited  number  of  suppliers,  which  required
businesses  seeking  complete  systems  to  work  with  a  number  of  different
suppliers.  A business seeking a telephone system,  voice mail and long distance
services  would most  likely  purchase  the  products  and  services  from three
separate vendors. As business  telecommunications  requirements have become more
advanced,   the  integration  of  different  systems  has  become   increasingly
difficult.

Strategy

         Inter-Tel's  objective is to continue to  strengthen  its position as a
leading  single-source  provider  of  telecommunications   equipment,   software
applications  and network  services.  The Company's  strategy  incorporates  the
following key elements:

         Offer Total Telephony Solution

         The Company  intends to continue to offer a broad range of products and
services that incorporates  advanced  technologies and provides customers with a
single  source to fulfill  their  telecommunications  needs on a  cost-effective
basis.  Inter-Tel couples this  solution-oriented  approach with a high level of
customer  service  and  support  and a  commitment  to  quality  throughout  the
Company's  operations.  The Company's  telephone systems are integrated with the
Company's long distance calling services,  voice mail,  automated  attendant and
other telecommunications  applications,  support for interactive voice response.
Because of the  modular  design of the  Company's  systems and the high level of
software  content in its products,  customers can readily  increase the size and
functionality  of their  systems as their needs  change by adding  software  and
hardware  applications  or services or by  upgrading  to new systems or advanced
versions of existing systems.  The Company believes that its customers prefer to
purchase telecommunications  equipment and services from a single source because
of the  convenience,  consistency of service,  ease of upgrade,  availability of
financing  alternatives and confidence in the performance of integrated  systems
and services.

         Accelerate Adoption of Inter-Tel Vocal'Net Gateway

         In September 1997, Inter-Tel commercially released Inter-Tel Vocal'Net,
a gateway for bridging public circuit switched  telephone networks and IP packet
switched networks such as the Internet. The Company intends to focus its initial
marketing efforts on existing customers as well
                                       4
<PAGE>
as other  multi-location  companies  and  international  enterprises.  Inter-Tel
Vocal'Net  can be used to reduce an  enterprise's  communications  costs through
more  effective  use of its data  network and reduced  use of  traditional  long
distance services.  In addition,  the Company plans to pursue relationships with
ISPs,  long distance  resellers,  cable  television  companies and other service
providers  that  choose  to  establish  alternative  networks  to  compete  with
traditional  long distance  services and to provide  additional  applications to
their customers.

         Expand Inter-Tel.net Network

         The Company is currently developing and implementing its own private IP
telephony network,  Inter-Tel.net, to carry telephone traffic at rates typically
lower than those of standard  telephone  networks.  To date,  the  Inter-Tel.net
network  has  established  points of  presence  in the San  Francisco  Bay Area,
Washington,  D.C., Chicago, Reno, New York, Phoenix and Los Angeles. The Company
intends  to expand  the  number of points of  presence,  both  domestically  and
internationally,  as well as increase capacity in existing cities. Inter-Tel.net
is designed to carry long distance traffic originated from Inter-Tel's  customer
base and  provide  other  exchange  carriers,  individuals,  and  enterprises  a
cost-effective  alternative  to current  offerings of the  conventional  circuit
switched long distance carriers.

         Continue to Develop Advanced Communications Products

         The Company commits substantial  research and development  resources in
order to provide its customers with advanced telecommunications  technologies on
a  cost-effective  basis. The Company has developed an extensive C++ library and
significant  telecommunications  expertise.  In many cases, the Company develops
new technologies as software upgrades or add-ons to existing  products.  In this
regard, the AXXESS 5.0 platform, which is currently scheduled for release in the
first  half of 1998,  will  provide an  extensive  enhancement  of  AXXESS,  the
Company's primary product. Ongoing research and development efforts are directed
to the development of new products,  applications and services for sale into the
Company's existing customer base and to new customers.  Through CTI applications
and advanced network services, Inter-Tel provides technology that is designed to
enable  its   customers  to  improve   their   efficiency   and  enhance   their
competitiveness.

         Expand Distribution Channels

         The Company  continues to expand its  distribution  channels  through a
growing  network of direct  dealers,  expansion  of the  Company's  direct sales
presence,   hiring   additional   direct  sales  personnel  and  extension  into
international  markets.  The Company has established  sales  relationships  with
hundreds of direct dealers and continues to expand this network.  The Company is
in the process of establishing  dealer networks in Japan and other parts of Asia
and is  expanding  its dealer  network in the United  Kingdom  and  Europe.  The
Company  has  expanded  its direct  sales  activity  in recent  periods  through
strategic  acquisitions of resellers of telephony products and services in areas
where the Company has existing direct sales offices and other strategic markets,
and considers  additional  acquisition  opportunities  on an ongoing basis.  The
Company also is expanding its distribution  into other channels such as computer
equipment  dealers,  resellers  of data  communications  equipment  and software
resellers.

Products and Services

         The Company  offers a broad range of products and services  designed to
support the needs of businesses and other organizations requiring voice and data
communications  systems.  The Company's principal products are digital telephone
systems which support  installations up to 512 ports, IP telephony  products and
services,  CTI  applications,  unified  messaging  software and voice processing
software.  The Company's principal system sales consist of systems supporting 10
to 300  telephones  with  suggested  retail prices of up to $300,000 per system,
depending on
                                       5
<PAGE>
configuration.  The Company also offers long distance calling services,  network
design and implementation services,  maintenance,  leasing and support services,
and resells other telecommunications products.

          Digital Communication Platforms

         Inter-Tel  offers an extensive line of digital  communication  systems,
including  hardware  platforms  and C++  software  applications.  Because  these
platforms are based upon open  architecture and conform to established  computer
and telephone  industry standard  programming  interfaces and protocols (such as
TAPI,  TSAPI and TCP/IP),  customers  can choose from a variety of either server
level or desktop applications.

         AXXESS. Inter-Tel's primary product, the AXXESS platform,  incorporates
advanced technology for computer and telephone  integration providing businesses
with the ability to  customize  applications  to enhance  their  operations  and
increase  productivity.  The current  AXXESS system  release  supports up to 512
ports and includes such advanced  capabilities as primary rate ISDN,  integrated
call  recording,  voice  prompts in  different  languages,  and a  Windows-based
attendant's console.  The AXXESS 5.0 platform,  which is currently scheduled for
release  in the  first  half of  1998,  is  designed  to  allow,  through  fully
transparent  digital  networking,  two or more systems to operate as one, and to
increase capacity to 5,000 ports. AXXESS 5.1, currently scheduled for release in
the second half of 1998, is designed to increase capacity to 20,000 ports.

         The system  incorporates  fully-digital  processing and transmission to
the  desktop  and open  architecture  interfaces  which  allow the  system to be
integrated   with  and  controlled  by  attached   computers  such  as  PCs  and
workstations.  The system incorporates object-oriented C++ software developed by
the Company,  which  facilitates  upgrades and the  incorporation  of additional
features and functionality.

         AXXESS system telephones incorporate  user-friendly,  6-by-16 character
LCD displays  with menu keys that permit the user to select from  multiple  menu
choices or access additional menu screens.  AXXESSORY Talk, permits  push-button
selection of voice processing commands to appear on the telephone's LCD display,
as well as voice-prompted  selections  through the telephone keypad.  The AXXESS
system is  multi-lingual,  currently  offering English or Japanese voice prompts
and LCD displays and allowing the user to switch from one language to the other.
Spanish is scheduled for controlled  product  introduction in the second quarter
of 1998. Additional languages can be added in the future.

         The open architecture  interface permits tight integration with a PC or
workstation  system bus, using several  industry-standard  interfaces to provide
efficient  access  to  voice  processing  and  other  applications  on the PC or
workstation.  Applications  include database  look-up (which utilizes  Caller-ID
information to retrieve customer  information  automatically from a computerized
database),  automated  attendant,  interactive  voice  response,  automatic call
distribution (which queues and prioritizes  incoming calls), and call accounting
(which  permits the  monitoring  of telephone  usage and toll cost).  The AXXESS
system is managed through a Microsoft  Windows-based graphical user interface on
a PC to facilitate installation, system configuration and programming.

         The AXXESS system utilizes  advanced  software to configure and utilize
real-time   digital   signal   processor   semiconductor   components   ("DSPs")
incorporated  into the system  hardware.  The use of DSPs and  related  software
lowers  system  costs,   permits  higher   functionality  and  increases  system
flexibility.  For  example,  DSPs can be  configured  by the system  manager for
different  combinations  of  speakerphones,  conference  capabilities  and other
DSP-based  facilities.   The  system's  speakerphones   incorporate  full-duplex
technology,  which permits  speakerphones  to transmit in both directions at the
same time  without the  necessity  to override  one  speaker's  voice to prevent
feedback interference.
                                       6
<PAGE>
         The  AXXESS  software  is  written  in  a  high-level,  object-oriented
language which can operate on many commonly used  processors.  Accordingly,  the
software can be readily ported to other hardware platforms.  The Company intends
to port the AXXESS  software  to faster  microprocessors  which will  permit the
AXXESS to grow to a much larger size, in order to enhance the  functionality and
performance  of these  larger  systems and to permit a  migration  path from the
smaller AXXESS system as a customer's system requirements increase.

         Inter-Tel  Axxent.  Small businesses are demanding  advanced  telephony
applications  formerly  within reach of only large  corporations.  The Inter-Tel
Axxent is designed to bring many of the advanced  features and  functionality of
the AXXESS  system to smaller  installations  on a  cost-effective  basis  while
enabling users to migrate to an AXXESS system as their  telecommunications needs
evolve.  The  Inter-Tel  Axxent  supports  24 lines and 12 trunks  and  provides
capabilities such as computer telephone integration,  DSP technology,  real-time
ACD reporting,  and integrated voice  processing.  Housed in a compact,  PC-type
mid-tower chassis,  the Inter-Tel Axxent platform also offers the convenience of
a default  database so the system is fully  operational as soon as it is plugged
in.  Basic  database  programming  can also be  performed  through  the  digital
telephone terminals.

         IP Network Gateway and Inter-Tel.net Network

         Gateway  products  are  designed  as  transition   points  between  two
different network types,  such as between the public circuit switched  telephone
network and a packet switched IP network such as the Internet.  Gateway products
convert regular voice  transmissions to or from the compressed data packets that
travel over packetized networks.

         In  September  1997,  the  Company  released  Inter-Tel  Vocal'Net,   a
stand-alone  IP network  telephony  solution  available  for use with the AXXESS
system or other  traditional  telephone  systems equipped with T-1/E-1,  ISDN or
analog capability.  It provides a gateway for bridging the telephone network and
a company's  intranet or the  Internet.  With the Inter-Tel  Vocal'Net  gateway,
users can conduct real-time,  two-way voice communications over the Internet and
realize potential savings compared to standard long distance  telephone service.
Designed to meet the needs of most businesses,  the Inter-Tel  Vocal'Net gateway
is available in multiple port sizes.

         Inter-Tel  Vocal'Net  does not  require  customized  telephone  sets or
specialized  software  or cards in each  desktop  computer.  Further,  Inter-Tel
Vocal'Net does not rely on the central  processing  unit of the computer for the
compression or packetization  of information,  but instead uses high speed DSPs,
enabling the server to handle additional functions such as unified messaging.

         A caller can dial from a standard telephone to the Inter-Tel  Vocal'Net
gateway,  which connects the call from the circuit switched  telephone  network,
converts it into the  compressed,  digitized data packets used by an IP network,
and routes the call via the IP network to another Inter-Tel  Vocal'Net  gateway.
The second  gateway  connects  with the regular  telephone  system and dials the
final destination.

         When  used  in a  corporate  environment,  Inter-Tel  Vocal'Net  can be
attached to a T-1/E-1,  ISDN or analog trunk interface on the PBX, and the PBX's
Automatic Route  Selection or Least Cost Routing  features will be programmed to
automatically  route calls for other  locations  that have  Inter-Tel  Vocal'Net
Servers  through  that trunk  interface.  When phone users wish to place a call,
they simply dial the desired  telephone number like any other call. The PBX will
route the call to Inter-Tel  Vocal'Net,  which converts it into the  compressed,
digitized  data  packets  used by an IP network,  and routes the call via the IP
network to another Inter-Tel Vocal'Net gateway. The second gateway connects with
the far-end PBX and dials either the  extension  number of the desired  party or
accesses a trunk on the PBX and makes a call into the switched network.
                                       7
<PAGE>
         Because IP network  telephony  converts all  transmissions  to the same
type of  packets,  both voice and data can use the same data  circuits,  thereby
increasing efficiency and maximizing the use of bandwidth. Bandwidth utilization
can be  maximized  to a point that some users may be able to reduce the  overall
number of circuits needed.

         In its initial commercial  release,  Inter-Tel Vocal'Net is designed to
work with business telephone systems that operate over T-1/E-1,  ISDN and analog
lines, and to handle up to 24 simultaneous calls per server. Inter-Tel Vocal'Net
servers can also be networked to operate seamlessly in configurations consisting
of  thousands  of  ports.  The  Company  is  currently   developing   additional
enhancements,  including industry standard compatibility (H.323) for integration
with PC-based software applications and other types of gateways as well as a fax
gateway to provide fax and broadcast fax capabilities across the Internet. Other
planned enhancements to the Inter-Tel Vocal'Net include  functionality  designed
to allow  businesses to create virtual offices,  enabling  traveling or off-site
employees to connect to the main office from remote  locations.  Another planned
application is  "Touch-To-Talk"  telephony-enabled  web pages,  which will allow
users  to press a link on a web page  and to  automatically  connect  over an IP
network to talk to customer service agents.

         In addition to the Vocal'Net  Gateway  Server,  Inter-Tel has developed
the Inter-Tel Vocal'Net Service Provider and Centralized Accounting System which
provides a centralized  pre-paid and post-paid  billing  system for IP Telephony
service providers.  This system provides back-office support necessary to run an
IP  Telephony  service  business.  Future  planned  enhancements  to the Service
Provider and Centralized  Accounting  System include the integration of an H.323
Gatekeeper  to allow the  system  to  provide  pre-paid  and  post-paid  billing
services for compatible H.323 gateways, routers, or software clients.

         Utilizing  Inter-Tel  Vocal'Net  technology,   Inter-Tel  continues  to
develop and expand  Inter-Tel.net,  a private IP network  designed to carry long
distance  telephone  traffic  at rates  typically  lower than  traditional  long
distance  providers.  Inter-Tel.net  is  currently  being used by the  Company's
employees for calls between  Inter-Tel.net's  seven points of presence:  the San
Francisco Bay Area,  Washington D.C.,  Chicago,  Reno, New York, Phoenix and Los
Angeles.  In its initial  commercial  release,  the Inter-Tel  Vocal'Net gateway
supports calls placed from telephone to telephone. Later releases are planned to
support  communications  from  telephone  to  computer,  computer to  telephone,
computer to computer and a facsimile machine to facsimile machine.  See "Factors
That May  Affect  Future  Operating  Results--Developing  Market  for IP Network
Telephony; Uncertain Regulatory Environment," "--Risks Associated with Inter-Tel
Vocal'Net;  Dependence upon IP Network Infrastructures;  Risk of System Failure;
Security Risks" and "--Development and Maintenance of Inter-Tel.net Network."

         Computer-Telephone Integration

         Through  CTI,  the  computer  and the  telephone  are  linked  into one
environment.  Inter-Tel's  AXXESSORY  Connect  software  for the  AXXESS  system
enables  users to receive  phone calls  through  their  desktop PC. Using Caller
I.D., a caller's  information can be retrieved from the company's  database even
before the call is accepted.  On an individual desktop or a company-wide network
basis,  Inter-Tel offers a variety of products,  such as AXXESSORY ACD, that can
manage  automatic  call  distribution  at  peak  efficiency  or  route  incoming
telephone calls, based on various parameters,  to a specific person. It can also
collect,  analyze and report  real-time call  processing  information  for staff
forecasting and analysis.

         Inter-Tel's  software  applications  integrate,   through  the  use  of
Novell's   TSAPI  and   Microsoft's   TAPI  standard   interfaces,   with  other
"off-the-shelf" Windows applications such as personal information managers, call
routing or call management  software that can further enhance  customer  service
while increasing call efficiency and employee productivity. Inter-Tel has formed
relationships
                                       8
<PAGE>
with a number  of third  party  software  developers  to  integrate  with  their
existing  applications to create a working  environment  for database,  personal
organizer, or terminal emulation programs.

         If these "off-the-shelf"  applications do not adequately meet the needs
of a  customer,  the open design of  Inter-Tel's  software  enables  independent
software developers to write custom applications through Inter-Tel's Developer's
Program. Alternatively, Inter-Tel's CTI Solutions Group can provide professional
consulting  services or development  of individual  customer  applications,  for
either desktop or local area network ("LAN")-based applications.

         Unified Messaging and Voice Processing Software

         Inter-Tel's   unified  messaging   software,   Visual  Mail,  works  in
conjunction  with a variety of  messaging  platforms,  including  the  Microsoft
Exchange messaging application,  Lotus Notes, Lotus cc:Mail,  Novell's GroupWise
and Internet mail applications such as Qualcomm's Eudora. Visual Mail integrates
all types of messages into a single-user  interface on a PC, supports both voice
mail and  facsimile  mail and provides  another  means for  improving  workplace
productivity and retrieving messages from a PC connected to a modem.

         Inter-Tel's AXXESSORY Talk, Axxent Talk and IVX500 are voice processing
platforms  that  work  with  Inter-Tel's   communication  platforms.  All  three
applications  use the  Multi-Vendor  Interface  Protocol  ("MVIP"),  an industry
standard for connecting  multi-vendor PC-based boards in voice processing,  data
switching and video systems.

         Other Services and Products

         Networking Technologies Integration.  To develop a solid foundation for
state-of-the-art  data  and  telecommunications  networking,  customers  require
strategic network expertise from their networking  provider.  Inter-Tel designs,
installs and supports the complete  integration of a customer's complex data and
telecommunications  network,  from land-based LANs to  geographically  dispersed
wide area networks ("WANs").

         By forming  relationships  with major  manufacturers  of  hardware  and
software  technologies,  Inter-Tel  provides  the  routers,  ATM,  LAN  and  WAN
switches,  file servers,  intelligent hubs and any other device required for the
customer's  intranet  or for usage of the  Internet.  Pre-sale  design  support,
project coordination for implementation, and installation support are offered on
the full line of Inter-Tel server-based telephony products and services.

         Network and Long Distance Services. The Company,  through its Inter-Tel
NetSolutions,  Inc.  subsidiary,  resells a  variety  of long  distance  calling
services,  including  domestic and international  calling services,  800 calling
services,  dedicated services, voice and video conferencing,  customized billing
and a variety of other  telecommunication  services.  The Company  believes that
certain of its  customers  desire the  convenience  of acquiring  long  distance
calling  services through the same vendor that the customer uses to purchase its
other  telephony  equipment and  services.  The Company  currently  resells long
distance  services  pursuant to contracts with four of the six largest U.S. long
distance  carriers.  There can be no  assurance  that the Company  will meet its
minimum use commitments,  will be able to negotiate lower rates with carriers in
the  event of any  decrease  in end user  rates  or will be able to  extend  its
contracts with long distance carriers on prices favorable to the Company.

         Call centers  using T-1 access for incoming  toll-free  traffic,  sales
offices using NetSolutions' switched long distance or companies linking multiple
offices  throughout  the  country on a frame relay  network are  examples of the
applications currently supported by Inter-Tel NetSolutions.
                                       9
<PAGE>
         Leasing Services.  The Company offers its Totalease program through its
Inter-Tel Leasing,  Inc. subsidiary.  Totalease enables an end user to acquire a
full range of telephony systems, applications, maintenance and support services,
as well as  lease  financing,  from a  single  vendor.  The  Totalease  contract
provides a total  system  solution to the customer at a set monthly  cost,  with
system expansion available at predictable additional fees. The typical Totalease
contract  has a term of 60  months,  with the  customer  entitled  to renew  the
contract at a specified price for up to an additional 36 months.

         Inter-Tel  also  offers a line of low cost  lease  purchase  financing.
Lease terms range from 24 to 84 months with $1.00,  fixed and fair market  value
purchase options.  In addition,  Inter-Tel will customize  financing packages to
suit customers with special  financial needs. By offering this type of financing
to acquire  Inter-Tel  products  and  services,  the  customer  is able to lease
directly from the manufacturer and Inter-Tel,  or the Inter-Tel  dealer, is able
to maintain a close customer relationship.

         Other   Products.    Inter-Tel   also    distributes    other   leading
telecommunications  products  from its Factored  Products  Division  through its
direct sales offices,  dealers and VARs.  Factored Products  represents products
that Inter-Tel has endorsed as leading  communications  peripherals  utilized in
many day-to-day  functions.  Businesses require  telecommunications  products to
provide  increased  productivity,  ease of operations and  reliability.  Many of
these products interface with Inter-Tel  telephone systems.  Inter-Tel's product
selection  consists  of  videoconferencing,   battery  backup,  headsets,  surge
protection, paging equipment, wireless communications and data multiplexers.

Sales and Distribution

         The  Company  has  developed  a  distribution  network of direct  sales
offices, dealers and VARs which market the Company's products to small to medium
size organizations and divisions or departments of larger organizations.  In the
United States, the Company has 30 direct sales offices and a network of hundreds
of dealers who purchase  systems  directly from the Company.  Direct dealers are
typically  located in  geographic  areas in which the Company  does not maintain
direct sales offices.  The Company also  distributes its products  through VARs.
These resellers have traditionally sold complex data solutions to customers, and
the Company is seeking to leverage  this  distribution  network to capitalize on
the merging of the computer and telephony  industries.  The Company  maintains a
dealer  support  office and direct sales office in the United  Kingdom and has a
network of dealers in the United  Kingdom and Europe.  In addition,  the Company
maintains a dealer support office and direct sales office in Japan.

         The Company believes that its success depends in part upon the strength
of its  distribution  channels and the ability of the Company to maintain  close
access to its end user customers.  In recent periods,  the Company has sought to
improve its access to end user customers by effecting strategic  acquisitions of
resellers of telephony products and services in markets in which the Company has
existing  direct sales offices and in other strategic  markets.  The Company has
expanded  its  direct  sales  office  personnel  from a total of 374  persons at
December 31, 1993 to a total of 822 at December 31, 1997.

         The Company's sales through its direct sales offices as a percentage of
total sales have decreased from 66.4% of net sales in 1994 to 56.7% of net sales
in 1997. Sales to distributors,  dealers,  and VARs have increased from 24.5% of
net sales in 1994 to 28.0% of net sales in 1997.  Sales  through  the  Company's
long distance and network  services  operation  have  increased from 3.4% of net
sales in 1994 to 8.1% of net sales in 1997.

         Direct dealers and VARs  typically  enter into  non-exclusive  reseller
contracts  for a term of one or  more  years.  The  Company  generally  provides
support  and  other  services  to the  reseller  pursuant  to the  terms  of the
agreement.  The agreements often include  requirements that the reseller meet or
use its best efforts to meet minimum annual purchase  quotas.  The Company faces
intense
                                       10
<PAGE>
competition   from  other   telephone   system  and  voice   processing   system
manufacturers for its dealers' attention, as most of the Company's dealers carry
products  which compete with the Company's  products.  There can be no assurance
that any such dealer will not promote the products of the Company's  competitors
to the detriment of the Company's  products.  The loss of any significant dealer
or group of dealers, or any event or condition adversely affecting the Company's
dealer network,  could have a material adverse effect on the Company's business,
financial  condition and operating results.  See "Factors That May Affect Future
Operating Results--Reliance on Dealer Network."

         International sales, which to date have been made through the Company's
United Kingdom and Japan subsidiaries,  accounted for approximately 2.3%, of net
sales in 1997.  In order to sell its products to  customers in other  countries,
the Company must comply with local  telecommunications  standards. The Company's
AXXESS system can be readily altered through software  modifications,  which the
Company  believes will facilitate  compliance with these local  regulations.  In
addition,   the  AXXESS  system  has  been  designed  to  support  multi-lingual
functionality,  and  currently  supports  English and  Japanese.  The Company is
presently  establishing  dealer networks in Japan and other parts of Asia and is
working  to  expand  its  dealer  network  in the  United  Kingdom  and  Europe.
International  sales are  subject  to a number of risks,  including  changes  in
foreign government regulations and telecommunications  standards, export license
requirements,  tariffs and taxes, other trade barriers, fluctuations in currency
exchange  rates,  difficulty in collecting  accounts  receivable,  difficulty in
staffing and managing foreign operations and political and economic instability.
Fluctuations  in currency  exchange rates could cause the Company's  products to
become relatively more expensive to customers in a particular  country,  leading
to a reduction in sales or profitability in that country. In addition, the costs
associated  with developing  international  sales may not be offset by increased
sales in the short term, or at all.

Customer Service and Support

         The Company  believes  that  customer  service and support are critical
components of customer  satisfaction and the success of the Company's  business.
The Company operates a technical support hotline to provide a range of telephone
support to its distributors,  dealers and end user customers through a toll-free
number.  The Company also provides  on-site customer support and, through remote
diagnostic  procedures,  has the ability to detect and correct  system  problems
from its technical support facilities.

         Information  taken from  customer  call records  allows  feedback  into
Inter-Tel's Quality First continuous  improvement process, thus providing a road
map for continuous product and service enhancements. Each direct sales office is
given  a  periodic  service   activity  report   summarizing  the  reasons  that
technicians  are  asking for  assistance  and  common  issues  that give rise to
technical  inquiries.  This  allows  them to  analyze  trends  in their  service
operations and provide better customer service.

Research and Development

         The Company believes that its ability to enhance its current  products,
develop and  introduce new products on a timely  basis,  maintain  technological
competitiveness  and meet customer  requirements  are essential to the Company's
success.  The Company's  research and development  efforts over the last several
years have been focused  primarily on  development  of and  enhancements  to the
existing  AXXESS  and  AXXESSORY  Talk  systems  with  additional  applications,
capacity and  features,  developing a unified  messaging  software  application,
developing a telecommunications  networking package, and developing new products
like the Inter-Tel Vocal'Net Server.  Current efforts are related to support the
development  and  enhancement  of  IP  telephony  products  like  the  Inter-Tel
Vocal'Net Gateway Server, the Vocal'Net Service Provider Package, the support of
H.323  on both  the  gateway  and  service  provider  products,  development  of
additional applications and features
                                       11
<PAGE>
of the AXXESS and AXXESSORY Talk  communications  products.  The  software-based
architecture of the AXXESS system facilitates maintenance and support, upgrades,
and incorporation of additional features and functionality.

         The  Company  had a total  of 97  personnel  engaged  in  research  and
development  as of December 31, 1997.  Research and  development  expenses  were
$7,998,000; $6,581,000 and $5,764,000 for 1997, 1996, and 1995, respectively.

Manufacturing

         The Company manufactures substantially all of its systems through third
party  subcontractors  located in the United States,  China and the Philippines.
These  subcontractors use both standard and proprietary  integrated circuits and
other  electronic   devices  and  components  to  produce  telephone   switches,
telephones   and   printed   circuit   boards  to  the   Company's   engineering
specifications  and designs.  The suppliers  also inspect and test the equipment
before delivering them to the Company, which in some cases then performs systems
integration,   software   loading,   final  testing  and  shipment.   Varian,  a
multinational electronic company,  currently manufacturers a significant portion
of the Company's  products,  including  substantially all of the printed circuit
boards used in the AXXESS and  Inter-Tel  Axxent  systems,  at  Varian's  Tempe,
Arizona  facility.  If Varian or any of the Company's other  manufacturers  were
unable or unwilling to  manufacture  the Company's  products in the future,  the
Company could  experience  substantial  delays in finding  alternative  sources,
which  could  have a  material  adverse  effect on the  Company's  business  and
operating  results.  The Company maintains written agreements with its principal
suppliers. The Company provides a forecast schedule to its suppliers and revises
the forecast on a periodic basis.

         Foreign manufacturing facilities are subject to changes in governmental
policies,  imposition  of tariffs  and import  restrictions,  and other  factors
beyond  the  Company's  control.  Certain  of  the  microprocessors,  integrated
circuits and voice processing  interface cards used in the Company's systems are
currently  available  from a single or limited  sources of supply.  From time to
time,  the Company  experiences  delays in the supply of components and finished
goods. Delay or lack of supply from existing sources or the inability to develop
alternative  sources if and when  required in the future  could  materially  and
adversely affect operating results.  See "Risk  Factors--Dependence  on Contract
Manufacturers and Component Suppliers."

Quality

         The Company believes that the quality of its systems,  customer service
and support,  and other  aspects of its  organization  is a critical  element of
meeting  the  needs of its  customers.  Through  its  Quality  First  continuous
improvement  process initiated in 1991,  Inter-Tel  implements quality processes
throughout  its  business   operations.   The  Company  has  established  formal
procedures to ensure  responsiveness to customer  requests,  to monitor response
times and to measure  customer  satisfaction.  The Company has also  established
means by which all end users,  including  customers of the Company's  resellers,
can make  product  enhancement  requests  directly to the  Company.  The Company
supports  its  dealers and VARs  through an  extensive  training  program at the
Company's  facility and at dealer sites, a toll-free  telephone number for sales
and technical support,  and the provision of end user marketing  materials.  The
Company  typically  provides a one year warranty on its systems to end users. In
manufacturing,  the Company  continuously  monitors  the quality of the products
produced on its behalf by the  Company's  manufacturing  subcontractors,  and is
extending the  Company's  Quality First  continuous  improvement  process to its
suppliers.
                                       12
<PAGE>
Competition

         The market for the  Company's  products  is highly  competitive  and in
recent  periods  has  been  characterized  by  pricing  pressures  and  business
consolidations.  The Company's  competitors  include Lucent  Technologies,  Inc.
("Lucent")  and  Northern  Telecom  Limited  ("NorTel"),   as  well  as  Comdial
Corporation  ("Comdial"),  EXECUTONE  Information Systems,  Inc.  ("Executone"),
Iwatsu America, Inc. ("Iwatsu"),  Mitel Corporation  ("Mitel"),  NEC Corporation
("NEC"),  Nitsuko Corporation  ("Nitsuko"),  Matsushita Electric Industrial Co.,
Ltd.  ("Panasonic"),  Siemens Rolm  Communications,  Inc.  ("Siemens"),  Toshiba
America,   Inc.   ("Toshiba")  and  others.   Many  of  these  competitors  have
significantly  greater  financial,  marketing and technical  resources  than the
Company. The Company also competes against the regional Bell operating companies
("RBOCs"),  which offer  systems  produced by one or more of the  aforementioned
competitors and also offer Centrex systems in which automatic calling facilities
are  provided  through  equipment  located in the  telephone  company's  central
office.

         The Telecommunications Act of 1996 (the  "Telecommunications  Act") and
AT&T Corporation's ("AT&T") announcement to divide itself into three enterprises
has  had  an  impact  on  competition  in  the  communications   industry.   The
Telecommunications  Act opened the market  for  telephone  and cable  television
services,  forcing telephone companies to open their networks to competitors and
giving  consumers  a choice of local  phone  carriers.  Conversely,  local phone
companies  are now able to offer long  distance  services.  In  addition,  cable
television  companies can offer telephone  services and Internet  access.  These
changes  have  increased  competition  in the  communications  industry and have
created additional  competition and opportunities in customer premise equipment,
as these new services and interfaces have become available.

         In the market for voice processing applications,  including voice mail,
the Company  competes against Applied Voice  Technology,  Inc.  ("AVT"),  Active
Voice  Corporation  ("Active  Voice"),   Centigram  Communications   Corporation
("Centigram"), Lucent and other competitors, certain of which have significantly
greater  resources than the Company.  In the market for long distance  services,
the  Company  competes  against  AT&T,  MCI  Communication  Corporation,  Sprint
Corporation,  Qwest  Communications  Corporation and other competitors,  many of
which have  significantly  greater resources than the Company.  The Company also
expects to compete with RBOCs, cable television  companies,  satellite and other
wireless  broadband  service  providers and others for long distance business as
those companies gradually respond to the Telecommunications Act. Key competitive
factors in the sale of telephone systems and related applications include price,
performance,  features,  reliability,  service and support, name recognition and
distribution capability.  The Company believes that it competes favorably in its
markets with respect to the price,  performance and features of its systems,  as
well as the level of  service  and  support  that the  Company  provides  to its
customers.  Certain of the Company's competitors have significantly greater name
recognition and distribution  capabilities than the Company. The Company expects
that  competition  will  continue to be intense in the markets  addressed by the
Company, and there can be no assurance that the Company will be able to continue
to compete successfully.

         In the market for IP telephony  products,  the Company competes against
existing IP telephony  gateway providers such as Lucent,  NetSpeak  Corporation,
VocalTec  Communications Ltd., Vienna Systems Corporation and others. Several of
these  competitors  have been active in  developing  and  marketing IP telephony
products  for a  greater  period  of time  than the  Company  and  have  already
established  relationships with customers within their market. In addition,  the
Company could face  significant  competition from vendors such as Cisco Systems,
Inc.,  Bay  Networks,   Inc.,  3Com  Corporation,   Motorola,   Inc.  and  MICOM
Communications  Corp.,  should such established data vendors choose to enter the
market for IP telephony  products.  Such companies  currently  produce  products
that, if equipped with voice capabilities, could represent a considerable threat
to the Company within that market. Moreover,  should the market for IP telephony
                                       13
<PAGE>
products become fully developed or develop at a rapid rate, large companies such
as IBM Corporation ("IBM") and Microsoft Corporation  ("Microsoft") could choose
to develop proprietary  software designed to facilitate voice communication over
an IP network.

         As the Company  enters the markets for local  telephone  service and IP
network  access,  it will  face  additional  competition  from  RBOCs  and other
providers,  which have larger marketing and sales  organizations,  significantly
greater  financial  and technical  resources  and a larger and more  established
customer  base than the Company.  In addition,  RBOCs and other  providers  have
greater  name  recognition,  more  established  positions in the market and long
standing relationships with customers. Therefore, there can be no assurance that
the Company will compete successfully in these markets.

Intellectual Property Rights

         The Company's  future success will depend in part upon its  proprietary
technology.  Although the Company has applied to the U.S.  Patent and  Trademark
Office  for a patent  related  to certain  aspects  of the  Inter-Tel  Vocal'Net
technology,  the Company currently has no issued patents and relies  principally
on copyright  and trade  secret law and  contractual  provisions  to protect its
intellectual property.  There can be no assurance that any patent,  trademark or
copyright  owned  by the  Company  will  not  be  invalidated,  circumvented  or
challenged  or that  the  rights  granted  thereunder  will  provide  meaningful
protection  or any  commercial  competitive  advantage to the Company.  Further,
there can be no  assurance  that others will not develop  technologies  that are
similar or superior to the Company's  technology or that duplicate the Company's
technology.  As the Company  expands  its  international  operations,  effective
intellectual  property  protection  may be  unavailable  or  limited  in certain
foreign countries. There can be no assurance that the steps taken by the Company
will prevent misappropriation of its technology.  Litigation may be necessary in
the future to enforce the Company's intellectual property rights, to protect the
Company's trade secrets,  to determine the validity and scope of the proprietary
rights of others,  or to defend  against claims of  infringement  or invalidity.
Such litigation could result in substantial costs and diversion of resources and
could have a material  adverse  effect on the  Company's  business and operating
results.

         From time to time,  the  Company  is subject  to  proceedings  alleging
infringement  by the Company of intellectual  property rights of others.  If any
such claim is  asserted  against the  Company,  the Company may seek to obtain a
license under the third party's  intellectual  property rights.  There can be no
assurance that a license will be available on terms acceptable to the Company or
at all. In the alternative,  the Company could resort to litigation to challenge
any such  claim.  Any such  litigation  could  require  the  Company  to  expend
significant  sums and could  require  the  Company to pay  significant  damages,
develop non-infringing technology or acquire licenses to the technology which is
the  subject of the  asserted  infringement,  any of which could have a material
adverse  effect on the Company's  business and operating  results.  In the event
that the Company is unable or chooses not to license such  technology or decides
not to  challenge  such  third  party's  rights,  the  Company  could  encounter
substantial  and costly  delays in product  introductions  while  attempting  to
design  around  such third  party  rights,  or could find that the  development,
manufacture or sale of products requiring such licenses could be foreclosed.

Employees

         As of December 31, 1997, the Company had a total of 1,248 employees, of
whom 1,029 were engaged in sales, marketing and customer support, 47 in quality,
manufacturing and related operations, 97 in research and development,  and 75 in
finance and  administration.  The Company's  future success will depend upon its
ability to attract,  retain and motivate highly qualified employees,  who are in
great demand. The Company believes that its employee relations are excellent.
                                       14
<PAGE>
Factors That May Affect Results of Future Operations

Rapid Technological Change; Dependence On Recently Introduced Products

         The  market  for the  Company's  software,  products  and  services  is
characterized  by rapid  technological  change  and  continuing  demand  for new
products, features and applications.  Current competitors or new market entrants
may develop new products or product  features  that could  adversely  affect the
competitive  position  of  the  Company's  products.   Accordingly,  the  timely
introduction   of  new   products   and  product   features,   as  well  as  new
telecommunications  applications,  will be key factors in the  Company's  future
success.

         During  the  past  eighteen  months,  the  Company  introduced  unified
messaging on its AXXESSORY Talk platform,  developed a number of enhancements to
its existing  AXXESS and  AXXESSORY  Talk  platforms  and  introduced  Inter-Tel
Vocal'Net.  The Company is also  currently in the later stages of developing the
AXXESS 5.0 platform,  which is a significant software upgrade and enhancement to
its AXXESS and  AXXESSORY  Talk  platforms.  The Company's  future  success will
depend, in large part, upon the timely and successful introduction of the AXXESS
5.0  platform.  The  Company's  future  success  will also  depend  upon  market
acceptance  of the  Company's  other new  products  or  enhancements,  including
Inter-Tel  Vocal'Net.  There can be no assurance that these introduced  products
and enhancements will be successful.  In the event that the Company were to fail
to successfully introduce new software,  products or services or upgrades to its
existing  systems or  products  on a regular  and timely  basis,  demand for the
Company's  existing software,  products and services could decline,  which could
have a material adverse effect on the Company's  business and operating results.
Further,  if the markets for IP network  products  or CTI  applications  fail to
develop or grow more slowly than the Company  anticipates,  or if the Company is
unable  for any  reason  to  capitalize  on  either  of  these  emerging  market
opportunities,  the  Company's  business,  financial  condition  and  results of
operations could be materially adversely affected.

         Occasionally,  new products contain undetected program errors or "bugs"
when released.  Such bugs may result from defects contained in software products
offered by the  Company's  suppliers or other third parties that are intended to
be compatible with the Company's products,  over which the Company has little or
no control.  Although  the Company  seeks to minimize  the number of bugs in its
products by its test procedures and quality  control,  there can be no assurance
that its new products will be error free when introduced.  Any significant delay
in the commercial introduction of the Company's products due to bugs, any design
modifications   required  to  correct  bugs  or  any   impairment   of  customer
satisfaction  as a result of bugs could have a  material  adverse  effect on the
Company's business and operating results.  In addition,  new products often take
several months before their manufacturing  costs stabilize,  which may adversely
affect operating results for a period of time following introduction.

Developing Market for IP Network Telephony; Uncertain Regulatory Environment

         The  market  for IP  network  voice  communications  products  has only
recently  begun to  develop,  is rapidly  evolving  and is  characterized  by an
increasing  number of market entrants who have introduced or developed  products
and  services  for  Internet  or other IP network  voice  communications.  As is
typical in the case of a new and rapidly evolving  industry,  the demand for and
market  acceptance of recently  introduced IP network  products and services are
subject to a high degree of  uncertainty.  There can be no assurance  that voice
communications over IP networks will become widespread.  Further,  even if voice
communications over IP networks achieve broad market acceptance, there can be no
assurance that the Company's products,  in particular Inter-Tel Vocal'Net,  will
achieve market acceptance.

         The  adoption  of  voice  communications  over  IP  networks  generally
requires the acceptance of a new way of exchanging  information.  In particular,
enterprises that have already invested
                                       15
<PAGE>
substantial  resources  in  other  means  of  communicating  information  may be
reluctant or slow to adopt a new approach to communications. The lack of control
over IP network  infrastructure  and each user's system  configuration may cause
users of IP network voice  communications  delays in the transmission of speech,
loss of voice packets and inferior sound quality relative to standard  telephony
networks.  If these factors cause the market for IP network voice communications
to fail to develop or to develop more slowly than the Company  anticipates,  the
Company's IP network telephony products could fail to achieve market acceptance,
which in turn could have a material  adverse  effect on the Company's  business,
financial condition and results of operations.

         The  regulatory  environment  for IP  network  telephony  is subject to
substantial  uncertainty.  There can be no assurance that the sale and use of IP
network  telephony  products  such  as  Inter-Tel  Vocal'Net  will  not  violate
telecommunications  or other  regulations  in any of the countries in which such
products are or will be marketed  and used.  In the United  States,  the Company
believes that there are currently few laws or regulations directly applicable to
voice  communications  over IP  networks  or to access  to, or  commerce  on, IP
networks generally. However, changes in the regulatory environment, particularly
in  regulations  relating  to  the  telecommunications  industry,  could  have a
material  adverse  effect on the Company's  business.  The increased  commercial
acceptance of voice communications over IP networks could result in intervention
by  governmental  regulatory  agencies in the United  States or elsewhere in the
world under existing or newly enacted legislation and in the imposition of fees,
charges or taxes on users and  providers  of products and services in this area.
There can be no assurance that such intervention or imposition of fees,  charges
or taxes  would not have a  material  adverse  effect  upon the  acceptance  and
attractiveness  of  IP  network  voice  communications.   Moreover,  legislative
proposals from  international,  federal and state government bodies could impose
additional  regulations and  obligations  upon on-line  service  providers.  The
growing  popularity and use of the Internet has increased public focus and could
lead to  increased  pressure on  legislatures  to impose such  regulations.  The
Company cannot predict the likelihood that any future  legislation or regulation
will be enacted, nor the financial impact, if any, of such resulting legislation
or regulation.  In the future,  the Company may also develop and introduce other
products with new or  additional  telecommunications  capabilities  or services,
which could be subject to existing federal  government  regulations or result in
the  imposition of new  government  regulations,  either in the United States or
elsewhere.

Risks   Associated  with  Inter-Tel   Vocal'Net;   Dependence  Upon  IP  Network
Infrastructures; Risk of System Failure; Security Risks

         In September 1997, the Company began  commercial  shipment of Inter-Tel
Vocal'Net,  its stand-alone IP telephony gateway product and, to date,  revenues
from the sale of this  product  have not been  significant.  To  achieve  market
acceptance,   Inter-Tel   Vocal'Net   will  be  required  to   demonstrate   its
functionality,  scalability and reliability, of which there can be no assurance.
In addition, there can be no assurance that Inter-Tel Vocal'Net will comply with
industry  standards  or that  industry  standards  will not  change  and  render
Inter-Tel  Vocal'Net  obsolete.  In the event that Inter-Tel  Vocal'Net fails to
achieve  market  acceptance,  the Company's  business,  financial  condition and
results of operations could be materially and adversely affected.

         The success of Inter-Tel  Vocal'Net will also depend upon,  among other
things, the continued  expansion of the Internet and other IP networks and their
network  infrastructures.  There can be no assurance that the  infrastructure or
complementary  products  necessary  to make the  Internet  a  viable  commercial
network will  continue to be developed.  In addition,  there can be no assurance
that  IP   networks   will   retain   their   current   volume,   distance   and
time-of-day-independent  pricing  structure,  or that the  costs of access to IP
networks,  lack of  capacity or poor voice  transmission  quality of IP networks
will not  adversely  affect the market for IP  network  products  and  services.
Moreover,  critical  issues  concerning  the  commercial  use  of  the  Internet
(including  security,  reliability,  cost, ease of use and access and quality of
service) remain unresolved and may affect the growth of IP network use.
                                       16
<PAGE>
There can be no  assurance  that the  Internet  will be able to meet  additional
demand or its users' changing  requirements on a timely basis, at a commercially
reasonable cost, or at all.

         The Inter-Tel  Vocal'Net  gateway can be vulnerable to computer viruses
or similar  disruptive  problems.  Computer  viruses or problems caused by third
parties could lead to  interruptions,  delays or cessation of service.  Further,
inappropriate  use of the Internet or other IP networks by third  parties  could
potentially jeopardize the security of confidential information,  such as credit
card or bank account  information  or the content of  conversations  over the IP
network,  which may deter certain  persons from ordering and using the Company's
products.  Until more  comprehensive  security  technologies are developed,  the
security and privacy  concerns of existing and  potential  users may inhibit the
growth of IP  networks in general  and the market for the  Company's  IP network
products in particular.

Development and Maintenance of Inter-Tel.net Network

         The Company is currently utilizing its Inter-Tel  Vocal'Net  technology
to develop  and expand its own IP  network,  Inter-Tel.net,  to carry  telephone
traffic.  The Inter-Tel.net  network is in its initial stages of deployment and,
accordingly,  is subject to a high degree of risk.  To date,  the  Inter-Tel.net
network  has  established  points of  presence  in the San  Francisco  Bay Area,
Washington,  D.C.,  Chicago,  New York,  Phoenix,  Reno and Los Angeles.  If the
market for IP network products fails to develop or develops more slowly than the
Company   anticipates,   the  Company's   Inter-Tel.net   network  could  become
financially burdensome to maintain or obsolete, either of which could materially
and adversely affect the Company's business,  financial condition and results of
operations.

         The Company is dependent on third-party suppliers of telecommunications
and Internet network  transmission  services for implementation of Inter-Tel.net
and does not  currently  have  long-term  contracts  with  such  suppliers.  The
Company's  ability to expand  Inter-Tel.net  is  dependent  upon its  ability to
obtain services from such suppliers.  Certain of these third party suppliers are
or may become competitors of the Company,  and such suppliers  generally are not
subject to restrictions  upon their ability to compete with the Company.  To the
extent that any of these  suppliers  raise their rates or change  their  pricing
structure,  the Company may be materially adversely affected.  Also, the Company
faces the risk that there will be a disruption in the service  provided by these
suppliers,  and can give no  assurance  that  there  will  not be a  significant
disruption  in such service in the future,  thereby  causing a disruption in the
services provided by the Company to its customers.

         Moreover,  although the Company has devoted, and intends to continue to
devote,  substantial resources to improve the quality of telephone conversations
using  Inter-Tel  Vocal'Net  and  the  Inter-Tel.net  network,  there  can be no
assurance  that the  problems  of voice  communications  over the  Inter-Tel.net
network that exist today,  including delays in the transmission of speech,  loss
of voice  packets  and sound  quality  inferior  to that of  standard  telephony
networks, will be eliminated or reduced. In the event that the Company is unable
to improve upon the sound quality and other limitations of voice  communications
over the  Inter-Tel.net  network and to offer such improvements to its customers
on a  cost-effective  basis,  the  Inter-Tel.net  network  could fail to achieve
market acceptance,  and the Company's business,  financial condition and results
of operations could be materially and adversely affected.

Highly Competitive Industry

         The market for the  Company's  products  is highly  competitive  and in
recent  periods  has  been  characterized  by  pricing  pressures  and  business
consolidations.  The Company's competitors include Lucent and NorTel, as well as
Comdial, Executone, Iwatsu, Mitel, NEC, Nitsuko, Panasonic, Siemens, Toshiba and
others.  Many  of  these  competitors  have  significantly   greater  financial,
marketing and technical  resources  than the Company.  The Company also competes
against  the  RBOCs,  which  offer  systems  produced  by  one  or  more  of the
aforementioned competitors and also
                                       17
<PAGE>
offer Centrex systems in which automatic calling facilities are provided through
equipment located in the telephone company's central office.

         The  Telecommunications  Act and AT&T's  announcement  to divide itself
into three  enterprises  has had an impact on competition in the  communications
industry.  The  Telecommunications Act opened the market for telephone and cable
television  services,  forcing  telephone  companies  to open their  networks to
competitors and giving  consumers a choice of local phone carriers.  Conversely,
local phone companies are now able to offer long distance services. In addition,
cable companies can offer telephone services and Internet access.  These changes
have  increased  competition  in the  communications  industry  and have created
additional competition and opportunities in customer premise equipment, as these
new services and interfaces have become available.

         In the market for voice processing applications,  including voice mail,
the Company  competes  against AVT,  Active Voice,  Centigram,  Lucent and other
competitors,  certain of which have  significantly  greater  resources  than the
Company. In the market for long distance services,  the Company competes against
AT&T,  MCI,  Sprint  Corporation,  Qwest  Communications  Corporation  and other
competitors,  many of  which  have  significantly  greater  resources  than  the
Company.  The Company will also compete with RBOCs, cable television  companies,
satellite and other wireless  broadband service  providers,  and others for long
distance business as those companies gradually respond to the Telecommunications
Act.  Key  competitive  factors in the sale of  telephone  systems  and  related
applications  include price,  performance,  features,  reliability,  service and
support, name recognition and distribution capability. The Company believes that
it competes favorably in its markets with respect to the price,  performance and
features of its  systems,  as well as the level of service and support  that the
Company  provides to its customers.  Certain of the Company's  competitors  have
significantly  greater name recognition and distribution  capabilities  than the
Company,  although  the Company  believes  that it has  developed a  competitive
distribution  presence in certain markets,  particularly those where the Company
has direct sales offices.  The Company expects that competition will continue to
be  intense  in the  markets  addressed  by the  Company,  and  there  can be no
assurance that the Company will be able to continue to compete successfully.

         In the market for IP telephony  products,  the Company competes against
existing IP telephony  gateway providers such as Lucent,  NetSpeak  Corporation,
VocalTec  Communications Ltd., Vienna Systems Corporation and others. Several of
these  competitors  have been active in  developing  and  marketing IP telephony
products  for a  greater  period  of time  than the  Company  and  have  already
established  relationships with customers within their market. In addition,  the
Company could face  significant  competition from vendors such as Cisco Systems,
Inc.,  Bay  Networks,   Inc.,  3Com  Corporation,   Motorola,   Inc.  and  MICOM
Communications  Corp.,  should such established data vendors choose to enter the
market for IP telephony  products.  Such companies  currently  produce  products
that, if equipped with voice capabilities, could represent a considerable threat
to the Company within that market. Moreover,  should the market for IP telephony
products become fully developed or develop at a rapid rate, large companies such
as IBM and Microsoft could choose to develop  proprietary  software  designed to
facilitate voice communication over an IP network.

         As the Company  enters the markets for local  telephone  service and IP
network  access,  it will  face  additional  competition  from  RBOCs  and other
providers,  which have larger marketing and sales  organizations,  significantly
greater  financial  and technical  resources  and a larger and more  established
customer  base than the Company.  In addition,  RBOCs and other  providers  have
greater  name  recognition,  more  established  positions in the market and long
standing relationships with customers. Therefore, there can be no assurance that
the Company will compete  successfully  in these markets.  Many of the Company's
current  and  potential   competitors  have  longer  operating  histories,   are
substantially  larger,  and have greater  financial,  manufacturing,  marketing,
technical and other resources. A number also have greater name recognition and a
larger installed base of products than the Company. Competition in the Company's
markets may result in significant price
                                       18
<PAGE>
reductions.  As a result of their greater resources,  many current and potential
competitors  may be better  able than the  Company  to  initiate  and  withstand
significant  price  competition  or downturns  in the  economy.  There can be no
assurance that the Company will be able to continue to compete effectively,  and
any  failure  to do so would  have a material  adverse  effect on the  Company's
business, financial condition and operating results.

Management of Growth; Implementation of New Management Information Systems

         The growth in the  Company's  business  has placed,  and is expected to
continue to place, a significant strain on the Company's  personnel,  management
and  other  resources.  The  Company's  ability  to  manage  any  future  growth
effectively will require it to attract, train, motivate and manage new employees
successfully,  to integrate new  employees  into its overall  operations  and to
continue  to improve  its  operational,  financial  and  management  information
systems.

         The Company  implemented a new MIS system late in 1995.  The MIS system
significantly  affected  many aspects of the Company's  business,  including its
accounting, operations, purchasing, sales and marketing functions. Following the
date of  implementation,  the Company  experienced  difficulty  with the new MIS
software,  which  increased the Company's  costs,  had an adverse  effect on the
Company's  ability to provide products and services to its customers on a timely
basis and caused delays in coordinating accounting and financial results. During
the fourth quarter of 1996, the Company  determined  that the limitations of the
existing system software would prevent Inter-Tel from establishing an integrated
and centralized  dispatch and  telemarketing  center.  As a result,  the Company
signed an agreement with a large,  established  software and database  vendor to
replace its existing MIS software and implement,  maintain and support alternate
MIS  software to be utilized  throughout  the Company.  Accordingly,  during the
fourth  quarter  of  1996,  the  Company  wrote  off the  software  license  and
implementation costs relating to the system software being replaced.

         The  actions to replace the MIS  software  could  result in  additional
costs and delays  associated  with  obtaining  a fully  functional  MIS  system,
including  but not limited to the costs of  procuring  additional  or  alternate
hardware  and  software  required  but  not  available  in  the  current  system
configuration,  and  additional  personnel.  Any such cost or delay could have a
material  adverse  effect on the  Company's  business,  financial  condition and
operating results.  In addition,  implementation of this system software and the
transition  from the  current  system  software  to the new  information  system
software will require substantial financial resources, time and personnel.

         The Company has made strategic  acquisitions in the past and expects to
continue to do so in the future.  Acquisitions  require a significant  amount of
the Company's management attention and financial and operational resources,  all
of which are limited.  The  integration of acquired  entities may also result in
unexpected  costs and disruptions and  significant  fluctuations  in, or reduced
predictability  of,  operating  results  from period to period.  There can be no
assurance   that  an  acquisition   will  not  adversely   affect  the  business
relationships  of the  Company  or  the  acquired  entity  with  its  respective
suppliers or customers. Further, there can be no assurance that the Company will
be able to successfully  integrate any acquired operations or achieve any of the
intended benefits of an acquisition.  The Company's failure to manage its growth
effectively  could have a material  adverse  effect on its  business,  financial
condition and operating results.

Dependence Upon Contract Manufacturers and Component Suppliers

         The Company currently  procures certain  components used in its digital
communication platforms, including certain microprocessors, integrated circuits,
power supplies,  voice processing  interface cards and IP telephony cards from a
single  source  or  limited   sources  of  supply  and,   accordingly,   product
availability could be limited.  As the Company deploys its IP telephony products
and the Inter-Tel.net  network,  the Company expects that it will be required to
increasingly rely upon third party software and hardware suppliers.  The Company
currently manufactures its
                                       19
<PAGE>
products  through a limited  number of  contract  manufacturers  located  in the
United  States,  the  Philippines  and the People's  Republic of China.  Foreign
manufacturing  facilities  are  subject  to changes  in  governmental  policies,
imposition  of tariffs  and import  restrictions  and other  factors  beyond the
Company's control.  Varian Associates,  Inc. ("Varian") currently manufactures a
significant  portion  of the  Company's  products  at  Varian's  Tempe,  Arizona
facility,  including substantially all of the printed circuit boards used in the
AXXESS and Inter-Tel Axxent digital communication platforms.  From time to time,
the Company has  experienced  delays in the supply of  components  and  finished
goods,  and there can be no assurance that the Company will not experience  such
delays in the  future.  The  Company's  reliance  on third  party  manufacturers
involves a number of additional  risks,  including reduced control over delivery
schedules,  quality  assurance  and costs.  Any delay in delivery or shortage of
supply of components or finished goods from Varian or any other supplier, or the
Company's  inability to develop in a timely  manner  alternative  or  additional
sources if and when  required,  could damage the  Company's  relationships  with
current and prospective  customers and could materially and adversely affect the
Company's business,  financial condition and operating results.  The Company has
no long term  agreements  with its  suppliers  that  require  such  suppliers to
provide fixed  quantities of components or finished  goods at set prices.  There
can be no  assurance  that  the  Company  will  be able to  continue  to  obtain
components or finished goods in sufficient quantities or quality or on favorable
pricing and delivery terms in the future.

Product Protection and Infringement

         The Company's  future success will depend in part upon its  proprietary
technology.  Although the Company has applied to the U.S.  Patent and  Trademark
Office  for a patent  related  to certain  aspects  of the  Inter-Tel  Vocal'Net
technology,  the Company currently has no issued patents and relies  principally
on copyright  and trade  secret law and  contractual  provisions  to protect its
intellectual property.  There can be no assurance that any patent,  trademark or
copyright  owned  by the  Company  will  not  be  invalidated,  circumvented  or
challenged  or that  the  rights  granted  thereunder  will  provide  meaningful
protection  or any  commercial  competitive  advantage to the Company.  Further,
there can be no  assurance  that others will not develop  technologies  that are
similar or superior to the Company's  technology or that duplicate the Company's
technology.  As the Company  expands  its  international  operations,  effective
intellectual  property  protection  may be  unavailable  or  limited  in certain
foreign countries. There can be no assurance that the steps taken by the Company
will prevent misappropriation of its technology.  Litigation may be necessary in
the future to enforce the Company's intellectual property rights, to protect the
Company's trade secrets,  to determine the validity and scope of the proprietary
rights of others,  or to defend  against claims of  infringement  or invalidity.
Such litigation could result in substantial costs and diversion of resources and
could  have a  material  adverse  effect on the  Company's  business,  financial
condition and operating results.

         From time to time,  the  Company  is subject  to  proceedings  alleging
infringement  by the Company of intellectual  property rights of others.  If any
such claim is  asserted  against the  Company,  the Company may seek to obtain a
license under the third party's  intellectual  property rights.  There can be no
assurance that a license will be available on terms acceptable to the Company or
at all. In the alternative,  the Company could resort to litigation to challenge
any such  claim.  Any such  litigation  could  require  the  Company  to  expend
significant sums, divert  management's  attention and require the Company to pay
significant damages,  develop  non-infringing  technology or acquire licenses to
the technology which is the subject of the asserted  infringement,  any of which
could  have a  material  adverse  effect on the  Company's  business,  financial
condition  and  operating  results.  In the event that the  Company is unable or
chooses not to license such  technology  or decides not to challenge  such third
party's  rights,  the Company could  encounter  substantial and costly delays in
product introductions while attempting to design around such third party rights,
or could find that the  development,  manufacture or sale of products  requiring
such licenses could be foreclosed.
                                       20
<PAGE>
Reliance on Dealer Network

         A  substantial  portion of the Company's net sales are made through its
network of independent dealers. The Company faces intense competition from other
telephone system and voice  processing  system  manufacturers  for such dealers'
business, as most of the Company's dealers carry products which compete with the
Company's  products.  The Company has no  exclusive  agreements  with any of its
dealers. The loss of any significant dealer or group of dealers, or any event or
condition  adversely  affecting  the  Company's  dealer  network,  could  have a
material  adverse  effect on the  Company's  business,  financial  condition and
operating results.

Dependence on Key Personnel

         The Company is dependent on the  continued  service of, and its ability
to attract and retain,  qualified  technical,  marketing,  sales and  managerial
personnel. The competition for such personnel is intense, and the loss of any of
such  persons,  as well as the failure to recruit  additional  key technical and
sales personnel in a timely manner,  would have a material adverse effect on the
Company's  business and operating  results.  There can be no assurance  that the
Company will be able to continue to attract and retain the  qualified  personnel
necessary for the development of its business.

Risks of Providing Long Distance and Network Services

         Inter-Tel  depends on its  supply of  telecommunications  services  and
information  from  several  long  distance  carriers.  Because  it does  not own
transmission facilities, the Company relies on long distance carriers to provide
network services to the Company's  customers and for billing  information.  Long
distance services are subject to extensive and uncertain governmental regulation
on both  the  federal  and  state  level.  There  can be no  assurance  that the
promulgation of certain regulations will not materially and adversely affect the
Company's business,  financial  condition and operating results.  Contracts with
the long distance  carriers from which the Company  currently  resells  services
typically  have a one year term in which the  Company's  prices  are  relatively
fixed and have minimum use  requirements.  The market for long distance services
is  currently   experiencing  and  is  expected  to  experience  in  the  future
significant price competition, resulting in decreasing end-user rates. There can
be no assurance that the Company will meet minimum use commitments, will be able
to negotiate  lower rates with carriers in the event of any decrease in end user
rates or will be able to extend its  contracts  with long  distance  carriers at
prices favorable to the Company. The Company's ability to continue to expand its
long distance  services  depends upon its ability to continue to secure reliable
long  distance  services  from a  number  of  long  distance  carriers  and  the
willingness of such carriers to continue to provide telecommunications  services
and billing information to the Company on favorable terms.

Potential Fluctuations In Quarterly Results; Limited Backlog

         The  Company's  quarterly  operating  results  depend upon a variety of
factors,  including the volume and timing of orders received during the quarter,
the  mix of  products  sold,  mix of  distribution  channels,  general  economic
conditions, patterns of capital spending by customers, the timing of new product
announcements  and  releases  by  the  Company  and  its  competitors,   pricing
pressures, the cost and effect of acquisitions, and the availability and cost of
products and components from the Company's  suppliers.  The Company's  customers
typically require immediate shipment and installation of platforms and software.
As a result,  the Company has  historically  operated  with a  relatively  small
backlog,  and  sales  and  operating  results  in any  quarter  are  principally
dependent  on  orders  booked  and  shipped  in that  quarter.  Historically,  a
substantial  portion of the  Company's  net sales in a given  quarter  have been
recorded in the third month of the  quarter,  with a  concentration  of such net
sales in the last two weeks of the  quarter.  Market  demand for  investment  in
capital  equipment such as digital  communication  platforms and associated call
processing and voice processing  software  applications is largely  dependent on
general economic
                                       21
<PAGE>
conditions, and can vary significantly as a result of changing conditions in the
economy  as a  whole.  The  Company's  expense  levels  are  based  in  part  on
expectations  of future  sales and,  if sales  levels do not meet  expectations,
operating  results  could  be  adversely  affected.  Because  sales  of  digital
communication  platforms  through  the  Company's  dealers  produce  lower gross
margins than sales through the Company's  direct sales  organization,  operating
results  have  varied,  and will  continue  to vary  based upon the mix of sales
through direct and indirect channels. Although the Company to date has been able
to resell the rental streams from leases under its Totalease program  profitably
and on a  substantially  current basis,  the timing and  profitability  of lease
resales from quarter to quarter could impact operating results,  particularly in
an environment of fluctuating  interest rates.  Long distance sales,  which have
lower gross  margins  than the  Company's  core  business,  have grown in recent
periods at a faster  rate than the  Company's  overall  net sales.  As a result,
gross  margins  could be  adversely  affected  in the event  that long  distance
calling services continue to increase as a percentage of net sales. In addition,
the Company is subject to seasonality in its operating results, as net sales for
the first and third quarters are frequently less than those experienced,  in the
fourth  and  second  quarters,  respectively.  As a result  of these  and  other
factors,  the  Company  has in the past  experienced,  and  could in the  future
experience,  fluctuations in sales and operating  results on a quarterly  basis.
See "Management's  Discussion and Analysis of Financial Condition and Results of
Operations."

Volatility of Stock Price

         The  market  price  for the  Company's  Common  Stock  has been  highly
volatile.   The  Company   believes  that  factors  such  as   announcements  of
developments  relating to the Company's business,  fluctuations in the Company's
operating  results,  shortfalls  in revenue or earnings  relative to  securities
analysts'  expectations,  announcements  of  technological  innovations  or  new
products or enhancements by the Company or its competitors,  general  conditions
in the telecommunications industry or the national or worldwide economy, changes
in  legislation  or regulation  affecting the  telecommunications  industry,  an
outbreak  of  hostilities,  developments  in  intellectual  property  rights and
developments  in the  Company's  relationships  with its customers and suppliers
could  cause the  price of the  Company's  Common  Stock to  fluctuate,  perhaps
substantially.  Many of such  factors  are  beyond  the  Company's  control.  In
addition, in recent years the stock market in general, and the market for shares
of technology stocks in particular, have experienced extreme price fluctuations,
which  have  often been  unrelated  to the  operating  performance  of  affected
companies.  There can be no  assurance  that the market  price of the  Company's
Common  Stock  will  not  experience  significant  fluctuations  in the  future,
including fluctuations that are unrelated to the Company's performance.

Year 2000 Compliance

         Many currently  installed  computer  systems and software  products are
coded to accept only two digit entries in the date code field.  Beginning in the
year 2000,  these date code  fields  will need to accept  four digit  entries to
distinguish  21st century dates from 20th century  dates.  As a result,  in less
than two years, computer systems and/or software used by many companies may need
to be  upgraded  to  comply  with such  "Year  2000"  requirements.  Significant
uncertainty  exists in the software  industry  concerning the potential  effects
associated  with such  compliance.  The Company has  established  procedures for
evaluating and managing the risks and costs  associated  with Year 2000 problems
for its internal information systems, as well as its software, and, although the
Company currently offers software designed to be Year 2000 compliant,  there can
be no assurance that the Company's  software products contain all necessary date
code changes  necessary to prevent  processing errors  potentially  arising from
calculations using the Year 2000 date.

         The Company has  completed an  assessment  of its internal  information
systems and  believes  the current  software  being  implemented  will  function
properly  with  respect  to dates in the Year 2000.  The total  costs of the new
software  implementation  are being capitalized as the Company has abandoned its
current  MIS  software  in favor of a different  system.  The  software is being
replaced with
                                       22
<PAGE>
an integrated solution from a more established vendor and was not in response to
the Year 2000 issue. The Company believes that with conversions to new software,
the Year 2000 will not pose  significant  operational  problems for its computer
systems,  based in part on the vendor's assurance that the software is Year 2000
compliant.  The  software  conversion  is estimated to be completed in phases in
1998 and 1999, which is prior to any estimated impact on its operating  systems.
However, if such conversions are not completed timely, the Year 2000 issue could
have a material impact on the operations of the Company.

         The Company  believes  that the  purchasing  patterns of customers  and
potential  customers  may be  affected by Year 2000 issues in a variety of ways.
Many  companies  are expending  significant  resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase  software  products such as those offered
by the Company.  Many  potential  customers may also choose to defer  purchasing
Year 2000 compliant products until they believe it is absolutely necessary, thus
resulting in potentially  stalled market sales within the industry.  Conversely,
Year 2000 issues may cause other  companies  to  accelerate  purchases,  thereby
causing an increase in short-term demand and a consequent  decrease in long-term
demand for  software  products.  Additionally,  Year 2000  issues  could cause a
significant number of companies, including existing customers of the Company, to
reevaluate their current communications  platform, IP network telephony or voice
processing  software needs, and as a result consider  switching to other systems
or suppliers.

Concentration of Ownership

         As of March 13, 1998, Steven G. Mihaylo,  the Company's Chairman of the
Board of Directors and Chief Executive Officer  beneficially owned approximately
20.0% of the  outstanding  shares of the Common Stock.  As a result,  he has the
ability to exercise  significant  influence over matters  requiring  shareholder
approval.  In addition,  the concentration of ownership could have the effect of
delaying or preventing a change in control of the Company.

         Any of the foregoing  could result in a material  adverse effect on the
Company's business, financial condition and operating results.
                                       23
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Name                            Age               Position
----                            ---               --------

Steven G. Mihaylo               54                Chairman of the Board of
                                                  Directors and Chief
                                                  Executive Officer
Thomas C. Parise                43                President and Chief
                                                  Operating Officer
Craig W. Rauchle                42                Executive Vice President
Ross McAlpine                   46                Sr. Vice President
Kurt R. Kneip                   35                Chief Financial Officer,
                                                  Vice President and Secretary
J. Robert Anderson              61                Director
Gary Edens                      56                Director
Maurice H. Esperseth            72                Director
C. Roland Haden                 57                Director
Norman Stout                    40                Director

         MR. MIHAYLO,  the founder of the Company, has served as Chairman of the
Board of Directors of the Company since  September  1983 and as Chief  Executive
Officer of the Company since its formation in July 1969.  Mr.  Mihaylo served as
President of the Company from 1969 to 1983 and from 1984 to December  1994,  and
as  Chairman  of the Board of  Directors  from July 1969 to  October  1982.  Mr.
Mihaylo also is a director of MicroAge, Inc. and Microtest, Inc.

         MR.  PARISE was elected  President and Chief  Operating  Officer of the
Company in December 1994. He served as Senior Vice President of the Company from
1986 to 1994. He is also  President of Inter-Tel  Integrated  Services,  Inc., a
wholly owned research and development, manufacturing and distribution subsidiary
of the Company.  Mr. Parise joined the Company in 1981 and became Branch General
Manager of the  Phoenix  Direct  Sales  Office in 1982.  In 1983,  he became the
Mountain  Regional Vice  President,  and in January 1985 he was  appointed  Vice
President of  Operations  and Sales  Support.  Mr.  Parise also is a director of
Globe Business Resources, Inc.

         MR.  RAUCHLE was elected  Executive Vice President in December 1994. He
had been Senior Vice  President  of the Company and  continues  as  President of
Inter-Tel Technologies, Inc., a wholly owned sales subsidiary of the Company. In
addition,  he  currently  serves the Company and all  subsidiaries  in corporate
strategic planning and mergers and acquisitions  activities.  Mr. Rauchle joined
the Company in 1979 as Branch General  Manager of the Denver Direct Sales Office
and in 1983 was appointed the Central Region Vice President and subsequently the
Western  Regional  Vice  President.  From 1990 to 1992,  Mr.  Rauchle  served as
President  of Inter-Tel  Communications,  Inc. He is also a director of Prologic
Management Systems, Inc.

         MR.  MCALPINE was elected Senior Vice  President in September  1997. He
also has  served  as  President  of  Inter-Tel  Leasing,  Inc.,  a  wholly-owned
subsidiary of the Company,  since April 1993,  and  President of  Inter-Tel.net,
Incorporated and Inter-Tel NetSolutions, Inc. since 1997. He also served as Vice
President of Inter-Tel  Communications,  Inc.  from April 1991 to April 1992 and
Treasurer  since April 1992.  He joined the Company in July 1991 when  Inter-Tel
acquired  Telecommunications  Specialists,  Inc. Prior to joining Inter-Tel, Mr.
McAlpine  worked 17 years in the leasing and financial  services  industry.  Mr.
McAlpine holds an undergraduate  degree in Accounting from Southwest Texas State
University.

         MR. KNEIP has served as Vice President and Chief  Financial  Officer of
the Company  since  September  1993.  He was elected  Secretary and Treasurer in
October 1994. In May 1996 he was elected Assistant Treasurer, as John Abbott was
elected  Treasurer.  He joined the Company in May
                                       24
<PAGE>
1992 as Director of Corporate Tax, after seven years with the accounting firm of
Ernst &  Young.  Mr.  Kneip  is a  Certified  Public  Accountant,  and  holds an
undergraduate  degree in Commercial Economics from South Dakota State University
and a Masters Degree in  Professional  Accountancy  from the University of South
Dakota.

         MR.  ANDERSON has been a director of the Company since  February  1997.
Mr.  Anderson  held various  positions at Ford Motor  Company from 1963 to 1983,
serving  from  1978 to 1983 as  President  of the Ford  Motor  Land  Development
Corporation.  He served as Senior Vice President,  Chief Financial Officer and a
member of the Board of Directors of The Firestone  Tire and Rubber  Company from
1983 to 1989,  and as Vice  Chairman of  Bridgestone/Firestone,  Inc.  from 1989
through 1991. He most recently served as Vice Chairman,  Chief Financial Officer
and a member of the Board of Directors of the Grumman  Corporation  from 1991 to
1994.  Mr.  Anderson is currently  semi-retired,  and he is an active  leader in
various business, civic and philanthropic organizations.

         MR. EDENS has been a director of the Company since October 1994. He was
a broadcasting  media executive from 1970 to 1994, serving as Chairman and Chief
Executive  Officer  of Edens  Broadcasting,  Inc.  from 1984 to 1994,  when that
corporation's  nine radio  stations were sold. He is currently  President of The
Hanover  Companies,  Inc., an investment firm. He is an active leader in various
business, civic and philanthropic organizations.

         MR.  ESPERSETH  has been a director of the Company  since October 1986.
Mr.   Esperseth   joined   the   Company  in   January   1983  as  Senior   Vice
President-Research and Development,  after a 32-year career with GTE, and served
as  Executive  Vice  President  of Inter-Tel  from 1986 to 1988.  Mr.  Esperseth
retired as an officer of the Company on December 31, 1989.

         DR. HADEN has been a director of the Company since 1983.  Dr. Haden has
been Vice Chancellor and Dean of Engineering of Texas A&M University since 1993.
Previously, he served as Vice Chancellor of Louisiana State University from 1991
to 1993,  Dean of the College of  Engineering  and  Applied  Sciences at Arizona
State  University  from 1989 to 1991,  Vice  President  for Academic  Affairs at
Arizona  State  University  from  1987  to  1988,  and  Dean of the  College  of
Engineering  and Applied  Sciences from 1978 to 1987. Dr. Haden holds a doctoral
degree  in  Electrical  Engineering  from the  University  of Texas and has also
served on the faculty of the University of Oklahoma.

         MR. STOUT has been a director of the Company since  October  1994.  Mr.
Stout has been President of Superlite  Block, a manufacturer  of concrete block,
since February  1993.  Since 1996 Mr. Stout has also been President of Oldcastle
Architectural  West,  the  parent  company  of  Superlite  Block and four  other
concrete products plants. Prior thereto he was employed by Boorhem-Fields,  Inc.
of Dallas,  Texas, a manufacturer of crushed stone,  as Chief Executive  Officer
from 1990 to 1993 and as Chief Financial Officer from 1986 to 1990.  Previously,
Mr. Stout was a Certified Public Accountant with Coopers & Lybrand.

         The  Board of  Directors  has an  Audit  Committee  and a  Compensation
Committee.  The Audit  Committee,  consisting of Directors  Anderson,  Stout and
Esperseth,  is charged with reviewing the Company's  annual audit and meets with
the Company's independent auditors to review the Company's internal controls and
financial  management  practices.  The  Compensation  Committee,  consisting  of
Messrs.  Esperseth,  Edens  and  Stout,  recommends  to the  Board of  Directors
compensation for the Company's key employees and administers the Company's stock
option plans.

ITEM 2.  PROPERTIES

The Company  maintains  its  corporate  headquarters  in 23,000 square feet of a
building  located in Phoenix,  Arizona pursuant to a lease that expires in 2000,
and its  principal  manufacturing  operations  in an 96,000 square foot building
located in  Chandler,  Arizona  pursuant  to a lease that
                                       25
<PAGE>
expires in 2008. The Company also leases sales and support offices in a total of
30 locations in the United  States and two  locations  overseas.  The  Company's
aggregate  monthly  payments  under  these  leases are  currently  approximately
$271,000.  The Company believes that its facilities will be adequate to meet its
current  needs and that  additional  or  alternative  space will be available as
necessary  in  the  future  on   commercially   reasonable   terms.   See  "Risk
Factors--Management  of Growth;  Implementation  of New  Management  Information
Systems."

ITEM 3.  LEGAL PROCEEDINGS

The  Company  is  involved  from time to time in  litigation  incidental  to its
business.  The Company believes that the outcome of current  litigation will not
have a material adverse effect upon its business, financial condition or results
of operations and will not disrupt the normal operations of the Company.

ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

              1.  On November 12, 1997, the Company called a Special  Meeting of
                  Shareholders  for a proposal  to approve an  amendment  to the
                  Company's  Restated  Articles of Incorporation to increase the
                  authorized  number of Common Shares to  100,000,000.  A quorum
                  was not present at the meeting.

              2.  On  November  13,  1997,  the Company  again  called a Special
                  Meeting of Shareholders for a proposal to approve an amendment
                  to  the  Company's   Restated  Articles  of  Incorporation  to
                  increase   the   authorized   number  of   Common   Shares  to
                  100,000,000. A quorum was not present at the meeting.

              3.  On  November  14,  1997,  the Company  again  called a Special
                  Meeting of Shareholders for a proposal to approve an amendment
                  to  the  Company's   Restated  Articles  of  Incorporation  to
                  increase   the   authorized   number  of   Common   Shares  to
                  100,000,000. A quorum was present at the meeting.

                  The proposal to approve an amendment to the Company's Restated
                  Articles of Incorporation to increase the authorized number of
                  Common Shares to 100,000,000 received the following votes:

                                                 Votes         Percentage
                                                 -----         ----------

                  For:                       9,899,140             82.71%
                  Against:                   1,751,065             14.63%
                  Abstain:                     318,963              2.66%


                                     PART II

ITEM 5.       MARKET FOR THE REGISTRANT'S COMMON STOCK AND
              RELATED STOCKHOLDER MATTERS

              The information required by this Item is incorporated by reference
              to Exhibit 13.0 and Page 38 of the Company's 1997 Annual Report to
              Shareholders.

ITEM 6.       SELECTED FINANCIAL DATA

              The information required by this Item is incorporated by reference
              to Exhibit 13.0 and Page 18 of the Company's 1997 Annual Report to
              Shareholders.
                                       26
<PAGE>
ITEM 7.       MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION AND RESULTS OF OPERATIONS

              The information required by this Item is incorporated by reference
              to  Exhibit  13.0 and Pages 30 through  37 of the  Company's  1997
              Annual Report to Shareholders.

ITEM 7A.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

              Not Applicable.

ITEM 8.       FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

              The information required by this Item is incorporated by reference
              to  Exhibit  13.0 and Pages 19 through  29 of the  Company's  1997
              Annual Report to Shareholders.

ITEM 9.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
              ACCOUNTING AND FINANCIAL DISCLOSURE

              Not applicable.


                                    PART III

         Certain information required by Part III is omitted from this report in
that  the  Registrant  will  file  a  definitive  proxy  statement  pursuant  to
Regulation 14A (the "Proxy  Statement") not later than 120 days after the end of
the fiscal year covered by this Report, and the information  included therein is
incorporated herein by reference.

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

              Information  with respect to directors and  executive  officers is
              included  at the end of Part I,  Item 1 on  Pages 24 to 25 of this
              report under the caption  "Directors and Executive Officers of the
              Registrant."

ITEM 11.      EXECUTIVE COMPENSATION

              The information required by this Item is incorporated by reference
              to Pages 6 to 8 of the Company's Proxy  Statement  relating to its
              1998 Annual Meeting of Shareholders.


ITEM 12.      SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
              MANAGEMENT

              The information required by this Item is incorporated by reference
              to Pages4 and 5 of the Company's Proxy Statement.

ITEM 13.      CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

              Not applicable.
                                       27
<PAGE>
                                     PART IV

ITEM 14.      EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
              ON FORM 8-K

              (a) The following documents are filed as part of this Report:

1.   Financial Statements

         The   following   consolidated   financial   statements  of  Inter-Tel,
         Incorporated,  and  subsidiaries,  are  incorporated  by  reference  to
         Exhibit 13.0 and Pages 19 to 29 of the Company's Annual Report:

         Report of Ernst & Young LLP, Independent Auditors

         Consolidated balance sheets--December 31, 1997 and 1996

         Consolidated  statements  of income--years ended December 31, 1997,
         1996 and 1995

         Consolidated  statements of shareholders' equity--years ended December
         31, 1997, 1996 and 1995

         Consolidated  statements  of cash flows--years ended December 31,
         1997, 1996 and 1995

         Notes to consolidated financial statements

2.   Financial Statement Schedules

         The following  consolidated  financial statement schedule of Inter-Tel,
         Incorporated,  and  subsidiaries  is filed as part of this  Report  and
         should  be  read  in  conjunction  with  the   Consolidated   Financial
         Statements of Inter-Tel,  Incorporated and subsidiaries,  and the notes
         thereto.

         Schedule for the three years ended December 31, 1997:
                                                                    Page No.
                                                                    --------

              Schedule II--Valuation and Qualifying Accounts            31

         Schedules  not listed  above  have been  omitted  because  they are not
applicable  or are not  required  or the  information  required  to be set forth
therein is included in the Consolidated Financial Statements or notes thereto.

3.  Exhibits

         3.1(10)         Articles of Incorporation, as amended.

         3.2(16)         By-Laws, as amended.

         10.15(1)        Registrant's form of standard Distributor Agreement.

         10.16(1)        Registrant's form of standard Service Agreement.
                                       28
<PAGE>
         10.34(2)        1984  Incentive  Stock  Option  Plan and forms of Stock
                         Option Agreement.

         10.35(3)        Agreement between Registrant and Samsung  Semiconductor
                         and Telecommunications  Company, Ltd. dated October 17,
                         1984.

         10.37(3)        Tax Deferred Savings Plan.

         10.51(11)       1990  Directors'  Stock  Option  Plan and form of Stock
                         Option Agreement.

         10.52(15)       Inter-Tel,  Incorporated  Long-Term  Incentive Plan and
                         forms of Stock Option Agreements.

         10.53(12)       Agreement  between  Registrant and Maxon Systems,  Inc.
                         dated February 27, 1990.

         10.54(12)       Agreement   between   Registrant   and   Varian   Tempe
                         Electronics Center dated February 26, 1991.

         10.55(12)       Agreement  between  Registrant and Jetcrown  Industrial
                         Ltd. dated February 18, 1993.

         10.56(13)       Employee Stock Ownership Plan.

         10.57(14)       Loan and Security Agreement dated March 4, 1997 between
                         Bank One, Arizona, N.A. and Registrant and Modification
                         Agreement dated July 25, 1997.

         10.58           (16) Development,  Supply and License Agreement between
                         Registrant and QUALCOMM dated January 17, 1996.

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

(1)  Previously filed with Registrant's Registration Statement on Form S-1 (File
     No. 2-70437).

(2)  Previously filed with Registrant's Registration Statement on Form S-8 (File
     No. 2-94805).

(3)  Previously filed with Registrant's  Annual Report on Form 10-K for the year
     ended November 30, 1984 (File No. 0-10211).

(10) Previously filed with Registrant's  Annual Report on Form 10-K for the year
     ended December 31, 1988 (File No. 0-10211).

(11) Previously filed with Registrant's Registration Statement on Form S-8 (File
     No. 33-40353).

(12) Previously filed with Registrant's Registration Statement on Form S-1 (File
     No. 33-70054).

(13) Previously filed with Registrant's Registration Statement on Form S-8 (File
     No. 33-73620).

(14) Filed herewith.

(15) Previously filed with Registrant's Proxy Statement dated March 23, 1994.

(16) Previously filed with Registrant's  Annual Report on Form 10-K for the year
     ended December 31, 1995 (File No. 0-10211).
                                       29
<PAGE>
(17) Filed herewith, except as noted.

         (b)  Reports on Form 8-K.

              None.

         (c)  Exhibits.

              13.0  Excerpts  from  Annual  Report  to  Security  Holders.  (not
                    attached  herewith;  a copy of the excerpts of the Company's
                    Annual  Report  to  Security  Holders  was  filed  with  the
                    Securities  and Exchange  Commission  and a complete copy of
                    the Annual  Report is  available  upon request by writing to
                    Shareholder Relations, Inter-Tel,  Incorporated, 120 N. 44th
                    Street, Suite 200, Phoenix, Arizona 85034)

              23.0  Consent of Ernst & Young LLP,  Independent  Auditors.  (Page
                    33)

              24.1  Power of Attorney. (Page 31)

              See Item 14(a) (3) also.

         (d)  Financial Statement Schedules

              The response to this portion of Item 14 is submitted as a separate
              section of this report. See Item 8.




                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant,  Inter-Tel,  Incorporated, has duly caused
this  Report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.



                                 INTER-TEL, INCORPORATED




DATED: March 23, 1998            BY: /S/  Steven G. Mihaylo
                                    -----------------------
                                     Steven G. Mihaylo
                                     Chairman and Chief Executive Officer
                                       30
<PAGE>
                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                 (in thousands)
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
          COL. A             COL. B              COL. C                    COL. D            COL. E
--------------------------------------------------------------------------------------------------------
                                               ADDITIONS
--------------------------------------------------------------------------------------------------------
                                          Charged         Charged to
                            Balance at      to             Other           Charged to        Balance
                            Beginning     Costs &         Accounts         Deductions        at End of
          DESCRIPTION       of Period     Expenses        Describe          Describe          Period
--------------------------------------------------------------------------------------------------------
<S>                           <C>          <C>             <C>             <C>               <C>
Year ended December 31, 1997

Deducted from asset accounts:
   Allowance for doubtful
      accounts                $3,096       $2,194          $ 17            $1,585(1)         $3,722
                               -----        -----           ---             -----             -----
   Allowance for lease
      accounts                $2,706       $1,910          $ --            $  647(1)         $3,969
                               -----        -----           ---             -----             -----
   Inventory allowance        $2,979       $4,021          $ --            $1,260(2)         $5,740
                               -----        -----           ---             -----             -----


Year ended December 31, 1996

Deducted from asset accounts:
   Allowance for doubtful
      accounts (4)            $1,822       $1,801          $ 87 (3)        $  614(1)         $3,096
                               -----        -----           ---             -----             -----
  Allowance for lease
      accounts                $1,513       $1,945          $(87)(3)        $  665(1)         $2,706
                               -----        -----           ---             -----             -----
   Inventory allowance (4)    $2,499       $  609          $175 (5)        $  304(2)         $2,979
                               -----        -----           ---             -----             -----

Year ended December 31, 1995

Deducted from asset accounts:
   Allowance for doubtful
      accounts (4)            $1,181       $  814          $ 71 (3)        $  244(1)         $1,822
                               -----        -----           ---             -----             -----
   Allowance for lease
      accounts                $1,198       $  780          $(71)(3)        $  394(1)         $1,513
                               -----        -----           ---             -----             -----
   Inventory allowance (4)    $1,795       $1,109          $ --            $  405(2)         $2,499
                               -----        -----           ---             -----             -----
--------------------------------------------------------------------------------------------------------
</TABLE>
(1)  Uncollectible accounts written off, net of recoveries.
(2)  Inventory written off.
(3)  Reclassed between appropriate valuation and qualifying accounts.
(4)  Adjusted for pooling of Florida Telephone Systems, Inc.
(5)  Acquired in purchase of NTL Corporation (dba ComNet of Ohio).
                                       31