##### Table of Contents



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:September 30, 2006
    
    0-10211
 INTER-TEL (DELAWARE), INCORPORATED
 Incorporated in the State of Delaware
    
    I.R.S. No. 86-0220994
 1615
S.
52 nd Street  Tempe, Arizona 85281
 (480) 449-8900
 
 Title of Class
    
    Outstanding as of September 30, 2006Common Stock, par value $0.001
    
    26,723,577
 þ o
  o þ o
 o þ




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##### 



INDEX
 INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 PagePART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (unaudited)Condensed Consolidated Balance SheetsSeptember 30, 2006 and December 31, 2005
    
    
    3Condensed Consolidated Statements of Incomethree and nine months ended September 30, 2006 and September 30, 2005
    
    
    4Condensed Consolidated Statements of Cash Flowsnine months ended September 30, 2006 and September 30, 2005
    
    
    5Notes to Condensed Consolidated Financial StatementsSeptember 30, 2006
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    32Item 4.
    
    Controls and Procedures
    
    
    33PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    34Item 1A
    
    Risk Factors
    
    
    34Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    48Item 3.
    
    Defaults Upon Senior Securities
    
    
    49Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    49Item 5.
    
    Other Information
    
    
    49Item 6.
    
    Exhibits
    
    
    50SIGNATURES
    
    
    50EXHIBITS AND MANAGEMENT CERTIFICATIONS
    
    
    51Exhibit 31.1Exhibit 31.2Exhibit 32.1
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    December 31,2006
    
    2005(in thousands, except share amounts)
    
    (Unaudited)
    
    (Note A)ASSETSCURRENT ASSETSCash and equivalents
    
    $
    133,337
    
    
    $
    103,774Short-term investments
    
    
    63,627
    
    
    
    63,689TOTAL CASH AND SHORT-TERM INVESTMENTS
    
    
    196,964
    
    
    
    167,463Accounts receivable, net of allowances of $6,829
in 2006 and $6,235 in 2005
    
    
    49,543
    
    
    
    44,072Inventories
    
    
    26,096
    
    
    
    19,644Net investment in sales-leases, net of allowances
of $950 in 2006 and $998 in 2005
    
    
    20,092
    
    
    
    19,699Income taxes receivable
    
    
    
    
    
    
    2,062Deferred income taxes
    
    
    13,286
    
    
    
    12,590Prepaid expenses and other assets
    
    
    18,278
    
    
    
    14,253TOTAL CURRENT ASSETS
    
    
    324,259
    
    
    
    279,783PROPERTY, PLANT & EQUIPMENT
    
    
    25,808
    
    
    
    28,236GOODWILL
    
    
    29,866
    
    
    
    29,840PURCHASED INTANGIBLE ASSETS
    
    
    20,158
    
    
    
    23,651NET INVESTMENT IN SALES-LEASES, net of allowances
of $1,731 in 2006 and $1,926 in 2005
    
    
    30,837
    
    
    
    34,758OTHER ASSETS
    
    
    409
    
    
    
    TOTAL ASSETS
    
    $
    431,337
    
    
    $
    396,268LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    36,987
    
    
    $
    29,879Other current liabilities
    
    
    63,389
    
    
    
    54,386TOTAL CURRENT LIABILITIES
    
    
    100,376
    
    
    
    84,265DEFERRED TAX LIABILITY
    
    
    67,966
    
    
    
    70,439LEASE RECOURSE LIABILITY
    
    
    14,603
    
    
    
    14,199OTHER LIABILITIES
    
    
    7,089
    
    
    
    7,034SHAREHOLDERS EQUITYCommon stock, $0.001 par value-authorized
100,000,000 shares; issued27,161,823 shares;
outstanding26,723,577 at September 30, 2006 and
26,264,458 shares at December 31, 2005
    
    
    27
    
    
    
    27Additional Paid-In Capital
    
    
    125,328
    
    
    
    120,462Retained earnings
    
    
    121,717
    
    
    
    114,653Accumulated other comprehensive income
    
    
    1,464
    
    
    
    (36
    )248,536
    
    
    
    235,106Less: Treasury stock at cost  438,246 shares at
September 30, 2006 and 897,365 shares at December
31, 2005
    
    
    (7,233
    )
    
    
    (14,775
    )TOTAL SHAREHOLDERS EQUITY
    
    
    241,303
    
    
    
    220,331TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    431,337
    
    
    $
    396,268
  3




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##### Table of Contents



INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
 Three Months
    
    Nine Months(In thousands, except
    
    Ended September 30,
    
    Ended September 30,per share amounts)
    
    2006
    
    2005
    
    2006
    
    2005NET SALESTelecommunications systems, software and related
    
    $
    101,837
    
    
    $
    97,014
    
    
    $
    295,002
    
    
    $
    291,320Resale of local, long distance and network services
    
    
    15,197
    
    
    
    14,321
    
    
    
    44,881
    
    
    
    40,898TOTAL NET SALES
    
    
    117,034
    
    
    
    111,335
    
    
    
    339,883
    
    
    
    332,218COST OF SALESTelecommunications systems, software and related
    
    
    49,415
    
    
    
    46,295
    
    
    
    143,527
    
    
    
    136,595Resale of local, long distance and network services
    
    
    9,591
    
    
    
    8,780
    
    
    
    28,287
    
    
    
    25,353TOTAL COST OF SALES
    
    
    59,006
    
    
    
    55,075
    
    
    
    171,814
    
    
    
    161,948GROSS PROFIT
    
    
    58,028
    
    
    
    56,260
    
    
    
    168,069
    
    
    
    170,270Research and development
    
    
    8,705
    
    
    
    8,288
    
    
    
    25,812
    
    
    
    25,456Selling, general and administrative
    
    
    41,858
    
    
    
    36,977
    
    
    
    120,555
    
    
    
    115,953Amortization of purchased intangible assets
    
    
    1,185
    
    
    
    1,173
    
    
    
    3,501
    
    
    
    3,058Write-off of in-process research and development costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,600Legal judgment and settlement
    
    
    
    
    
    
    10,378
    
    
    
    1,314
    
    
    
    10,37851,748
    
    
    
    56,816
    
    
    
    151,182
    
    
    
    157,445OPERATING INCOME (LOSS)
    
    
    6,280
    
    
    
    (556
    )
    
    
    16,887
    
    
    
    12,825Interest and other income
    
    
    1,687
    
    
    
    946
    
    
    
    4,509
    
    
    
    2,814Foreign currency transaction (losses) gains
    
    
    139
    
    
    
    (37
    )
    
    
    (223
    )
    
    
    104Interest expense
    
    
    (57
    )
    
    
    (19
    )
    
    
    (92
    )
    
    
    (64
    )INCOME BEFORE INCOME TAXES
    
    
    8,049
    
    
    
    334
    
    
    
    21,081
    
    
    
    15,679INCOME TAXES (BENEFIT)
    
    
    570
    
    
    
    (401
    )
    
    
    5,615
    
    
    
    6,045NET INCOME
    
    $
    7,479
    
    
    $
    735
    
    
    $
    15,466
    
    
    $
    9,634NET INCOME PER SHARE  BASIC
    
    $
    0.28
    
    
    $
    0.03
    
    
    $
    0.58
    
    
    $
    0.37NET INCOME PER SHARE  DILUTED
    
    $
    0.27
    
    
    $
    0.03
    
    
    $
    0.57
    
    
    $
    0.35DIVIDENDS PER SHARE
    
    $
    0.08
    
    
    $
    0.08
    
    
    $
    0.24
    
    
    $
    1.24Average number of common shares outstanding  Basic
    
    
    26,668
    
    
    
    26,147
    
    
    
    26,503
    
    
    
    26,274Average number of common shares outstanding  Diluted
    
    
    27,299
    
    
    
    27,056
    
    
    
    27,169
    
    
    
    27,304
  4




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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 Nine Months EndedSeptember 30,(In thousands)
    
    2006
    
    2005OPERATING ACTIVITIESNet income
    
    $
    15,466
    
    
    $
    9,634Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation of fixed assets
    
    
    6,905
    
    
    
    7,031Amortization of patents included in R&D expenses
    
    
    14
    
    
    
    166Amortization of purchased intangible assets
    
    
    3,501
    
    
    
    3,058Purchased in-process research and development
    
    
    
    
    
    
    2,600Provision for losses on receivables
    
    
    1,179
    
    
    
    1,286Provision for losses on leases
    
    
    1,759
    
    
    
    2,901Provision for inventory valuation
    
    
    1,247
    
    
    
    619Share based compensation expense
    
    
    3,383
    
    
    
    Excess tax benefits from stock options exercised
    
    
    (1,483
    )
    
    
    Decrease in other liabilities
    
    
    (991
    )
    
    
    (1,142
    )(Gain) Loss on sale of property and equipment
    
    
    (8
    )
    
    
    77Deferred income taxes
    
    
    (3,170
    )
    
    
    5,600Changes in operating assets and liabilities
    
    
    4,055
    
    
    
    (4,269
    )NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    31,857
    
    
    
    27,561INVESTING ACTIVITIESPurchases of available for sale short-term investments
    
    
    (47,678
    )
    
    
    (41,527
    )Maturities and sales of available for sale investments
    
    
    47,740
    
    
    
    42,842Maturities and sales of held-to-maturity investments
    
    
    
    
    
    
    2,000Additions to property, plant and equipment
    
    
    (5,319
    )
    
    
    (6,213
    )Proceeds from disposal of property, plant and equipment
    
    
    850
    
    
    
    26Cash used in acquisitions
    
    
    (9
    )
    
    
    (28,008
    )NET CASH USED IN INVESTING ACTIVITIES
    
    
    (4,416
    )
    
    
    (30,880
    )FINANCING ACTIVITIESCash dividends paid
    
    
    (6,342
    )
    
    
    (32,760
    )Treasury stock purchases
    
    
    
    
    
    
    (13,777
    )Payments on term debt
    
    
    (37
    )
    
    
    (35
    )Proceeds from stock issued under the Employee Stock
Purchase Plan
    
    
    542
    
    
    
    582Proceeds from exercise of stock options
    
    
    4,976
    
    
    
    7,923Excess tax benefits from stock options exercised
    
    
    1,483
    
    
    
    NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
    
    
    622
    
    
    
    (38,067
    )EFFECT OF EXCHANGE RATE CHANGES
    
    
    1,500
    
    
    
    (575
    )INCREASE (DECREASE) IN CASH AND EQUIVALENTS
    
    
    29,563
    
    
    
    (41,961
    )CASH AND EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    103,774
    
    
    
    152,330CASH AND EQUIVALENTS AT END OF PERIOD
    
    $
    133,337
    
    
    $
    110,369
  5




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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
  NOTE ABASIS OF PRESENTATION
    Share-Based Payments
   6




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Contingencies
       7




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Inventories
  Recently Issued Accounting Standards
 Accounting for Uncertainty in
Income Taxes
 Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)
 8




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Considering the Effects of Prior Year Misstatements when Quantifying Current Year
Misstatements.
 Fair Value Measurements,
 NOTE BEARNINGS PER SHARE
   Three Months Ended
    
    Nine Months Ended(In thousands, except
    
    September 30,
    
    September 30,per share amounts)
    
    2006
    
    2005
    
    2006
    
    2005Numerator: Net income
    
    $
    7,479
    
    
    $
    735
    
    
    $
    15,466
    
    
    $
    9,634Denominator:Denominator for basic earnings per
share  weighted average shares
    
    
    26,668
    
    
    
    26,147
    
    
    
    26,503
    
    
    
    26,274Effect of dilutive securities:Employee and director stock options(1)
    
    
    631
    
    
    
    909
    
    
    
    666
    
    
    
    1,030Denominator for diluted earnings per
share  adjusted weighted average shares
and assumed conversions
    
    
    27,299
    
    
    
    27,056
    
    
    
    27,169
    
    
    
    27,304Basic earnings per share
    
    $
    0.28
    
    
    $
    0.03
    
    
    $
    0.58
    
    
    $
    0.37Diluted earnings per share
    
    $
    0.27
    
    
    $
    0.03
    
    
    $
    0.57
    
    
    $
    0.35Options excluded from diluted net
earnings per share calculations(2)

    
    1,104
    
    
    
    648
    
    
    
    1,104
    
    
    
    633
 
 (1)
    
    The adoption of SFAS No. 123R, effective January 1, 2006, also changed the method of
computation of dilutive shares for 2006. If the same method used to determine dilutive shares
in 2005 was used in 2006, the dilutive shares would have been 690 and 745 for the three month
and nine month periods ended September 30, 2006. This did not change the diluted earnings per
share for the three month or nine month periods ended September 30, 2006.(2)
    
    At September 30, 2006 and 2005, options to purchase shares of Inter-Tel stock were excluded
from the calculation of diluted net earnings per share because the exercise price of these
options was greater than the average market price of the common shares for the respective
periods, and therefore the effect would have been antidilutive. 9




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NOTE C  ACQUISITIONS
 Lake.
    NOTE D  SEGMENT INFORMATION
  ®
 10




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As of and for the Three Months Ended September 30, 2006
 Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    101,837
    
    
    $
    15,197
    
    
    $
    117,034Gross profit
    
    
    52,422
    
    
    
    5,606
    
    
    
    58,028Operating income
    
    
    4,236
    
    
    
    2,044
    
    
    
    6,280Interest and other income
    
    
    1,629
    
    
    
    58
    
    
    
    1,687Foreign currency transaction gains
    
    
    139
    
    
    
    
    
    
    
    139Interest expense
    
    
    (57
    )
    
    
    
    
    
    
    (57
    )Net income
    
    $
    5,097
    
    
    $
    2,382
    
    
    $
    7,479Net income per diluted share (1)
    
    $
    0.19
    
    
    $
    0.09
    
    
    $
    0.27Weighted average diluted shares (1)
    
    
    27,299
    
    
    
    27,299
    
    
    
    27,299Goodwill
    
    $
    27,731
    
    
    $
    2,135
    
    
    $
    29,866Total assets
    
    
    417,915
    
    
    
    13,422
    
    
    
    431,337Depreciation and amortization
    
    
    3,581
    
    
    
    18
    
    
    
    3,599
 As of and for the Three Months Ended September 30, 2005
 Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    97,014
    
    
    $
    14,321
    
    
    $
    111,335Gross profit
    
    
    50,720
    
    
    
    5,540
    
    
    
    56,260Legal judgment and settlement
    
    
    (10,378
    )
    
    
    
    
    
    
    (10,378
    )Operating income (loss)
    
    
    (2,994
    )
    
    
    2,438
    
    
    
    (556
    )Interest and other income
    
    
    911
    
    
    
    35
    
    
    
    946Foreign currency transaction losses
    
    
    (37
    )
    
    
    
    
    
    
    (37
    )Interest expense
    
    
    (18
    )
    
    
    (1
    )
    
    
    (19
    )Net income
    
    $
    (920
    )
    
    $
    1,656
    
    
    $
    735Net income per diluted share (1)
    
    $
    (0.03
    )
    
    $
    0.06
    
    
    $
    0.03Weighted average diluted shares (1)
    
    
    27,056
    
    
    
    27,056
    
    
    
    27,056Goodwill
    
    $
    27,782
    
    
    $
    2,135
    
    
    $
    29,917Total assets
    
    
    389,612
    
    
    
    11,984
    
    
    
    401,596Depreciation and amortization
    
    
    3,522
    
    
    
    14
    
    
    
    3,536
 As of and for the Nine Months Ended September 30, 2006
 Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    295,002
    
    
    $
    44,881
    
    
    $
    339,883Gross profit
    
    
    151,475
    
    
    
    16,594
    
    
    
    168,069Operating income
    
    
    10,005
    
    
    
    6,882
    
    
    
    16,887
 11




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Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalInterest and other income
    
    
    4,367
    
    
    
    142
    
    
    
    4,509Foreign currency transaction losses
    
    
    (223
    )
    
    
    
    
    
    
    (223
    )Interest expense
    
    
    (91
    )
    
    
    (1
    )
    
    
    (92
    )Net income
    
    $
    10,175
    
    
    $
    5,291
    
    
    $
    15,466Net income per diluted share (1)
    
    $
    0.37
    
    
    $
    0.20
    
    
    $
    0.57Weighted average diluted shares (1)
    
    
    27,169
    
    
    
    27,169
    
    
    
    27,169Goodwill
    
    $
    27,731
    
    
    $
    2,135
    
    
    $
    29,866Total assets
    
    
    417,915
    
    
    
    13,422
    
    
    
    431,337Depreciation and amortization
    
    
    10,364
    
    
    
    56
    
    
    
    10,420
 As of and for the Nine Months Ended September 30, 2005
 Resale of Local,Long DistancePrincipal
    
    and Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    291,320
    
    
    $
    40,898
    
    
    $
    332,218Gross profit
    
    
    154,725
    
    
    
    15,545
    
    
    
    170,270Legal judgment and settlement
    
    
    (10,378
    )
    
    
    
    
    
    
    (10,378
    )In-process research and development
    
    
    (2,600
    )
    
    
    
    
    
    
    (2,600
    )Operating income
    
    
    6,683
    
    
    
    6,142
    
    
    
    12,825Interest and other income
    
    
    2,701
    
    
    
    113
    
    
    
    2,814Foreign currency transaction gains
    
    
    104
    
    
    
    
    
    
    
    104Interest expense
    
    
    (60
    )
    
    
    (4
    )
    
    
    (64
    )Net income
    
    $
    5,556
    
    
    $
    4,078
    
    
    $
    9,634Net income per diluted share (1)
    
    $
    0.19
    
    
    $
    0.16
    
    
    $
    0.35Weighted average diluted shares (1)
    
    
    27,304
    
    
    
    27,304
    
    
    
    27,304Goodwill
    
    $
    27,782
    
    
    $
    2,135
    
    
    $
    29,917Total assets
    
    
    389,612
    
    
    
    11,984
    
    
    
    401,596Depreciation and amortization
    
    
    10,212
    
    
    
    44
    
    
    
    10,255
 
 (1)
    
    Options that are antidilutive because the exercise price was greater than the average
market price of shares of the Companys common stock are not included in the computation of diluted
earnings per share.  Three Months Ended
    
    Three Months EndedSeptember 30, 2006
    
    September 30, 2005Source of net sales
    
    $
    
    %
    
    $
    
    %Domestic
    
    $
    106,412
    
    
    
    90.9
    %
    
    $
    100,190
    
    
    
    90.0
    %Lake Communications
    
    
    6,575
    
    
    
    5.6
    %
    
    
    7,076
    
    
    
    6.4
    %Other International
    
    
    4,047
    
    
    
    3.5
    %
    
    
    4,069
    
    
    
    3.7
    %Total net sales
    
    $
    117,034
    
    
    
    100.0
    %
    
    $
    111,335
    
    
    
    100.0
    %
 Nine Months Ended
    
    Nine Months EndedSeptember 30, 2006
    
    September 30, 2005Source of net sales
    
    $
    
    %
    
    $
    
    %Domestic
    
    $
    308,058
    
    
    
    90.6
    %
    
    $
    304,134
    
    
    
    91.5
    %Lake Communications
    
    
    19,691
    
    
    
    5.8
    %
    
    
    17,573
    
    
    
    5.3
    %Other International
    
    
    12,134
    
    
    
    3.6
    %
    
    
    10,511
    
    
    
    3.2
    %Total net sales
    
    $
    339,883
    
    
    
    100.0
    %
    
    $
    332,218
    
    
    
    100.0
    %
 12




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NOTE E NET INVESTMENT IN SALES-LEASES
  September 30,
    
    December 31,(in thousands)
    
    2006
    
    2005Lease balances included in consolidated accounts receivable, net
of allowances of $1,453 in 2006, and $980 in 2005
    
    $
    9,975
    
    
    $
    8,860Net investment in Sales-Leases:Current portion, net of allowances of $950 in 2006, and $998 in 2005
    
    
    20,092
    
    
    
    19,699Long-term portion, includes residual amounts of $1,785 in 2006 and,
$625 in 2005, net of allowances of $1,731 in 2006, and $1,926 in
2005
    
    
    30,837
    
    
    
    34,758Total investment in Sales-Leases, net of allowances of $4,134 in 2006,
and $3,904 in 2005
    
    
    60,904
    
    
    
    63,317Sold rental payments remaining unbilled (subject to limited recourse
provisions), net of allowances of $14,603 in 2006, and $14,199 in 2005
    
    
    260,093
    
    
    
    256,143Total balance of sales-leases and sold rental payments remaining
unbilled, net of allowances
    
    $
    320,997
    
    
    $
    319,460Total allowances for entire lease portfolio (including limited recourse
liabilities)
    
    $
    18,738
    
    
    $
    18,103
  13




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##### Table of Contents



Nine Months Ended
    
    Year Ended(In thousands)
    
    September 30, 2006
    
    December 31, 2005Sales of rental payments
    
    $
    77,250
    
    
    $
    119,060Sold payments remaining unbilled at end of period
    
    $
    274,697
    
    
    $
    270,342
   NOTE F  SHARE BASED COMPENSATION
   14




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##### Table of Contents



Three Months
    
    Nine MonthsEnded
    
    EndedSeptember 30,
    
    September 30,2006
    
    2006Cost of revenues
    
    $
    68
    
    
    $
    190Research and development
    
    
    338
    
    
    
    909Selling, general and administrative
    
    
    843
    
    
    
    2,285Share-based compensation expense before income taxes
    
    
    1,249
    
    
    
    3,384Related income tax benefits
    
    
    199
    
    
    
    584Share-based compensation expense, net of taxes
    
    $
    1,050
    
    
    $
    2,800Net share-based compensation expense, per common share:Basic
    
    $
    0.04
    
    
    $
    0.11Diluted
    
    $
    0.04
    
    
    $
    0.10
   WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateNumber
    
    Exercise
    
    Contractual
    
    Intrinsicof Shares
    
    Price
    
    Term (years)
    
    ValueBalance at December 31, 2005
    
    
    3,855,988
    
    
    $
    16.36Granted
    
    
    802,350
    
    
    $
    22.73Exercised
    
    
    (439,839
    )
    
    $
    11.60Terminated/expired
    
    
    (139,695
    )
    
    $
    19.96Balance at September 30, 2006
    
    
    4,078,804
    
    
    $
    17.99
    
    
    
    6.3
    
    
    $
    14,765,270Exercisable
at September 30, 2006
    
    
    2,600,047
    
    
    $
    16.90
    
    
    
    5.2
    
    
    $
    12,246,221
 15




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Nine Months Ended
    
    Nine Months EndedSeptember 30, 2006
    
    September 30, 2005Expected dividend yield
    
    1.36% - 1.55%
    
    1.52% - 1.72%Expected stock price volatility
    
    0.41 - 0.53
    
    0.48 - 0.58Risk-free interest rate
    
    4.76% - 5.04%
    
    3.77% - 4.01%Expected life of options
    
    3-5 Years
    
    3-5 years
   Three Months EndedSeptember 30, 2005Net income, as reported
    
    $
    735Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (1)
    
    
    (565
    )Pro-forma net income
    
    $
    170Net income per common share:Basic, as reported
    
    $
    0.03Basic, pro forma
    
    $
    0.01Diluted, as reported
    
    $
    0.03Diluted, pro forma
    
    $
    0.01
 Nine Months EndedSeptember 30, 2005Net income, as reported
    
    $
    9,634Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (1)
    
    
    (7,808
    )Pro-forma net income
    
    $
    1,826Net income per common share:Basic, as reported
    
    $
    0.37Basic, pro forma
    
    $
    0.07Diluted, as reported
    
    $
    0.35Diluted, pro forma
    
    $
    0.07
 
  16




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Employee Stock Purchase Plan
  Performance Shares
  NOTE G  ACQUISITION OFFER
  17




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 The following discussion involves forward-looking statements. Actual results could
differ materially from those projected in the forward-looking statements. For further information
regarding forward-looking statements, see Forward Looking Statements in Item IA, Risk Factors.
 Overview
  
    
    Inter-Tel Axxessâ and Inter-Tel 5000 Network Communications Solutions converged
voice and data business communication systems,
    
    Inter-Tel 7000 Network Communications platform,
    
    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,
    
    presence management, collaboration, web conference, and audio conferencing applications,
    
    managed services, including voice and data network design, traffic provisioning, and
financial solutions packages (leasing),
    
    networking applications, including the design and implementation of voice and data
networks,
    
    local and long distance calling services, voice circuits, data circuits and other
communications services and peripheral products,
    
    call accounting software, computer-telephone integration (CTI) applications, and
    
    maintenance and support services for our products.
  Ò
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
    
    End-user sales and sales-type leases through our direct sales offices and national,
government and education accounts division. We recognize revenue from sales of systems and
services to end-user customers upon installation of the systems and performance of the
services, respectively, allowing for use by our customers of these systems. We defer
pre-payments for communications services and recognize these pre-payments as revenue as the
communications services are provided. For our sales-type lease accounting, we record the
discounted present values of minimum rental payments under sales-type leases as sales, net
of provisions for continuing administration and other expenses over the lease period. We
record the lease sales at the time of system sale and installation as discussed above for
sales to end user customers, and upon receipt of the executed lease documents. The net
rental streams are sold to funding sources on a regular basis with the income streams
discounted by prevailing like-term rates at the time of sale. Gains or losses resulting
from the sale of net rental payments from such leases are also recorded as net sales.
Furthermore, when the initial term of the lease is concluded, customers have the option to
renew the lease at a payment and term less than the original lease.
    
    Dealer and VAR sales. For shipments to dealers, value added resellers and other
distributors, our revenue is recognized as products are shipped and services are rendered,
because the sales process is complete. Title to these products passes when goods are
shipped (free-on-board shipping point). However, in connection with our 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 generally recognize revenues from sales of software upon shipment to
dealers or upon downloading of such software from the Internet by such dealers, as
applicable, or upon installation at end-user sites.
    
    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
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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.
    
    The timing of quarterly sales of lease rental streams, which typically occur near the
end of the third month of the quarter, as well as interest rate fluctuations that may
impact the gain or loss on sale of such rental streams.
    
    Internal sales compensation programs for our sales personnel are linked to revenues and
the sales commissions generally increase at accelerated rates as sales volumes increase.
Sales performance bonuses are also frequently tied to quarter-end and year-end performance
targets, providing incentives to sales personnel to close business before the end of each
quarter.
    
    Historically, some price discounting to our dealer channel occurred during the last
month of a quarter or year, and some dealers have purchased consistently to take advantage
of potential product specific pricing discounts or end-of-quarter promotions. However,
such promotions are subject to change at any time, and discounts have been reduced in
recent periods in an effort to minimize this trend. Dealer buying habits have been
consistent for years.
  Cash Flows
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Axxess
  Results of Operations
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005NET SALESTelecommunications systems, software and related
    
    
    87.0
    %
    
    
    87.1
    %
    
    
    86.8
    %
    
    
    87.7
    %Resale of local, long distance and network services
    
    
    13.0
    
    
    
    12.9
    
    
    
    13.2
    
    
    
    12.3TOTAL NET SALES
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %COST OF SALESTelecommunications systems, software and related
    
    
    42.2
    
    
    
    41.6
    
    
    
    42.2
    
    
    
    41.1Resale of local, long distance and network services
    
    
    8.2
    
    
    
    7.9
    
    
    
    8.3
    
    
    
    7.6TOTAL COST OF SALES
    
    
    50.4
    
    
    
    49.5
    
    
    
    50.6
    
    
    
    48.7GROSS PROFIT
    
    
    49.6
    
    
    
    50.5
    
    
    
    49.4
    
    
    
    51.3Research and development
    
    
    7.4
    
    
    
    7.4
    
    
    
    7.6
    
    
    
    7.7Selling, general and administrative
    
    
    35.8
    
    
    
    33.2
    
    
    
    35.5
    
    
    
    34.9Amortization of intangibles
    
    
    1.0
    
    
    
    1.1
    
    
    
    1.0
    
    
    
    0.9Write-off of in-process research and development
costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.8Legal judgment and settlement
    
    
    
    
    
    
    9.3
    
    
    
    0.4
    
    
    
    3.1OPERATING INCOME (LOSS)
    
    
    5.4
    
    
    
    (0.5
    )
    
    
    5.0
    
    
    
    3.9Interest and other income
    
    
    1.4
    
    
    
    0.8
    
    
    
    1.3
    
    
    
    0.8Foreign currency transaction (losses) gains
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    INCOME BEFORE INCOME TAXES
    
    
    6.9
    
    
    
    0.3
    
    
    
    6.2
    
    
    
    4.7INCOME TAXES (BENEFIT)
    
    
    0.5
    
    
    
    (0.4
    )
    
    
    1.7
    
    
    
    1.8NET INCOME
    
    
    6.4
    %
    
    
    0.7
    %
    
    
    4.6
    %
    
    
    2.9
    %
 Net Sales.
 22




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®
  Gross Profit
 23




---



##### Table of Contents



Research and Development (R&D)
 Selling, general and administrative (SG&A).
 24




---



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Amortization of purchased intangible assets
  Write-off of in-process research and development (IPRD) costs
 Interest and Other Income
 25




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Income Taxes
 Net Income
   26




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Inflation/Currency Fluctuation
  Liquidity and Capital Resources
 Nine Months EndedSeptember 30,(In thousands)
    
    2006
    
    2005Net cash provided by operating activities
    
    $
    31,857
    
    
    $
    27,561Net cash used in investing activities
    
    
    (4,416
    )
    
    
    (30,880
    )Net cash (used in) provided by financing activities
    
    
    622
    
    
    
    (38,067
    )Effect of exchange rate changes
    
    
    1,500
    
    
    
    (575
    )Increase (decrease) in cash and equivalents
    
    
    29,563
    
    
    
    (41,961
    )Cash and equivalents at beginning of period
    
    
    103,774
    
    
    
    152,330Cash and equivalents at end of period
    
    $
    133,337
    
    
    $
    110,369
    27




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28




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Off-Balance Sheet Arrangements
  29




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Critical Accounting Policies and Estimates
  Revenue Recognition
 End-user sales through our direct sales offices and government and national accounts division
 Dealer and VAR sales
 Resale of long distance
 Maintenance revenues
 Sales-Leases
 30




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Goodwill and Other Intangible Assets. Business Combinations Goodwill and Other Intangible Assets.
    31




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Allowance for Doubtful Accounts
 Inventories
 Contingencies
 32




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
      
 ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of disclosure controls and procedures
 33




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Changes in internal controls over financial reporting
 INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 1A. RISK FACTORS
 FORWARD LOOKING STATEMENTS
 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. You can identify these statements by the fact that they do not relate strictly to
historical or current facts. They use words such as anticipate, estimate, expect, project,
intend, plan, believe and other words and terms of similar meaning. Any or all of our
forward-looking statements in this report and in any other public statements we make may turn out
to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown
risks and uncertainties. No forward-looking statement can be guaranteed, and you are cautioned not
to place undue reliance on these forward-looking statements. Actual future results may differ
materially.
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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 and the mix of new and
recurring customers;
    
    the mix of distribution channels;
    
    general economic conditions, including interest rates and the condition of the markets our
business addresses;
    
    patterns of capital spending by customers and the relative size of our customers, in
particular at times when we are introducing new systems and software targeted to and designed
for larger customers;
    
    the timing of new product announcements and releases by us and our competitors and other
competitive factors;
    
    pricing pressures;
    
    the cost and effects of acquisitions;
    
    the availability and cost of products and components from our suppliers, including shipping
and manufacturing problems associated with subcontracted vendors;
    
    the impact of the E-Rate settlement, the one year debarment by the FCC of Inter-Tel
Technologies from E-Rate opportunities, and expected fines and penalties associated with our
former GSA variances and noncompliance, which could affect both our government business and
our commercial business;
    
    the impact of settlements, continuing litigation, proceedings and other contingencies,
which could affect our business;
    
    the impact of costs and uncertainties resulting from stockholder actions, including actual
or potential proxy contests or tender offers;
    
    fluctuations in interests rates, and the timing and volume of sales of leases to third party funding sources;
    
    the potential impact of accounting pronouncements, such as FIN 48 or FAS 123R;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances.
   35




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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.
    36




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Our future success largely depends on increased commercial acceptance of our Inter-Tel 5000 series
and Inter-Tel 7000 Network Communications Solutions, the Lake OfficeLink product (branded
EncoreCXâ in North America), the Lake Sigma product (branded Sprint Connection
Central TM in North America), speech recognition, Interactive Voice Response, presence
management, collaboration, messaging products, Session Initiation Protocol (SIP) applications, and
related computer-telephony products, as well as continued acceptance of our Axxessâ systems
and software.
 ® ®
 We have many competitors and expect new competitors to enter our market, which could increase price
competition and spending on research and development and which may impair our ability to compete
successfully.
  
    
    PABX, converged systems and IP-PBX providers, distributors, or resellers such as Aastra,
Adtran, Alcatel, Altigen, Avaya, Cisco Systems, 3Com, Iwatsu, Interactive Intelligence, Lucky
Goldstar, Mitel, NEC, Nortel, Panasonic, Samsung, ShoreTel, Siemens, Toshiba, Vertical
Networks/ArtiSoft/Comdial/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, Citrix, eDial (a division
of Alcatel), IBM, Microsoft, Raindance Communications, and WebEx;
    
    hosting service providers such as Layered Technologies and Vonage using servers to host
call processing functions that have traditionally been owned by customers;
    
    long distance services providers such as AT&T, MCI, Qwest and Sprint;
    
    large computer and software corporations such as IBM, HP, Intel and Microsoft;
    
    peer-to-peer softphone services such as Skype/eBay;
    
    regional Bell operating companies, or RBOCs, competitive local exchange companies, or
CLECs; cable television companies, IP Centrex service providers, and satellite and other
wireless and wireline broadband service providers offering IP centrex services such as AT&T,
Covad, Level-3, New Global Telecom, Qwest, SBC, and Time-Warner Telecom; and
    
    independent leasing companies that provide telecom equipment financing.
  37




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
    
    offer broader product and service offerings;
    
    develop and expand their product and service offerings more quickly;
    
    offer greater price discounts or make substantial product promotions;
    
    adapt to new or emerging technologies and changing customer needs faster;
    
    take advantage of acquisitions and other opportunities more readily;
    
    negotiate more favorable licensing agreements with vendors;
    
    devote greater resources to the marketing and sale of their products; and
    
    address customers service-related issues more adequately.
  Our products are complex and may contain errors or defects that are detected only after their
release, which may cause us to incur significant unexpected expenses and lost sales.
  
    
    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;
 38




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
    
    increased service and warranty costs;
    
    liabilities to our customers; and
    
    increased insurance costs.
 The complexity of our products have caused delays and could cause future delays in the development
and release of new products and services. As a result, customer demand for our products could
decline, which could harm our business. Additionally, changes in technology could render current
inventories obsolete.
  Our founder and former Chief Executive Officer controls approximately 19.4% of our Common Stock,
may be able to exert significant influence over the Company and has signaled his willingness to
engage with the Company with respect to significant matters.
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Business acquisitions, new business ventures, dispositions or joint ventures entail numerous risks
and may disrupt our business, dilute shareholder value and distract management attention.
  
    
    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;
    
    potential disagreements and impact on the ongoing acquired operations related to the
computation of earn-outs associated with post-acquisition results; and
    
    impairment of relationships or risk of loss of acquired employees and customers occurring
as a result of integration of the acquired business.
   We may not be able to adequately protect our proprietary technology and may be infringing upon
third-party intellectual property rights.
  40




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rd
  Our reliance on a limited number of suppliers for key components and our dependence on contract
manufacturers could impair our ability to manufacture and deliver our products and services in a
timely and cost-effective manner.
  41




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We derive a substantial portion of our net sales from our dealer network and if these dealers do
not effectively promote and sell our products, our business and operating results could be harmed.
  42




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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.
      43




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We have been involved in legal disputes, which have resulted in a jury verdict, legal settlement
and associated legal costs, which may cause further competitive and financial harm to our business.
     Managing our international sales efforts may expose us to additional business risks, which may
result in reduced sales or profitability in our international markets.
  44




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If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may
not be able to achieve our objectives.
  Our IP network products may be vulnerable to viruses, other system failure risks and security
concerns, which may result in lost customers or slow commercial acceptance of our IP network
products.
  We may be unable to achieve or manage our growth effectively, which may harm our business.
  The introduction of new products and services has lengthened our sales cycles, which may result in
significant sales and marketing expenses.
 â
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We rely heavily upon third-party packaged software systems to manage and run our business
processes, to provide certain products and services and to produce our financial statements. From
time to time we upgrade these systems to ensure continuation of support and to expand the
functionality of the systems to meet our business needs. The risks associated with the upgrade
process include disruption of our business processes, which could harm our business.
  Our stock price has been and may continue to be volatile, impairing your ability to sell your
shares at or above purchase price.
  
    
    announcements of developments relating to our business;
    
    investors reactions to the proxy contest and/or the interim settlement thereof; the
proposals by Mr. Mihaylo and Vector Capital Corporation to acquire the company; the Companys
rejection of the proposals; the option by Mr. Mihaylo to hold a stockholder meeting; the
subsequent meeting and vote tally in favor of the Company and against the Mihaylo resolution
to arrange for a prompt sale of the Company to the highest bidder;
    
    fluctuations in our operating results;
    
    the impact of our dividend announcements, repurchase program or sales of stock by officers
and directors;
    
    shortfalls in revenue or earnings relative to securities analysts expectations;
 46




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
    
    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 on our business of the E-Rate settlement, the one year debarment of Technologies
from the E-Rate program, and expected fines and penalties associated with the GSA variances
and noncompliance which could affect both our government business and our commercial business;
    
    the impact on our business of settlements, continuing litigations, proceedings and other
contingencies, which could affect our business;
    
    changes in our relationships with our customers and suppliers, including shipping and
manufacturing problems associated with subcontracted vendors;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances.
  Changes in stock option accounting rules have adversely impacted our reported operating
results prepared in accordance with generally accepted accounting principles, and may affect our
stock price and our competitiveness in the employee marketplace.
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Risks Related to Our Industry
 Reductions in spending on enterprise communications equipment may materially and adversely affect
our business.
  The emerging market for IP network telephony is subject to market risks and uncertainties that
could cause significant delays and expenses.
 Axxess
  Government regulation of third party long distance and network service entities on which we rely
may harm our business.
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Consolidation within the telecommunications industry could increase competition and adversely
affect our business.
  Terrorist activities and resulting military and other actions could harm our business.
  We Are Exposed To Costs And Risks Associated With Compliance With Changing Laws, Regulations And
Standards In General, and Specifically With Regulation Of Corporate Governance And Disclosure
Standards.
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Board Authorization to Repurchase up to $75 Million of Inter-Tel Stock .
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ISSUER PURCHASES OF EQUITY SECURITIES
 (d) Maximum Number (or(c) Total Number of
    
    Approximate Dollar Value)(a) Total
    
    (b) Average
    
    Shares (or Units)
    
    of Shares (or Units) thatNumber of
    
    Price Paid
    
    Purchased as Part of
    
    May Yet Be PurchasedShares (or Units)
    
    per Share (or
    
    Publicly Announced
    
    Under the Plans orPeriod
    
    Purchased
    
    Unit)
    
    Plans or Programs
    
    Programs2005Feb. 15 to April 30
    
    None
    
    
    
    N/A
    
    
    NoneMay 1 to May 31
    
    
    716,500
    
    
    $
    19.228
    
    
    
    716,500June 1 to Dec. 31
    
    None
    
    
    
    N/A
    
    
    None2006
    
    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
    For:
    
    Against:
    
    Abstain:Proposal that the stockholders
urge the Inter-Tel Board of
Directors to arrange for the
prompt sale of Inter-Tel to the
highest bidder.
    
    
    11,013,912
    
    
    
    11,272,464
    
    
    
    238,159
 
 ITEM 5. OTHER INFORMATION
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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 and Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 SIGNATURES
  INTER-TEL (DELAWARE), INCORPORATEDNovember 9, 2006
    /s/  Norman StoutNorman StoutChief Executive OfficerNovember 9, 2006
    /s/  Kurt R. KneipKurt R. KneipSenior Vice President and
Chief Financial Officer 51