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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarter ended
    
    Commission File Number:June 30, 2005
    
    0-10211
 INTER-TEL, INCORPORATED
 Incorporated in the State of Arizona
    
    I.R.S. No. 86-0220994
 1615 S. 52 nd Street
Tempe, Arizona 85281
 (480) 449-8900
 
 Title of Class
    
    Outstanding as of June 30, 2005Common Stock, no par value
    
    26,078,154
 þ o
 þ o




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INDEX
 INTER-TEL, INCORPORATED AND SUBSIDIARIES
  
 PagePART I. FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (unaudited)Condensed Consolidated Balance SheetsJune 30, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Incomethree and six months ended June 30, 2005 and June 30, 2004
    
    
    4Condensed Consolidated Statements of Cash Flowssix months ended June 30, 2005 and June 30, 2004
    
    
    5Notes to Condensed Consolidated Financial StatementsJune 30, 2005
    
    
    6Item 2.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    41Item 4.
    
    Controls and Procedures
    
    
    41PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    43Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    43Item 3.
    
    Defaults Upon Senior Securities
    
    
    43Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    43Item 5.
    
    Other Information
    
    
    44Item 6.
    
    Exhibits
    
    
    44SIGNATURES
    
    
    45MANAGEMENT CERTIFICATIONS
    
    
    46EX-31.1EX-31.2EX-32.1EX-32.2
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PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 June 30,
    
    December 31,(in thousands, except share amounts)
    
    2005
    
    2004(Unaudited)
    
    (Note A)ASSETSCURRENT ASSETSCash and equivalents
    
    $
    94,018
    
    
    $
    152,330Short-term investments
    
    
    62,799
    
    
    
    52,644TOTAL CASH AND SHORT-TERM INVESTMENTS
    
    
    156,817
    
    
    
    204,974Accounts receivable, net of allowances of $9,016
in 2005 and $9,921 in 2004
    
    
    43,897
    
    
    
    45,176Inventories
    
    
    19,696
    
    
    
    16,055Net investment in sales-leases, net of allowances
of $974 in 2005 and $886 in 2004
    
    
    19,407
    
    
    
    17,151Income taxes receivable
    
    
    2,208
    
    
    
    4,017Deferred income taxes
    
    
    12,653
    
    
    
    9,905Prepaid expenses and other assets
    
    
    8,954
    
    
    
    7,194TOTAL CURRENT ASSETS
    
    
    263,632
    
    
    
    304,472LONG-TERM INVESTMENTS
    
    
    
    
    
    
    9,900PROPERTY, PLANT & EQUIPMENT
    
    
    28,423
    
    
    
    27,840GOODWILL
    
    
    26,549
    
    
    
    19,890PURCHASED INTANGIBLE ASSETS
    
    
    25,997
    
    
    
    10,987NET INVESTMENT IN SALES-LEASES, net of allowances
of $2,019 in 2005 and $1,810 in 2004
    
    
    36,559
    
    
    
    33,877TOTAL ASSETS
    
    $
    381,160
    
    
    $
    406,966LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    35,380
    
    
    $
    30,801Other current liabilities
    
    
    45,083
    
    
    
    52,196TOTAL CURRENT LIABILITIES
    
    
    80,463
    
    
    
    82,997DEFERRED TAX LIABILITY
    
    
    66,700
    
    
    
    65,234LEASE RECOURSE LIABILITY
    
    
    13,532
    
    
    
    12,241OTHER LIABILITIES
    
    
    6,964
    
    
    
    7,063SHAREHOLDERS EQUITYCommon stock, no par value-authorized 100,000,000
shares; issued27,161,823 shares;
outstanding26,078,154 at June 30, 2005 and
26,125,799 shares at December 31, 2004
    
    
    120,071
    
    
    
    116,598Retained earnings
    
    
    110,873
    
    
    
    134,455Accumulated other comprehensive income
    
    
    399
    
    
    
    924231,343
    
    
    
    251,977Less: Treasury stock at cost  1,083,669 shares
at June 30, 2005 and 1,036,024 shares at December
31, 2004
    
    
    (17,842
    )
    
    
    (12,546
    )TOTAL SHAREHOLDERS EQUITY
    
    
    213,501
    
    
    
    239,431TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    381,160
    
    
    $
    406,966
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
 (In thousands, except
    
    Three Months
    
    Six Monthsper share amounts)
    
    Ended June 30,
    
    Ended June 30,2005
    
    2004
    
    2005
    
    2004NET SALESTelecommunications systems, software and related
    
    $
    101,647
    
    
    $
    90,666
    
    
    $
    194,306
    
    
    $
    176,715Resale of local, long distance and network services
    
    
    13,905
    
    
    
    12,242
    
    
    
    26,953
    
    
    
    24,224TOTAL NET SALES
    
    
    115,552
    
    
    
    102,908
    
    
    
    221,259
    
    
    
    200,939COST OF SALESTelecommunications systems, software and related
    
    
    46,904
    
    
    
    41,138
    
    
    
    90,301
    
    
    
    80,013Resale of local, long distance and network services
    
    
    8,316
    
    
    
    7,471
    
    
    
    16,572
    
    
    
    14,529TOTAL COST OF SALES
    
    
    55,220
    
    
    
    48,609
    
    
    
    106,873
    
    
    
    94,542GROSS PROFIT
    
    
    60,332
    
    
    
    54,299
    
    
    
    114,386
    
    
    
    106,397Research and development
    
    
    8,713
    
    
    
    7,144
    
    
    
    17,168
    
    
    
    13,179Selling, general and administrative
    
    
    40,252
    
    
    
    34,337
    
    
    
    78,975
    
    
    
    69,341Amortization of purchased intangible assets
    
    
    1,122
    
    
    
    436
    
    
    
    1,884
    
    
    
    881Write-off of in-process research and development costs
    
    
    
    
    
    
    
    
    
    
    2,600
    
    
    
    50,087
    
    
    
    41,917
    
    
    
    100,627
    
    
    
    83,401OPERATING INCOME
    
    
    10,245
    
    
    
    12,382
    
    
    
    13,759
    
    
    
    22,996Interest and other income
    
    
    920
    
    
    
    570
    
    
    
    1,867
    
    
    
    1,076Foreign currency transaction gains (losses)
    
    
    88
    
    
    
    (113
    )
    
    
    141
    
    
    
    (274
    )Interest expense
    
    
    (23
    )
    
    
    (42
    )
    
    
    (46
    )
    
    
    (88
    )INCOME BEFORE INCOME TAXES
    
    
    11,230
    
    
    
    12,797
    
    
    
    15,721
    
    
    
    23,710INCOME TAXES
    
    
    4,237
    
    
    
    4,680
    
    
    
    6,793
    
    
    
    8,773NET INCOME
    
    $
    6,993
    
    
    $
    8,117
    
    
    $
    8,928
    
    
    $
    14,937NET INCOME PER SHARE  BASIC
    
    $
    0.27
    
    
    $
    0.32
    
    
    $
    0.34
    
    
    $
    0.58NET INCOME PER SHARE  DILUTED
    
    $
    0.26
    
    
    $
    0.30
    
    
    $
    0.33
    
    
    $
    0.55DIVIDENDS PER SHARE
    
    $
    0.08
    
    
    $
    0.06
    
    
    $
    1.16
    
    
    $
    0.12Average number of common shares outstanding  Basic
    
    
    26,301
    
    
    
    25,715
    
    
    
    26,337
    
    
    
    25,629Average number of common shares outstanding  Diluted
    
    
    27,069
    
    
    
    27,262
    
    
    
    27,429
    
    
    
    27,306
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 (In thousands)
    
    Six MonthsEnded June 30,2005
    
    2004OPERATING ACTIVITIESNet income
    
    $
    8,928
    
    
    $
    14,937Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation of fixed assets
    
    
    4,712
    
    
    
    3,976Amortization of patents included in R&D expenses
    
    
    111
    
    
    
    111Amortization of purchased intangible assets
    
    
    1,884
    
    
    
    881Purchased in-process research and development
    
    
    2,600
    
    
    
    Provision for losses on receivables
    
    
    846
    
    
    
    1,050Provision for losses on leases
    
    
    1,814
    
    
    
    1,795Provision for inventory valuation
    
    
    464
    
    
    
    258Decrease in other liabilities
    
    
    (442
    )
    
    
    (1,786
    )Loss on sale of property and equipment
    
    
    22
    
    
    
    3Deferred income taxes
    
    
    218
    
    
    
    7,010E-Rate settlement
    
    
    (8,461
    )
    
    
    Changes in operating assets and liabilities
    
    
    (640
    )
    
    
    (1,435
    )NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    12,056
    
    
    
    26,800INVESTING ACTIVITIESPurchases of available for sale short-term investments
    
    
    (20,578
    )
    
    
    (36,827
    )Maturities and sales of available for sale investments
    
    
    19,498
    
    
    
    49,831Purchases of held-to-maturity investments
    
    
    
    
    
    
    (12,730
    )Maturities and sales of held-to-maturity investments
    
    
    825
    
    
    
    Additions to property, plant and equipment
    
    
    (4,267
    )
    
    
    (4,066
    )Proceeds from disposal of property, plant and equipment
    
    
    16
    
    
    
    21Cash used in acquisitions
    
    
    (27,765
    )
    
    
    (100
    )NET CASH USED IN INVESTING ACTIVITIES
    
    
    (32,271
    )
    
    
    (3,871
    )FINANCING ACTIVITIESCash dividends paid
    
    
    (30,674
    )
    
    
    (3,064
    )Treasury stock purchases
    
    
    (13,777
    )
    
    
    Payments on term debt
    
    
    (23
    )
    
    
    (28
    )Proceeds from stock issued under the Employee Stock
Purchase Plan
    
    
    582
    
    
    
    500Proceeds from exercise of stock options
    
    
    6,320
    
    
    
    4,433NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
    
    
    (37,572
    )
    
    
    1,841EFFECT OF EXCHANGE RATE CHANGES
    
    
    (525
    )
    
    
    167(DECREASE) INCREASE IN CASH AND EQUIVALENTS
    
    
    (58,312
    )
    
    
    24,937CASH AND EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    152,330
    
    
    
    115,197CASH AND EQUIVALENTS AT END OF PERIOD
    
    $
    94,018
    
    
    $
    140,134
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 NOTE ABASIS OF PRESENTATION
   Stock-Based Compensation
   (In thousands, except
    
    Three Months Ended
    
    Six Months Endedper share amounts)
    
    June 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Net income, as reported
    
    $
    6,993
    
    
    $
    8,117
    
    
    $
    8,928
    
    
    $
    14,937Deduct: total stock-based
compensation expense, determined
under fair value based method for
all awards, net of tax
    
    
    (6,518
    )
    
    
    (837
    )
    
    
    (7,243
    )
    
    
    (1,620
    )Pro forma net income
    
    $
    475
    
    
    $
    7,280
    
    
    $
    1,685
    
    
    $
    13,317Earnings per share of common stock:Basic  as reported
    
    $
    0.27
    
    
    $
    0.32
    
    
    $
    0.34
    
    
    $
    0.58
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(In thousands, except
    
    Three Months Ended
    
    Six Months Endedper share amounts)
    
    June 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004Basic  pro forma
    
    $
    0.02
    
    
    $
    0.28
    
    
    $
    0.06
    
    
    $
    0.52Diluted  as reported
    
    $
    0.26
    
    
    $
    0.30
    
    
    $
    0.33
    
    
    $
    0.55Diluted  pro forma
    
    $
    0.02
    
    
    $
    0.27
    
    
    $
    0.06
    
    
    $
    0.49
    Contingencies
   7




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Inventories
  Recent Accounting Pronouncements
 Share Based Payment. Accounting for Stock Issued to Employees, Statement of Cash Flows.
 1.
    
    A modified prospective method in which compensation cost is recognized beginning with
the effective date (a) based on the requirements of SFAS No. 123R for all share-based
payments granted after the effective date and (b) based on the requirements of SFAS No. 123
for all awards granted to employees prior to the effective date of SFAS No. 123R that remain
unvested on the effective date, or2.
    
    A modified retrospective method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based on the
amounts previously
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recognized under SFAS No. 123 for purposes of pro forma disclosures
either (a) all prior periods presented or (b) prior interim periods of the year of adoption.
  NOTE BEARNINGS PER SHARE
   Three Months Ended
    
    Six Months Ended(In thousands, except
    
    June 30,
    
    June 30,per share amounts)
    
    2005
    
    2004
    
    2005
    
    2004Numerator: Net income
    
    $
    6,993
    
    
    $
    8,117
    
    
    $
    8,928
    
    
    $
    14,937Denominator:Denominator for basic earnings
per share  weighted average
shares
    
    
    26,301
    
    
    
    25,715
    
    
    
    26,337
    
    
    
    25,629Effect of dilutive securities:Employee and director stock options
    
    
    768
    
    
    
    1,547
    
    
    
    1,092
    
    
    
    1,677Denominator for diluted earnings per
share  adjusted weighted average
shares and assumed conversions
    
    
    27,069
    
    
    
    27,262
    
    
    
    27,429
    
    
    
    27,306Basic earnings per share
    
    $
    0.27
    
    
    $
    0.32
    
    
    $
    0.34
    
    
    $
    0.58Diluted earnings per share
    
    $
    0.26
    
    
    $
    0.30
    
    
    $
    0.33
    
    
    $
    0.55Options excluded from
diluted net earnings per
share calculations (1)
    
    
    669,100
    
    
    
    189,500
    
    
    
    252,000
    
    
    
    64,000
 
  NOTE C
 ACQUISITIONS, TECHNOLOGY INVESTMENTS AND RESTRUCTURING CHARGES
 Lake.
 9




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New Sales Offices in 2004.
 New Technology Investments in 2004.
 Technology Investment in 2003
   10




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Executone Restructuring Charge.
   Activity
    
    
    
    
    
    ReserveCash/
    
    Restructuring
    
    Through
    
    2005
    
    BalanceDescription
    
    Non-Cash
    
    Charge
    
    2004
    
    Activity
    
    At 6/30/05Personnel Costs:Severance and termination costs
    
    Cash
    
    $
    (1,583
    )
    
    $
    1,583
    
    
    $
    
    
    
    $
    Other plant closure costs
    
    Cash
    
    
    (230
    )
    
    
    230
    
    
    
    
    
    
    
    Lease termination and other
contractual obligations (net of
anticipated recovery):Building and equipment leases
    
    Cash
    
    
    (7,444
    )
    
    
    7,436
    
    
    
    8
    
    
    
    Other contractual obligations
    
    Cash
    
    
    (1,700
    )
    
    
    1,700
    
    
    
    
    
    
    
    Impairment of Assets:Inventories
    
    Non-Cash
    
    
    (3,454
    )
    
    
    3,454
    
    
    
    
    
    
    
    Prepaid inventory
and other expenses
    
    Non-Cash
    
    
    (2,485
    )
    
    
    2,485
    
    
    
    
    
    
    
    Accounts receivable
    
    Non-Cash
    
    
    (1,685
    )
    
    
    1,685
    
    
    
    
    
    
    
    Fixed assets
    
    Non-Cash
    
    
    (3,151
    )
    
    
    3,034
    
    
    
    3
    
    
    
    114Net intangible assets
    
    Non-Cash
    
    
    (29,184
    )
    
    
    29,184
    
    
    
    
    
    
    
    Total
    
    
    
    
    
    $
    (50,916
    )
    
    $
    50,791
    
    
    $
    11
    
    
    $
    114
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NOTE D
 SEGMENT INFORMATION
    Three Months Ended June 30, 2005Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    101,647
    
    
    $
    13,905
    
    
    $
    115,552Gross profit
    
    
    54,743
    
    
    
    5,589
    
    
    
    60,332Operating income
    
    
    7,909
    
    
    
    2,336
    
    
    
    10,245Interest and other income
    
    
    883
    
    
    
    37
    
    
    
    920Foreign currency transaction gains
    
    
    88
    
    
    
    
    
    
    
    88Interest expense
    
    
    (19
    )
    
    
    (4
    )
    
    
    (23
    )Net income
    
    $
    5,487
    
    
    $
    1,506
    
    
    $
    6,993Net income per diluted share (1)
    
    $
    0.20
    
    
    $
    0.06
    
    
    $
    0.26Weighted average diluted shares (1)
    
    
    27,069
    
    
    
    27,069
    
    
    
    27,069Goodwill
    
    $
    24,414
    
    
    $
    2,135
    
    
    $
    26,549Total assets
    
    
    370,467
    
    
    
    10,693
    
    
    
    381,160Depreciation and amortization
    
    $
    3,616
    
    
    $
    22
    
    
    $
    3,638
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Three Months Ended June 30, 2004Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    90,666
    
    
    $
    12,242
    
    
    $
    102,908Gross profit
    
    
    49,528
    
    
    
    4,771
    
    
    
    54,299Operating income
    
    
    10,332
    
    
    
    2,050
    
    
    
    12,382Interest and other income
    
    
    526
    
    
    
    44
    
    
    
    570Foreign currency transaction losses
    
    
    (113
    )
    
    
    
    
    
    
    (113
    )Interest expense
    
    
    (42
    )
    
    
    
    
    
    
    (42
    )Net income
    
    $
    6,800
    
    
    $
    1,317
    
    
    $
    8,117Net income per diluted share (1)
    
    $
    0.25
    
    
    $
    0.05
    
    
    $
    0.30Weighted average diluted shares (1)
    
    
    27,262
    
    
    

    27,262
    
    
    
    27,262Goodwill
    
    $
    15,726
    
    
    $
    2,135
    
    
    $
    17,861Total assets
    
    
    359,388
    
    
    
    20,126
    
    
    
    379,514Depreciation and amortization
    
    $
    2,578
    
    
    $
    8
    
    
    $
    2,586
 Six Months Ended June 30, 2005Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    194,306
    
    
    $
    26,953
    
    
    $
    221,259Gross profit
    
    
    104,005
    
    
    
    10,381
    
    
    
    114,386In-process research and development
    
    
    2,600
    
    
    
    
    
    
    
    2,600Operating income
    
    
    9,677
    
    
    
    4,082
    
    
    
    13,759Interest and other income
    
    
    1,789
    
    
    
    78
    
    
    
    1,867Foreign currency transaction gains
    
    
    141
    
    
    
    
    
    
    
    141Interest expense
    
    
    (42
    )
    
    
    (4
    )
    
    
    (46
    )Net income
    
    $
    6,272
    
    
    $
    2,656
    
    
    $
    8,928Net income per diluted share (1)
    
    $
    0.23
    
    
    $
    0.10
    
    
    $
    0.33Weighted average diluted shares (1)
    
    
    27,429
    
    
    
    27,429
    
    
    

    27,429Goodwill
    
    $
    24,414
    
    
    $
    2,135
    
    
    $
    26,549Total assets
    
    
    370,467
    
    
    
    10,693
    
    
    
    381,160Depreciation and amortization
    
    $
    6,677
    
    
    $
    30
    
    
    $
    6,707
 Six Months Ended June 30, 2004Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    176,715
    
    
    $
    24,224

    
    
    $
    200,939Gross profit
    
    
    96,702
    
    
    
    9,695
    
    
    
    106,397Operating income
    
    
    18,774
    
    
    
    4,222
    
    
    
    22,996Interest and other income
    
    
    976
    
    
    
    100
    
    
    
    1,076Foreign currency transaction losses
    
    
    (274
    )
    
    
    
    
    
    
    (274
    )Interest expense
    
    
    (87
    )
    
    
    (1
    )
    
    
    (88
    )Net income
    
    $
    12,215
    
    
    $
    2,722
    
    
    $
    14,937Net income per diluted share (1)
    
    $
    0.45
    
    
    $
    0.10
    
    
    $
    0.55Weighted average diluted shares (1)
    
    
    27,306
    
    
    
    27,306
    
    
    
    27,306Goodwill
    
    $
    15,726
    
    
    $
    2,135
    
    
    $
    17,861Total assets
    
    
    359,388
    
    
    
    20,126
    
    
    
    379,514Depreciation and amortization
    
    $
    4,945
    
    
    $
    22
    
    
    $
    4,967
 13




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##### Table of Contents



Quarter Ended June 30, 2005
    
    Quarter Ended June 30, 2004Source of net sales
    
    $
    
    %
    
    $
    
    %Domestic
    
    $
    104,566
    
    
    
    90.5
    %
    
    $
    99,662
    
    
    
    96.8
    %Lake Communications
    
    
    7,907
    
    
    
    6.8
    %
    
    
    
    
    
    
    
    %Other International
    
    
    3,079
    
    
    
    2.7
    %
    
    
    3,246
    
    
    
    3.2
    %Total net sales
    
    $
    115,552
    
    
    
    100.0
    %
    
    $
    102,908
    
    
    
    100.0
    %
 Six Months Ended June 30, 2005
    
    Six Months Ended June 30, 2004Source of net sales
    
    $
    
    %
    
    $
    
    %Domestic
    
    $
    204,319
    
    
    
    92.3
    %
    
    $
    194,443
    
    
    
    96.8
    %Lake Communications
    
    
    10,497
    
    
    
    4.7
    %
    
    
    
    
    
    
    
    %Other International
    
    
    6,443
    
    
    
    2.9
    %
    
    
    6,496
    
    
    
    3.2
    %Total net sales
    
    $
    221,259
    
    
    
    100.0
    %
    
    $
    200,939
    
    
    
    100.0
    %
   NOTE
E NET INVESTMENT IN SALES-LEASES
  14




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##### Table of Contents



June 30,
    
    December 31,(in thousands)
    
    2005
    
    2004Lease balances included in consolidated accounts receivable, net
of allowances of $1,044 in 2005, and $1,177 in 2004
    
    $
    6,033
    
    
    $
    6,390Net investment in Sales-Leases:Current portion, net of allowances of $974 in 2005, and $886 in 2004
    
    
    19,407
    
    
    
    17,151Long-term portion, includes residual amounts of $713 in 2005 and,
$510 in 2004, net of allowances of $2,019 in 2005, and $1,810 in
2004
    
    
    36,559
    
    
    
    33,877Total investment in Sales-Leases, net of allowances of $4,037 in 2005,
and $3,873 in 2004
    
    
    61,999
    
    
    
    57,418Sold rental payments remaining unbilled (subject to limited recourse
provisions), net of allowances of $13,532 in 2005, and $12,241 in 2004
    
    
    244,988
    
    
    
    229,163Total balance of sales-leases and sold rental payments remaining
unbilled, net of allowances
    
    $
    306,987
    
    
    $
    286,581Total allowances for entire lease portfolio (including limited recourse
liabilities)
    
    $
    17,569
    
    
    $
    16,114
   Six Months Ended
    
    Year Ended(In thousands)
    
    June 30, 2005
    
    December 31, 2004Sales of rental payments
    
    $
    60,640
    
    
    $
    113,172Sold payments remaining unbilled at end of period
    
    
    258,520
    
    
    
    241,404
   15




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 This Quarterly Report to Shareholders on Form 10-Q (10-Q) contains forward-looking
statements that involve risks and uncertainties. The statements contained in this 10-Q 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 our expectations, beliefs, intentions or strategies for the future.
All forward-looking statements included in this document are based on information available to us
on the date hereof, and we assume no obligation to update any such forward-looking statements. The
cautionary statements made in this 10-Q should be read as being applicable to all related
forward-looking statements wherever they appear in this document. Our 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 Future Operating Results below
and elsewhere in this document.
 Overview
  
    
    Inter-Tel Axxessâ and Inter-Tel 5000 Network Communications Solutions converged
voice and data business communication systems,
    
    Lake Communications converged voice and data business communication systems, including
those sold in the US under the EncoreCXâ brand,
    
    integrated voice mail, voice processing and unified messaging systems,
    
    managed services, including voice and data network design and traffic provisioning,
custom application development, and financial solutions packages (leasing),
    
    networking applications, including the design and implementation of voice and data
networks,
    
    local and long distance calling services, voice circuits, data circuits and other
communications services and peripheral products,
    
    call accounting software, computer-telephone integration (CTI) applications, and
    
    maintenance and support services for our products.
  Ò
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
    
    End-user sales and sales-type leases through our direct sales offices and government and
national accounts division. We recognize revenue from sales of systems and services to
end-user customers upon installation of the systems and performance of the services,
respectively, allowing for use by our customers of these systems. We defer pre-payments for
communications services and recognize these pre-payments as revenue as the communications
services are provided. For our sales-type lease accounting, we record the discounted
present values of minimum rental payments under sales-type leases as sales, net of
provisions for continuing administration and other expenses over the lease period. We
record the lease sales at the time of system sale and installation as discussed above for
sales to end user customers, and upon receipt of the executed lease documents. The net
rental streams are sold to funding sources on a regular basis with the income streams
discounted by prevailing like-term rates at the time of sale. Gains or losses resulting
from the sale of net rental payments from such leases are also recorded as net sales.
    
    Dealer and VAR sales. For shipments to dealers and other distributors, our revenue is
recognized as products are shipped to the dealers and VARs and services are rendered,
because the sales process is complete. Title to these products passes when goods are
shipped (free-on-board shipping point). However, in connection with our recent Lake
acquisition, shipments to one international dealer are initially held by that dealer on a
consignment basis. Such inventory is owned by Inter-Tel and reported on Inter-Tels books
and records until the inventory is sold to third parties, at which time the revenue is
recorded.
    
    Resale of long distance. We recognize revenue from long distance resale services as
services are provided.
    
    Software Sales. We recognize revenues from sales of software, such as our new Linktivity
products discussed above upon shipment to dealers or end-users.
    
    Maintenance and software support. Maintenance and software support revenue is recognized
ratably over the term of the maintenance or support agreement.
 Costs and gross margins
 17




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
    
    Customer leases generally expire at end of the month and commence at the beginning of
the month, which naturally leads to end-of-period sales. These factors apply to both
end-user and dealer sales.
    
    Internal sales compensation programs for our sales personnel are linked to revenues and
the sales commissions generally increase at accelerated rates as sales volumes increase.
Sales performance bonuses are also frequently tied to quarter-end and year-end performance
targets, providing incentives to sales personnel to close business before the end of each
quarter.
    
    Some price discounting to our dealer channel occurs during the last month of a quarter
or year, and some dealers purchase consistently to take advantage of potential pricing
discounts or end-of-quarter promotions. Dealer buying habits have been consistently
applied for years.
  Cash Flows
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19




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Results of Operations
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 302005
    
    2004
    
    2005
    
    2004NET SALESTelecommunications systems, software and
related
    
    
    88.0
    %
    
    
    88.1
    %
    
    
    87.8
    %
    
    
    87.9
    %Resale of local, long distance and
network services
    
    
    12.0
    
    
    
    11.9
    
    
    
    12.2
    
    
    
    12.1TOTAL NET SALES
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %COST OF SALESTelecommunications systems, software and
related
    
    
    40.6
    
    
    
    40.0
    
    
    
    40.8
    
    
    
    39.8Resale of local, long distance and
network services
    
    
    7.2
    
    
    
    7.3
    
    
    
    7.5
    
    
    
    7.2TOTAL COST OF SALES
    
    
    47.8
    
    
    
    47.2
    
    
    
    48.3
    
    
    
    47.1GROSS PROFIT
    
    
    52.2
    
    
    
    52.8
    
    
    
    51.7
    
    
    
    52.9Research and development
    
    
    7.5
    
    
    
    6.9
    
    
    
    7.8
    
    
    
    6.6Selling, general and administrative
    
    
    34.8
    
    
    
    33.4
    
    
    
    35.7
    
    
    
    34.5Amortization of intangibles
    
    
    1.0
    
    
    
    0.4
    
    
    
    0.9
    
    
    
    0.4Write-off of in-process research and
development costs
    
    
    
    
    
    
    
    
    
    
    1.2
    
    
    
    0.0OPERATING INCOME
    
    
    8.9
    
    
    
    12.0
    
    
    
    6.2
    
    
    
    11.4Interest and other income
    
    
    0.8
    
    
    
    0.6
    
    
    
    0.8
    
    
    
    0.5Foreign currency transaction gains (losses)
    
    
    0.1
    
    
    
    (0.1
    )
    
    
    0.1
    
    
    
    (0.1
    )Interest expense
    
    
    0.0
    
    
    
    (0.0
    )
    
    
    0.0
    
    
    
    (0.0
    )INCOME BEFORE INCOME TAXES
    
    
    9.7
    
    
    
    12.4
    
    
    
    7.1
    
    
    
    11.8INCOME TAXES
    
    
    3.7
    
    
    
    4.5
    
    
    
    3.1
    
    
    
    4.4NET INCOME
    
    
    6.1
    %
    
    
    7.9
    %
    
    
    4.0
    %
    
    
    7.4
    %
 Net Sales.
 20




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â â â
 Gross Profit
  â
 21




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Research and Development
 Selling, general and administrative.
 Amortization of purchased intangible assets
  22




---



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Write-off of in-process research and development (IPRD) costs
 Interest and Other Income
 Income Taxes
 Net Income
  Inflation/Currency Fluctuation
  23




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Liquidity and Capital Resources
 Six Months EndedJune 30,(In thousands)
    
    2005
    
    2004Net cash provided by operating activities
    
    $
    12,056
    
    
    $
    26,800Net cash used in investing activities
    
    
    (32,271
    )
    
    
    (3,871
    )Net cash (used in) provided by financing activities
    
    
    (37,572
    )
    
    
    1,841Effect of exchange rate changes
    
    
    (525
    )
    
    
    167Increase (decrease) in cash and equivalents
    
    
    (58,312
    )
    
    
    24,937Cash and equivalents at beginning of period
    
    
    152,330
    
    
    
    115,197Cash and equivalents at end of period
    
    $
    94,018
    
    
    $
    140,134
     24




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25




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##### Table of Contents



Off-Balance Sheet Arrangements
  Critical Accounting Policies and Estimates
  Revenue Recognition
 26




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End-user sales through our direct sales offices and government and national accounts division
 Dealer and VAR sales
 Resale of long distance
 Maintenance revenues
 Sales-Leases
  Goodwill and Other Intangible Assets. Business Combinations Goodwill and Other Intangible Assets.
 27




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Allowance for Doubtful Accounts
 28




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Inventories
 Contingencies
 FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
 This Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. Actual results could differ materially from those projected in the forward-looking
statements as a result of many risk factors including, without limitation, those set forth under
Factors That May Affect Future Results Of Operations below. In evaluating Inter-Tels business,
shareholders and prospective investors should consider carefully the following factors in
addition to the other information set forth in this document.
 Risks Related to Our Business
 Our operating results have historically depended on a number of factors, and these factors may
cause our operating results to fluctuate in the future.
  
    
    volume and timing of orders received during the quarter;
    
    gross margin fluctuations associated with the mix of products sold;
    
    the mix of distribution channels;
    
    general economic conditions and the condition of the markets our business addresses;
    
    patterns of capital spending by customers;
    
    the timing of new product announcements and releases by us and our competitors and other competitive factors;
    
    pricing pressures;
    
    the cost and effect of acquisitions;
    
    the availability and cost of products and components from our suppliers, including shipping and manufacturing problems
associated with subcontracted vendors;
 29




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##### Table of Contents




    
    the impact of the E-Rate settlement, possible FCC debarment, and expected fines and penalties associated with the GSA
variances and noncompliance which could affect both our government business and our commercial business;
    
    the potential impact of new accounting pronouncements such as FAS 123R;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances.
   Our market is subject to rapid technological change and to compete successfully, we must
continually introduce new and enhanced products and services that achieve broad market acceptance.
   Our future success largely depends on increased commercial acceptance of our Inter-Tel 5000 Network
Communications Solutions, Axxessâ system, the Lake OfficeLink product (branded
EncoreCXâ in North America), speech recognition, Interactive Voice Response, presence
 30




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##### Table of Contents



management, collaboration, messaging products, Session Initiation Protocol (SIP) applications, and
related computer-telephony products.
 â â
 Our products are complex and may contain errors or defects that are detected only after their
release, which may cause us to incur significant unexpected expenses and lost sales.
  
    
    costs associated with the remediation of any problems;
    
    costs associated with design modifications;
    
    loss of or delay in revenues;
    
    loss of customers;
    
    damage to our reputation;
    
    failure to achieve market acceptance or loss of market share;
    
    increased service and warranty costs;
    
    liabilities to our customers; and
    
    increased insurance costs.
 The complexity of our products could cause delays in the development and release of new products
and services. As a result, customer demand for our products could decline, which could harm our
business.
  Business acquisitions, new business ventures, dispositions or joint ventures entail numerous risks
and may disrupt our business, dilute shareholder value and distract management attention.
  31




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
    
    unanticipated costs and liabilities;
    
    difficulty of assimilating the operations, products and personnel of the acquired business;
    
    difficulties in managing the financial and strategic position of acquired or developed products, services and
technologies;
    
    difficulties in maintaining customer relationships;
    
    difficulties in servicing and maintaining acquired products, in particular where a substantial portion of the targets
sales were derived from our competitors products and services;
    
    difficulty of assimilating the vendors and independent contractors of the acquired business;
    
    the diversion of managements attention from the core business;
    
    inability to maintain uniform standards, controls, policies and procedures; and
    
    impairment of relationships with acquired employees and customers occurring as a result of integration of the acquired
business.
    We may not be able to adequately protect our proprietary technology and may be infringing upon
third-party intellectual property rights.
    32




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##### Table of Contents



rd
  We have many competitors and expect new competitors to enter our market, which could increase price
competition and spending on research and development and which may impair our ability to compete
successfully.
  
    
    PABX, converged systems and IP-PBX providers, distributors, or resellers such as Alcatel, Altigen, Avaya, Cisco
Systems, Comdial, 3Com, EADS Telecom, Iwatsu, Interactive Intelligence, Lucky Goldstar, Mitel, NEC, Nortel, Panasonic,
Samsung, ShoreTel, Siemens, Toshiba, Vertical Networks/ArtiSoft and Vodavi;
    
    large data routing and convergence companies such as 3Com, Adtran and Cisco Systems;
    
    voice processing applications providers such as ADC, InterVoice-Brite, Active Voice (a subsidiary of NEC America),
Avaya, and Captaris (formerly AVT);
    
    web collaboration product and service providers, such as Centra, eDial (a division of Alcatel), IBM, Microsoft,
Raindance Communications, and WebEx;
    
    long distance services providers such as AT&T, MCI, Qwest and Sprint;
    
    large computer and software corporations such as IBM, HP, Intel and Microsoft;
    
    regional Bell operating companies, or RBOCs, competitive local exchange companies (CLECs); cable television companies,
IP Centrex service providers, and satellite and other wireless and wireline broadband service providers offering IP
centrex services such as AT&T, Covad, Level-3, Qwest, SBC, and Time-Warner Telecom; and
    
    independent leasing companies that provide telecom equipment financing.
   
    
    develop and expand their product and service offerings more quickly;
    
    offer greater price discounts or make substantial product promotions;
    
    adapt to new or emerging technologies and changing customer needs faster;
 33




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##### Table of Contents




    
    take advantage of acquisitions and other opportunities more readily;
    
    negotiate more favorable licensing agreements with vendors;
    
    devote greater resources to the marketing and sale of their products; and
    
    address customers service-related issues more adequately.
  Our reliance on a limited number of suppliers for key components and our dependence on contract
manufacturers could impair our ability to manufacture and deliver our products and services in a
timely and cost-effective manner.
   We derive a substantial portion of our net sales from our dealer network and if these dealers do
not effectively promote and sell our products, our business and operating results could be harmed.
  We have been the subject of government investigations, which have resulted in convictions and civil
penalties and may cause further competitive and financial harm to our business.
  34




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Managing our international sales efforts may expose us to additional business risks, which may
result in reduced sales or profitability in our international markets.
  35




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##### Table of Contents



If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may
not be able to achieve our objectives.
  Our IP network products may be vulnerable to viruses, other system failure risks and security
concerns, which may result in lost customers or slow commercial acceptance of our IP network
products.
  We may be unable to achieve or manage our growth effectively, which may harm our business.
  The introduction of new products and services has lengthened our sales cycles, which may result in
significant sales and marketing expenses.
 â
 36




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##### Table of Contents



We rely heavily upon third-party packaged software systems to manage and run our business
processes, to provide certain products and services and to produce our financial statements. From
time to time we upgrade these systems to ensure continuation of support and to expand the
functionality of the systems to meet our business needs. The risks associated with the upgrade
process include disruption of our business processes, which could harm our business.
  Our stock price has been and may continue to be volatile, impairing your ability to sell your
shares at or above purchase price.
  
    
    announcements of developments relating to our business;
    
    fluctuations in our operating results;
    
    the impact of our dividend announcements, repurchase program or sales of stock by officers and directors;
 37




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##### Table of Contents




    
    shortfalls in revenue or earnings relative to securities analysts expectations;
    
    announcements of technological innovations or new products or enhancements by us or our competitors, including product
delays;
    
    announcements of acquisitions or planned acquisitions of other companies or businesses;
    
    investors reactions to acquisition announcements or any forecasts of our future results;
    
    general economic conditions in the telecommunications industry;
    
    the market for Internet-related voice and data products and services;
    
    changes in the national or worldwide economy;
    
    changes in legislation or regulation affecting the telecommunications industry;
    
    developments relating to our intellectual property rights and the intellectual property rights of third parties;
    
    litigation or governmental investigations of our business practices;
    
    the impact of the E-Rate settlement and possible FCC debarment, which could affect both our government business and our
commercial business.
    
    changes in our relationships with our customers and suppliers, including shipping and manufacturing problems associated
with subcontracted vendors;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances;
  Our CEO controls 19.9% of our Common Stock and is able to significantly influence matters requiring
shareholder approval.
  Changes in stock option accounting rules may adversely impact our reported operating results
prepared in accordance with generally accepted accounting principles, our stock price and our
competitiveness in the employee marketplace.
   38




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##### Table of Contents



Risks Related to Our Industry
 Reductions in spending on enterprise communications equipment may materially and adversely affect
our business.
  The emerging market for IP network telephony is subject to market risks and uncertainties that
could cause significant delays and expenses.
 Axxess
  39




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##### Table of Contents



Government regulation of third party long distance and network service entities on which we rely
may harm our business.
  Consolidation within the telecommunications industry could increase competition and adversely
affect our business.
  Terrorist activities and resulting military and other actions could harm our business.
  We Are Exposed To Increased Costs And Risks Associated With Compliance With Changing Laws,
Regulations And Standards In General, and Specifically With Increased And New Regulation Of
Corporate Governance And Disclosure Standards.
  40




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
      
 ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of disclosure controls and procedures
 41




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Changes in internal controls over financial reporting
 42




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INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Board Authorization to Repurchase up to $75 Million of Inter-Tel Stock .
 ISSUER PURCHASES OF EQUITY SECURITIES
 (d) Maximum Number (or(a) Total
    
    
    
    (c) Total Number of
    
    Approximate Dollar Value)Number of
    
    
    
    Shares (or Units)
    
    of Shares (or Units) thatPeriod
    

    Shares (or
    
    (b) Average
    
    Purchased as Part of
    
    May Yet Be PurchasedUnits)
    
    Price Paid per Share
    
    Publicly Announced
    
    Under the Plans orPurchased
    
    (or Unit)
    
    Plans or Programs
    
    ProgramsApril 1 to April 30
    
    None
    
    N/A
    
    NoneMay 1 to May 31
    
    716,500
    
    $19.228
    
    716,500June 1 to June 30
    
    None
    
    N/A
    
    NoneTotal
    
    716,500
    
    $19.228
    
    716,500
    
    $61,223,000(1)
 
 (1)

    On February 15, 2005, the Board of Directors approved and the Company announced a plan to
repurchase up to $75 million of the common stock of the Company.
 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  1.
    
    Election of Directors: Steven G. Mihaylo, J. Robert Anderson, Alexander L. Cappello, Jerry
W. Chapman, Gary D. Edens, C. Roland Haden and Agnieszka Winkler were elected to serve as
directors until the 2006 Annual Meeting of Shareholders. The votes were as follows:
 Nominee
    
    For:
    
    Against:
    
    Abstain:Steven G. Mihaylo
    
    
    25,091,538
    
    
    
    201,099
    
    
    
    J. Robert Anderson
    
    
    25,157,084
    
    
    
    135,553
    
    
    
    Alexander L. Cappello
    
    
    25,165,771
    
    
    
    126,866
    
    
    
    
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Nominee
    
    For:
    
    Against:
    
    Abstain:Jerry W. Chapman
    
    
    23,370,781
    
    
    
    1,921,856
    
    
    
    Gary D. Edens
    
    
    24,751,348
    
    
    
    541,289
    
    
    
    C. Roland Haden
    
    
    25,093,143
    
    
    
    199,494
    
    
    
    Agnieszka Winkler
    
    
    25,166,863
    
    
    
    125,774
    
    
    
    
 2.
    
    The shareholders voted on and approved a proposal to ratify the appointment of Ernst & Young
LLP to act as the independent auditors to audit our and our subsidiaries financial statements
for the year 2005. The votes were as follows:
 For:
    
    Against:
    
    Abstain:Proposal to ratify the appointment
of independent auditors
    
    
    25,090,625
    
    
    
    193,504
    
    
    
    8,508
 3.
    
    The shareholders also voted on and approved a proposal to transact such other business as may
properly come before the meeting or any adjournment thereof.
 For:
    
    Against:
    
    Abstain:Proposal to transact such other
business that may come before the
meeting or adjournment thereof
    
    
    14,283,367
    
    
    
    10,864,673
    
    
    
    144,597
 
 ITEM 5. OTHER INFORMATION
 
 ITEM 6. EXHIBITS:
 Exhibit 31.1:
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002Exhibit 31.2:
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002Exhibit 32.1:
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002Exhibit 32.2:
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 44




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##### Table of Contents



SIGNATURES
  INTER-TEL, INCORPORATEDAugust 8, 2005
    /s/  Steven G. MihayloSteven G. MihayloChief Executive Officer August 8, 2005
    /s/  Kurt R. KneipKurt R. KneipSenior Vice President and
Chief Financial Officer 45




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##### Table of Contents



EXHIBIT INDEX
 Exhibit 31.1:
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002Exhibit 31.2:
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002Exhibit 32.1:
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002Exhibit 32.2:
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002