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, 1998                                          0-10211


                             INTER-TEL, INCORPORATED


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


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

                                 (602) 302-8900


                                  Common Stock
               (27,119,854 shares outstanding as of June 30, 1998)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such shorter  periods that the  registrant  was
required  file  such  reports),   and  (2)  has  been  subject  to  such  filing
requirements for the past 90 days. Yes [X] No [ ]
<PAGE>
                                      INDEX
                    INTER-TEL, INCORPORATED AND SUBSIDIARIES


                                                                        Page
PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements (Unaudited)

         Condensed consolidated balance sheets--June 30,                  3
         1998 and December 31, 1997

         Condensed consolidated statements of operations--three           4
         and six months ended June 30, 1998 and June 30, 1997

         Condensed consolidated statements of cash flows                  5
         --three and six months ended June 30, 1998 and
         June 30, 1997

         Notes to condensed consolidated financial                        6
         statements--June 30, 1998

Item 2.  Management's Discussion and Analysis of Financial                7
           Condition and Results of Operations

PART II.  OTHER INFORMATION                                              20

SIGNATURES                                                               21

                                       2
<PAGE>
PART I.  FINANCIAL INFORMATION

INTER-TEL, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(In thousands)                                        June 30,      December 31,
                                                        1998            1997
                                                        ----            ----
ASSETS
CURRENT ASSETS
     Cash and equivalents                             $  66,691      $  88,868
     Accounts receivable - net                           37,627         33,737
     Inventories                                         18,494         22,688
     Net investment in sales-leases                      13,037          9,196
     Prepaid expenses and other assets                    6,415          5,977
                                                      ---------      ---------
     TOTAL CURRENT ASSETS                               142,264        160,466

PROPERTY & EQUIPMENT                                     25,449         19,910
OTHER ASSETS                                             22,240         18,100
                                                      ---------      ---------

                                                      $ 189,953      $ 198,476
                                                      =========      =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
     Accounts payable                                 $  14,619      $  15,552
     Other current liabilities                           25,094         21,424
                                                      ---------      ---------
     TOTAL CURRENT LIABILITIES                           39,713         36,976

DEFERRED TAXES AND OTHER LIABILITIES                      8,328         15,898

SHAREHOLDERS' EQUITY
     Common stock                                       100,856         99,402
     Retained earnings                                   41,332         46,471
     Equity adjustment for foreign
        currency translation                               (276)          (271)
                                                      ---------      ---------
TOTAL SHAREHOLDERS' EQUITY                              141,912        145,602
                                                      ---------      ---------

                                                      $ 189,953      $ 198,476
                                                      =========      =========

                                       3
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
<TABLE>
<CAPTION>
(In thousands, except                         Three Months                Six Months
per share amounts)                            Ended June 30,            Ended June 30,
                                            1998          1997         1998         1997
                                            ----          ----         ----         ----
<S>                                       <C>          <C>            <C>        <C>      
NET SALES                                 $  70,509    $  54,823    $ 136,374    $ 105,145
Cost of sales                                37,121       30,422       71,115       58,574
                                          ---------    ---------    ---------    ---------
GROSS PROFIT                                 33,388       24,401       65,259       46,571

  Research & development                      2,828        2,134        5,256        3,979
  Selling, general and administrative        22,667       17,139       43,860       33,191
  Special charge                                897           --          897           --
  Purchased in-process research and
    development and acquisition related
    expenses                                 24,229           --       24,229           --
                                          ---------    ---------    ---------    ---------
                                             50,621       19,273       74,242       37,170
                                          ---------    ---------    ---------    ---------

OPERATING INCOME (LOSS)                     (17,233)       5,128       (8,983)       9,401

  Interest and other income                     888          595        1,858          818
  Interest expense                              (71)         (17)        (114)         (24)
                                          ---------    ---------    ---------    ---------

INCOME (LOSS) BEFORE INCOME TAXES           (16,416)       5,706       (7,239)      10,195
     Income taxes                            (6,458)       2,282       (2,638)       4,101
                                          ---------    ---------    ---------    ---------

NET INCOME (LOSS)                         $  (9,958)   $   3,424    $  (4,601)   $   6,094
                                          =========    =========    =========    =========
NET INCOME (LOSS) PER SHARE
Basic                                     $   (0.37)   $    0.13    $   (0.17)   $    0.24
                                          =========    =========    =========    =========
Diluted                                   $   (0.37)   $    0.13    $   (0.17)   $    0.23
                                          =========    =========    =========    =========

Average common shares outstanding            27,017       25,438       26,949       25,670
                                          =========    =========    =========    =========
Average common shares outstanding
  assuming dilution                          27,017       26,623       26,949       26,537
                                          =========    =========    =========    =========
</TABLE>
                                       4
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
<TABLE>
<CAPTION>
(In thousands, except                                 Three Months             Six Months
per share amounts)                                   Ended June 30,          Ended June 30,
                                                    1998        1997         1998        1997
                                                    ----        ----         ----        ----
<S>                                               <C>         <C>         <C>         <C>
OPERATING ACTIVITIES
  NET INCOME (LOSS)                               $ (9,958)   $  3,424    $ (4,601)   $  6,094
  Adjustments to reflect operating activities:
    Purchased in-process research and
       development                                  24,229          --      24,229          --
    Depreciation and amortization                    1,524       1,171       2,808       2,240
    Changes in operating assets and liabilities     (3,395)     (1,279)     (6,838)     (1,445)
    Other                                           (5,553)      2,439      (3,823)      4,234
                                                  --------    --------    --------    --------
  NET CASH PROVIDED BY
    OPERATING ACTIVITIES                             6,847       5,755      11,775      11,123

INVESTING ACTIVITIES
  Proceeds from disposal of property
    and equipment                                       --           5           7           5
  Cash used in acquisitions                        (26,748)         --     (26,748)       (825)
  Additions to property and equipment               (5,294)     (4,711)     (8,130)     (6,420)
                                                  --------    --------    --------    --------
  NET CASH USED IN INVESTING
    ACTIVITIES                                     (32,042)     (4,706)    (34,871)     (7,240)

FINANCING ACTIVITIES
  Payments for repurchase of common stock               --     (17,493)         --     (17,493)
  Cash dividends paid                                 (270)         --        (537)         --
  Proceeds from sale of common stock                   359          --         359          --
  Proceeds from exercise of stock options              640         274       1,097         347
                                                  --------    --------    --------    --------
  NET CASH PROVIDED BY/(USED IN)
   FINANCING ACTIVITIES                                729     (17,219)        919     (17,146)

 DECREASE IN CASH AND EQUIVALENTS                  (24,466)    (16,170)    (22,177)    (13,263)

CASH AND EQUIVALENTS
 AT BEGINNING OF PERIOD                             91,157      41,843      88,868      38,936
                                                  --------    --------    --------    --------
CASH AND EQUIVALENTS
  AT END OF PERIOD                                $ 66,691    $ 25,673    $ 66,691    $ 25,673
                                                  ========    ========    ========    ========
</TABLE>
                                       5
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 1998

NOTE A--BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial  information and with the  instructions to Form 10-Q and Rule 10-01 of
Regulation  S-X.  Accordingly,  they do not include all of the  information  and
footnotes  required by generally  accepted  accounting  principles  for complete
financial statements. In the opinion of management,  all adjustments (consisting
of normal recurring  accruals)  considered  necessary for a fair presentation of
the results for the interim  periods  presented  have been  included.  Operating
results  for the three and six months  ended June 30,  1998 are not  necessarily
indicative of the results that may be expected for the year ending  December 31,
1998. For further  information,  refer to the consolidated  financial statements
and footnotes  thereto  included in the Company's annual report on Form 10-K for
the year ended December 31, 1997.

NOTE B--EARNINGS PER SHARE

Diluted earnings per share assume that outstanding  common shares were increased
by shares issuable upon the exercise of all  outstanding  stock options to which
market price exceeds  exercise price less shares which could have been purchased
with related proceeds, if the effect would not be antidilutive.

The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
(In thousands, except                       Three Months Ended                 Six Months Ended
per share amounts)                    June 30, 1998     June 30, 1997  June 30, 1998     June 30, 1997
                                      -------------     -------------  -------------     -------------
<S>                                    <C>                 <C>          <C>                 <C>
Numerator:
  Net income (loss)                    $ (9,958)           $ 3,424       $ (4,601)          $ 6,094
                                       ========            =======       ========           =======
Denominator:
  Denominator for basic earnings per
  Share - weighted average shares        27,017             25,438         26,949            25,670

Effect of dilutive securities:
  Employee and director stock options        --              1,185             --               867
                                       --------            -------       --------           -------
Denominator for diluted earnings per
  Share - adjusted weighted average
  Shares and assumed conversions         27,017             26,623         26,949            26,537
                                       ========            =======       ========           =======

Basic earnings (loss) per share        $  (0.37)           $  0.13       $  (0.17)          $  0.24
                                       ========            =======       ========           =======

Diluted earnings (loss) per share      $  (0.37)           $  0.13       $  (0.17)          $  0.23
                                       ========            =======       ========           =======
</TABLE>

NOTE C--ACQUISITIONS

During June,  Inter-Tel purchased certain assets and assumed certain liabilities
of Telecom  Multimedia  Systems,  Inc. ("TMSI") for approximately  $25.1 million
plus related  acquisition costs. TMSI,  formerly a majority-owned  subsidiary of
STM Wireless,  Inc.,  specializes in developing digital signal  processing-based
integrated   software,   hardware  and  systems  to  deliver  compressed  voice,
facsimile,  data and other multimedia solutions over IP and frame relay networks

                                       6
<PAGE>
for telecommunications  applications. The aggregate purchase price was allocated
to the fair value of the assets and liabilities acquired, of which $24.2 million
($14.5 million after taxes) was written-off as purchased in-process research and
development  since  there  was no  alternative  use.  The TMSI  transaction  was
accounted for using the purchase method of accounting. The operations related to
TMSI were not significant to the Company's consolidated operations.

Inter-Tel also acquired  Integrated Telecom Services  Corporation ("ITS") at the
end of the second quarter of 1998. ITS is based in Louisville, Kentucky, and has
offices located in Lexington,  Kentucky;  Indianapolis,  Indiana and Charleston,
West Virginia.  ITS specializes in database  design and systems  integration for
small- to  medium-size  businesses  which  utilize  advanced  telecommunications
products and  services.  The ITS  transaction  was accounted for as a pooling of
interests  transaction.  A special charge of $897,000 ($538,000 after taxes) was
taken to reflect the costs  associated  with  integrating the operations of ITS.
This special charge  principally  includes costs  associated  with redundancy in
inventories,  equipment  abandonment and the write-off of intangible  assets. As
this  acquisition  was not deemed  material  to the  overall  operations  of the
Company,  the consolidated  statements of operations were not restated for prior
periods.  Accordingly,  the net equity of ITS was added to the balance sheet and
statement of shareholders' equity as of December 31, 1997.

NOTE D--PURCHASED  IN-PROCESS  RESEARCH AND DEVELOPMENT AND ACQUISITION  RELATED
CHARGES

During the second quarter of 1998,  Inter-Tel  completed two  acquisitions  (see
NOTE C above) which resulted in pre-tax charges of an aggregate of $25.1 million
($15.1  million  after  taxes),  or $0.56 per  diluted  share.  Including  these
charges,  the Company  incurred net losses of $10.0  million  ($0.37 per diluted
share) for the second quarter and $4.6 million ($0.17 per diluted share) for the
six months ended June 30, 1998.

The aggregate  purchase price of the TMSI  acquisition was allocated to the fair
value of the assets and liabilities  acquired,  of which $24.2 million, or $14.5
million  after  taxes,  was  written-off  as purchased  in-process  research and
development.  A special charge of $897,000  ($538,000  after taxes) was taken to
reflect the costs  associated  with  integrating  the  operations  of ITS.  This
special  charge  principally   includes  costs  associated  with  redundancy  in
inventories, equipment abandonment and the write-off of intangible assets.

PART I.
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF
         FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     This  interim  report  on Form  10-Q  contains  trend  analysis  and  other
forward-looking  statements  within the meaning of Section 27A of the Securities
Act of 1933  and  Section  21E of the  Securities  Exchange  Act of  1934.  Such
statements include  expectations,  beliefs,  intentions or strategies  regarding
future operating results,  future  expenditures,  future cash requirements,  and
future industry  conditions and involve risks and  uncertainties.  The Company's
actual   results  could  differ   materially   from  those   projected  in  such
forward-looking statements as a result of many risk factors, including,  without
limitation,  those set forth  under this  section,  entitled  "Factors  That May
Affect Future Results Of  Operations"  below and elsewhere in the report on Form
10-Q.

Overview

Inter-Tel  is a single  point of  contact,  full  service  provider  of  digital
business  telephone  systems,  IP telephony  products,  CTI applications,  voice
processing  software and long distance calling  services.  Inter-Tel's  products
include the AXXESS and Axxent  digital  business  communication  platforms,  the
AXXESSORY Talk voice processing  platform,  the Inter-Tel  InterPrise IP gateway
and  software,  the  Inter-Tel  Vocal'Net  IP service  provider  gateway and the
Inter-Tel  Vocal'Net  Service  Provider  Software  and  Centralized   Accounting

                                       7
<PAGE>
Software.  Inter-Tel's  services  include  Inter-Tel  NetSolutions,  Inter-Tel's
resale long distance  service and  Inter-Tel.net,  Inter-Tel's  IP long distance
network  service.  The Company also  provides  maintenance,  leasing and support
services for its products and services.

Results of Operations

         Net sales  for the  second  quarter  of 1998  increased  28.6% to $70.5
million,  compared  to $54.8  million in the second  quarter of 1997.  Net sales
increased  29.7% to $136.4 million in the first six months of 1998,  compared to
$105.1  million in the first six months of 1997.  For the quarter and six months
ended June 30, 1998, sales from wholesale  distribution and direct sales offices
accounted for  approximately  $13.9 million and $28.1 million of the  increases,
respectively.  The remaining increases occurred in long distance sales and other
operations.

         The following table sets forth certain  statement of operations data of
the Company expressed as a percentage of net sales for the periods indicated:

                         Three Months Ended June 30,   Six Months Ended June 30,
                         ---------------------------   -------------------------
                             1998        1997               1998        1997
                             ----        ----               ----        ----

Net Sales                   100.0%      100.0%             100.0%      100.0%
Cost of Sales                52.6        55.5               52.1        55.7
                            -----       -----              -----       -----
Gross profit                 47.4        44.5               47.9        44.3

Research and development      4.0         3.9                3.9         3.8
Selling, general and
     administrative          32.1        31.3               32.2        31.6
Special charge                1.3        --                  0.7        --
In-process research and
  development and related
  acquisition expenses       34.4        --                 17.8        --
                            -----       -----              -----       -----
Operating income            (24.4)        9.3               (6.6)        8.9

Interest and other income     1.3         1.1                1.4         0.8
Interest expense             (0.1)        0.0               (0.1)        0.0
Income taxes                 (9.2)        4.2               (1.9)        3.9
                            -----       -----              -----       -----
Net income (loss)           (14.1)%       6.2%              (3.4)%       5.8%
                            =====       =====              =====       =====

         Gross profit for the second  quarter of 1998  increased  36.8% to $33.4
million,  or 47.4% of net  sales,  compared  to $24.4  million,  or 44.5% of net
sales,  for the second quarter of 1997.  Gross profit  increased  40.1% to $65.3
million,  or 47.9% of net  sales,  in the first six months of 1998  compared  to
$46.6  million,  or 44.3% of net sales,  in the first six months of 1997.  Gross
margin  increased  in the  second  quarter  of 1998  primarily  as a  result  of
increased  sales of AXXESS  digital  communication  platforms,  call  processing
software  and voice  processing  software as a  percentage  of net sales.  Gross
margins were offset in part by an increased  percentage of sales through  dealer
channels,  which  typically  generate  lower  gross  margins  than  sales of the
Company's products through its direct sales offices.

         Research  and  development  expenses  for the  second  quarter  of 1998
increased to $2.8 million,  or 4.0% of net sales,  compared to $2.1 million,  or
3.9% of net sales,  for the second  quarter of 1997.  Research  and  development
expenses  increased  to $5.3  million,  or 3.9% of net  sales,  in the first six
months of 1998 compared to $4.0 million,  or 3.8% of net sales, in the first six
months of 1997.  The  increases in absolute  dollars and as a percentage  of net
sales in both periods were primarily  attributable  to expenses  relating to the
development  and   introduction  of  new  products,   including  the  continuing
development  and  improvement  of the  Company's  AXXESS  digital  communication
platforms, call processing and voice processing software, CTI products,  unified
messaging,  and TCP/IP  intranet and internet  voice  solutions  (the  Company's
Vocal'Net and  Inter-Tel.net  products).  The Company  expects that research and

                                       8
<PAGE>
development  expenses  will  continue to  increase  in  absolute  dollars as the
Company  continues to develop new software and to enhance existing  technologies
and products. These expenses may vary, however, as a percentage of net sales.

         Selling,  general and administrative expenses for the second quarter of
1998  increased  to $22.7  million,  or 32.1% of net  sales,  compared  to $17.1
million, or 31.3% of net sales, for the second quarter of 1997. Selling, general
and administrative  expenses increased to $43.9 million,  or 32.2% of net sales,
in the  first six  months of 1998  compared  to $33.2  million,  or 31.6% of net
sales, in the first six months of 1997. The increases,  both in absolute dollars
and as a  percentage  of sales,  for the quarter  and six months  ended June 30,
1998, were  attributable in part to costs associated with hiring  incentives for
key employees,  increased consulting expenses,  expanding its technical training
staff, continued efforts to hire and train additional sales personnel throughout
Inter-Tel's direct sales offices, higher sales commissions paid to the Company's
sales  force  based upon  increased  levels of net sales,  providing  additional
marketing resources for the expanded dealer network and for network services and
long  distance  services.   The  Company  expects  that  selling,   general  and
administrative  expenses will continue to increase in absolute dollars,  but may
vary as a percentage of net sales.

         In June 1998, the Company  purchased  certain assets and liabilities of
Telecom Multimedia  Systems,  Inc. ("TMSI") for approximately $25.1 million plus
related  acquisition  costs.  The aggregate  purchase price was allocated to the
fair value of the assets and liabilities  acquired,  of which $24.2 million,  or
$14.5 million after taxes, was written-off as purchased  in-process research and
development.

         A  special  pre-tax  charge  of  $897,000,  or  $538,000  after  taxes,
reflected the costs associated with integrating the operations of ITS, which was
acquired via a pooling of  interests  at the end of the second  quarter in 1998.
This special charge  principally  reflected costs  associated with redundancy in
inventories, equipment abandonment and the write-off of intangible assets.

         Other income in both periods consisted primarily of interest income and
foreign exchange rate gains and losses.  Income from interest  increased in both
comparable  periods  of  1998  based  on  a  higher  level  of  invested  funds,
principally from the proceeds generated from the Company's public stock offering
in December 1997. Other changes in other income primarily reflected  differences
in net foreign exchange rate gains and losses.

         Net loss for the second  quarter was $9.96  million  ($0.37 per diluted
share) reflecting the write-off of in-process research and development costs and
the special  charge noted above,  compared to net income of $3.4 million  ($0.26
per diluted  share) for the second  quarter of 1997. Net loss for the six months
ended June 30, 1998 was $4.6 million, or $0.16 per diluted share, reflecting the
write-off of in-process  research and development  costs and the special charge,
compared to net income of $6.1 million, or $0.24 per diluted share, in the first
six months of 1997.  Without  the special  charge and  write-off  of  in-process
research and development  costs,  net income for the quarter ended June 30, 1998
would have been $5.1  million,  or $0.18 per  diluted  share,  which  would have
constituted an increase of 49.5% compared to 1997. Moreover, without the special
charge and write-off of in-process  research and development  costs,  net income
for the six months ended June 30, 1998 would have been $10.5  million,  or $0.37
per diluted share, which would have constituted an increase of 71.9% compared to
1997. In addition,  net income per share in 1998 is based on an  additional  1.6
million  and 1.8  million  average  shares  outstanding  for the quarter and six
months ended June 30, 1998,  respectively,  principally reflecting the Company's
public stock offering consummated in December 1997.

Inflation/Currency Fluctuation

         Inflation and currency  fluctuations have not previously had a material
impact on Inter-Tel's  operations.  International  procurement  agreements  have
traditionally been denominated in U.S. currency.  Moreover, a significant amount
of contract  manufacturing has been moved to domestic sources.  The expansion of
international  operations in the United Kingdom and Europe and increased  sales,
if any, in Japan and Asia and  elsewhere  could  result in higher  international

                                       9
<PAGE>
sales as a percentage of total  revenues;  however,  international  revenues are
currently not a significant component of the Company's consolidated operations.

Liquidity and Capital Resources

         At June 30, 198, the Company had $66.7 million in cash and equivalents,
which  represents a decrease of  approximately  $22.2  million from December 31,
1997. The Company maintains a $7.0 million,  unsecured  revolving line of credit
with Bank One,  Arizona,  NA. The credit  facility is annually  renewable and is
available  through June 1, 2000. Under the credit facility,  the Company has the
option to borrow at a prime rate or adjusted LIBOR interest rate.  Historically,
the credit facility has been used primarily to support  international letters of
credit to  suppliers.  In December  1997,  the Company  received net proceeds of
approximately  $59.2  million from a public stock  offering of 3,000,000  common
shares.  Approximately $25 million of the proceeds were used to purchase certain
assets  of TMSI;  the  remaining  proceeds  may be used to  develop  and  expand
Inter-Tel.net  and for  potential  acquisitions,  strategic  alliances,  working
capital and general corporate purposes.

         Net cash  provided by operating  activities  totaled  $11.8 for the six
months  ended  June  30,  1998,  compared  to net  cash  provided  by  operating
activities of $11.1  million for the same period in 1997.  This increase in cash
was primarily the result of profitable  operations  (excluding  the write-off of
in-process  research and development  costs associated with TMSI acquisition and
the special  charge  related to the  acquisition  of ITS),  and lower  inventory
levels,  offset in part by increased accounts  receivable.  During the first six
months of 1998, accounts receivable increased  approximately $3.9 million, while
inventories  decreased  approximately  $4.2  million.  The Company  continues to
expand its dealer  network,  which has  required  and is expected to continue to
require  working  capital for increased  accounts  receivable  and  inventories.
During the first six months of 1998,  other  assets  and  liabilities  decreased
primarily  as a result  of the  change in  deferred  taxes  attributable  to the
write-off of in-process  research and development costs associated with the TMSI
acquisition.

         Net  cash  used  in  investing  activities,  primarily  in the  form of
acquisitions  and capital  expenditures,  totaled $34.9 million and $7.2 million
for the six months ended June 30, 1998 and 1997, respectively.  This decrease in
cash in 1998 was primarily the result of the purchase of certain  assets of TMSI
and related write-off of in-process research and development costs. Cash used in
acquisitions  totaled  approximately  $26.7  million  in the first six months of
1998.  Capital  expenditures  totaled  approximately  $8.1  million for the same
period. The Company  anticipates  additional capital  expenditures  during 1998,
principally  relating  to  anticipated  increased  volumes of  operating  leases
offered by the  Company to its  customers  (which must be  capitalized  as fixed
assets by the  Company),  facilities  expansion,  and  expenditures  relating to
equipment and management information systems used in operations.

         Net cash provided by financing  activities totaled $919,000 for the six
months  ended June 30, 1998  compared to net cash used of $17.1  million for the
same period in 1997. Net cash provided by financing  activities  during the 1998
period was primarily  due to the exercise of stock  options and stock  issuances
pursuant to the Company's  Employee Stock Purchase Plan,  offset in part by cash
dividends paid. During the second quarter of 1997, the Company initiated a stock
repurchase program under which the Board of Directors  authorized the repurchase
of up to 1,470,000  shares of the Company's  common stock.  The Company expended
approximately $17.5 million for stock repurchases in the second quarter of 1997,
which was funded  primarily  by existing  cash  balances.  The Company  reissued
treasury  shares with a cost basis of  approximately  $2.0 million in connection
with stock  option  exercises  and  issuances.  The  proceeds  received  for the
treasury  stock  reissued  was  less  than  its  cost  basis.  Accordingly,  the
difference was recorded as a reduction to retained earnings. The Company's Board
of Directors has also recently  authorized  the repurchase of up to 2.5 millions
shares of the Company's  common stock. No shares have been  repurchased  through
the first six months of 1998.

                                       10
<PAGE>
         The Company offers to its customers lease financing and other services,
including its Totalease program,  through its Inter-Tel Leasing subsidiary.  The
Company funds these programs in part through the sale to financial  institutions
of rental income streams under the leases.  Resold lease rentals totaling $114.1
million and $99.9  million  remain  unbilled at June 30, 1998 and  December  31,
1997,  respectively.  The Company is obligated to repurchase such income streams
in the event of defaults by lease customers and, accordingly, maintains reserves
based upon loss  experience and past due accounts.  Although the Company to date
has been able to resell the rental  streams from leases under its lease programs
profitably and on a substantially current basis, the timing and profitability of
lease  resales  could  impact the  Company's  business  and  operating  results,
particularly  in an  environment  of  fluctuating  interest  rates and  economic
uncertainty. If the Company is required to repurchase rental streams and realize
losses thereon in amounts exceeding its reserves,  its operating results will be
adversely affected.

         The  Company  believes  that its cash  balances,  working  capital  and
available credit  facilities,  together with anticipated  ongoing cash generated
from  operations,  will be  sufficient  to develop and expand its  Inter-Tel.net
network, to finance  acquisitions of additional  resellers of telephony products
and other strategic acquisitions or corporate alliances, and to provide adequate
working capital for at least the next twelve months. However, to the extent that
additional funds are required in the future to address working capital needs and
to provide  funding for capital  expenditures,  expansion of the business or the
Inter-Tel.net network or additional  acquisitions,  the Company will seek, if at
all, additional  financing.  There can be no assurance that additional financing
will be available when required or on acceptable terms.

Factors That May Affect Results of Future Operations

         In addition to other  information  in this interim  report on form 10-Q
(the "10-Q"), the following factors should be considered carefully in evaluating
the Company's  business.  The  discussion in this 10-Q contains  forward-looking
statements.   Future  events  anticipated  in  the  forward-looking   statements
contained in this 10-Q are uncertain.  Actual events,  and the Company's  actual
results,  may differ  materially from those  predicted,  assumed or discussed in
such  forward-looking  statements.  Factors that may cause or contribute to such
differences  include,  but are not  limited  to,  those  discussed  below and in
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations." 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 10-Q.

Rapid Technological Change; Dependence On Recently Introduced Products

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

         During the past eighteen to twenty-four  months, the Company introduced
unified  messaging  on its  AXXESSORY  Talk  platform,  developed  a  number  of
enhancements  to its existing AXXESS and AXXESSORY Talk platforms and introduced
Inter-Tel  Vocal'Net.  In July 1998,  the Company  also  released the AXXESS 5.0
platform,  which is a significant software upgrade and enhancement to its AXXESS
and AXXESSORY Talk platforms. The Company's future success will depend, in large
part, upon the successful  introduction  of the AXXESS 5.0 platform,  as well as
future  upgrades and  enhancements to this  networking  platform.  The Company's
future  success will also depend upon market  acceptance of the Company's  other
new products or enhancements,  including  Inter-Tel  Vocal'Net and certain other
products that the Company  purchased  from TMSI.  There can be no assurance that
these introduced products and enhancements will be successful. In the event that
the Company were to fail to  successfully  introduce new  software,  products or
services or upgrades to its existing systems or products on a regular and timely

                                       11
<PAGE>
basis,  demand for the Company's existing software,  products and services could
decline,  which could have a material  adverse effect on the Company's  business
and operating  results.  Further,  if the markets for IP network products or CTI
applications fail to develop, or grow more slowly than the Company  anticipates,
or if the  Company  is  unable  for any  reason  to  capitalize  on any of these
emerging market opportunities,  the Company's business,  financial condition and
results of operations could be materially adversely affected.

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

Developing Market for IP Network Telephony; Uncertain Regulatory Environment

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

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

         The  regulatory  environment  for IP  network  telephony  is subject to
substantial  uncertainty.  There can be no assurance that the sale and use of IP
network telephony products such as Inter-Tel Vocal'Net and certain products that
the Company  purchased  from TMSI will not violate  telecommunications  or other
regulations  in any of the  countries  in  which  such  products  are or will be
marketed and used.  In the United  States,  the Company  believes that there are
currently few laws or regulations  directly  applicable to voice  communications
over IP  networks  or to access  to, or  commerce  on,  IP  networks  generally.
However,  changes in the  regulatory  environment,  particularly  in regulations
relating  to the  telecommunications  industry,  could have a  material  adverse
effect on the Company's business.  The increased commercial  acceptance of voice
communications  over IP  networks,  as well as other  factors,  could  result in
intervention  by  governmental  regulatory  agencies  in the  United  States  or
elsewhere in the world under  existing or newly enacted  legislation  and in the
imposition  of fees,  charges or taxes on users and  providers  of products  and
services  in this area.  There can be no  assurance  that such  intervention  or
imposition of fees,  charges or taxes would not have a material  adverse  effect

                                       12
<PAGE>
upon the  acceptance  and  attractiveness  of IP network  voice  communications.
Moreover, legislative proposals from international, federal and state government
bodies could impose additional  regulations and obligations upon on-line service
providers.  The growing  popularity and use of the Internet has increased public
focus and could  lead to  increased  pressure  on  legislatures  to impose  such
regulations.   The  Company  cannot  predict  the  likelihood  that  any  future
legislation or regulation will be enacted,  nor the financial impact, if any, of
such resulting  legislation or regulation.  In the future,  the Company may also
develop and introduce  other products with new or additional  telecommunications
capabilities or services,  which could be subject to existing federal government
regulations or result in the imposition of new government regulations, either in
the United States or elsewhere.

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

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

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

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

Development and Maintenance of Inter-Tel.net Network

         The Company is currently utilizing its Inter-Tel  Vocal'Net  technology
and certain IP  technology  acquired  from TMSI to develop and expand its own IP
network,  Inter-Tel.net, to carry voice traffic. The Inter-Tel.net network is in
its initial stages of deployment and,  accordingly,  is subject to a high degree
of risk. To date, the Inter-Tel.net  network has established  points of presence
in the San Francisco Bay Area,  Washington,  D.C.,  Chicago,  New York, Phoenix,
Reno and Los Angeles.  Certain products that the Company purchased from TMSI are

                                       13
<PAGE>
also in the process of being tested and deployed in this network.  If the market
for IP network  products  fails to  develop or  develops  more  slowly  than the
Company   anticipates,   the  Company's   Inter-Tel.net   network  could  become
financially burdensome to maintain or obsolete, either of which could materially
and adversely affect the Company's business,  financial condition and results of
operations.

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

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

Highly Competitive Industry

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

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

         In the market for voice processing applications,  including voice mail,
the Company  competes  against AVT,  Active Voice,  Centigram,  Lucent and other
competitors,  certain of which have  significantly  greater  resources  than the
Company. In the market for long distance services,  the Company competes against
AT&T,  MCI,  Sprint  Corporation,  Qwest  Communications  Corporation  and other
competitors,  many of  which  have  significantly  greater  resources  than  the
Company.  The Company will also compete with RBOCs, cable television  companies,

                                       14
<PAGE>
satellite and other wireless  broadband service  providers,  and others for long
distance business as those companies gradually respond to the Telecommunications
Act.  Key  competitive  factors in the sale of  telephone  systems  and  related
applications  include price,  performance,  features,  reliability,  service and
support, name recognition and distribution capability. The Company believes that
it competes favorably in its markets with respect to the price,  performance and
features of its  systems,  as well as the level of service and support  that the
Company  provides to its customers.  Certain of the Company's  competitors  have
significantly  greater name recognition and distribution  capabilities  than the
Company,  although  the Company  believes  that it has  developed a  competitive
distribution  presence in certain markets,  particularly those where the Company
has direct sales offices.  The Company expects that competition will continue to
be  intense  in the  markets  addressed  by the  Company,  and  there  can be no
assurance that the Company will be able to continue to compete successfully.

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

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

Management of Growth; Implementation of New Management Information Systems

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

         During the fourth  quarter of 1996,  the  Company  determined  that the
limitations  of the  existing  system  software  would  prevent  Inter-Tel  from
establishing an integrated and centralized dispatch and telemarketing center. As
a result, the Company signed an agreement with a large, established software and

                                       15
<PAGE>
database vendor to replace its existing MIS software and implement, maintain and
support   alternate  MIS  software  to  be  utilized   throughout  the  Company.
Accordingly,  during  the  fourth  quarter of 1996,  the  Company  wrote off the
software license and implementation  costs relating to the system software being
replaced.  The Company  implemented  various  components of the new MIS software
during the second  quarter and plans to roll-out  additional  components  of the
software over the next six to twelve months.

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

         The Company has made strategic  acquisitions in the past and expects to
continue to do so in the future.  During June 1998,  the Company  completed  its
purchase of certain  assets of TMSI for cash of  approximately  $25 million plus
the assumption of certain  liabilities and acquisition  costs.  The Company also
acquired  Integrated  Telecom  Services  Corporation  ("ITS")  in a  pooling  of
interests  transaction in which the Company issued approximately  140,000 shares
of common  stock.  Acquisitions  require a  significant  amount of the Company's
management attention and financial and operational  resources,  all of which are
limited.  The  integration of TMSI, ITS or any other acquired  entities may also
result in unexpected  costs and disruptions and significant  fluctuations in, or
reduced predictability of, operating results from period to period. There can be
no  assurance  that an  acquisition  will  not  adversely  affect  the  business
relationships  of the  Company  or  the  acquired  entity  with  its  respective
suppliers or customers. Further, there can be no assurance that the Company will
be able to successfully  integrate TMSI, ITS or any other acquired operations or
achieve any of the intended benefits of an acquisition. The Company's failure to
manage  its growth  effectively  could  have a  material  adverse  effect on its
business, financial condition and operating results.

Dependence Upon Contract Manufacturers and Component Suppliers

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

                                       16
<PAGE>
able to continue to obtain components or finished goods in sufficient quantities
or quality or on favorable pricing and delivery terms in the future.

Product Protection and Infringement

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

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

Reliance on Dealer Network

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

Dependence on Key Personnel

         The Company is dependent on the  continued  service of, and its ability
to attract and retain,  qualified  technical,  marketing,  sales and  managerial
personnel. The competition for such personnel is intense, and the loss of any of
such  persons,  as well as the failure to recruit  additional  key technical and

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<PAGE>
sales personnel in a timely manner,  would have a material adverse effect on the
Company's  business and operating  results.  There can be no assurance  that the
Company will be able to continue to attract and retain the  qualified  personnel
necessary for the development of its business.

Risks of Providing Long Distance and Network Services

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

Potential Fluctuations In Quarterly Results; Limited Backlog

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

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<PAGE>

the  future  experience,  fluctuations  in  sales  and  operating  results  on a
quarterly  basis.  See  "Management's   Discussion  and  Analysis  of  Financial
Condition and Results of Operations."

Volatility of Stock Price

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

Year 2000 Compliance

         Many currently  installed  computer  systems and software  products are
coded to accept only two digit entries in the date code field.  Beginning in the
year 2000,  these date code  fields  will need to accept  four digit  entries to
distinguish  21st century dates from 20th century  dates.  As a result,  in less
than two years, computer systems and/or software used by many companies may need
to be  upgraded  to  comply  with such  "Year  2000"  requirements.  Significant
uncertainty  exists in the software  industry  concerning the potential  effects
associated with such compliance.

         The Company has  evaluated its level of exposure to the risks and costs
associated  with Year 2000  problems and is currently in the process of updating
its information systems to be Year 2000 compliant. Currently, the total costs of
the new information systems software  implementation are being capitalized,  and
the Company does not currently  anticipate  that the costs of becoming Year 2000
compliant will be material.  The Company expects its  information  systems to be
Year 2000 compliant by the end of fiscal 1999, and anticipates no disruptions in
the  services it provides to its  customers  as a result of Year 2000  problems.
However,  no assurance  can be given that the Company's  software  products will
contain all necessary date code changes  necessary to prevent  processing errors
potentially  arising from  calculations  using the Year 2000 date,  or that such
updates will be fully completed in a timely manner or that such disruptions will
not occur. Any disruption in manufacturing services provided by the Company as a
result  of  Year  2000  noncompliance  would  materially  adversely  affect  the
Company's business, financial condition and results of operations. Moreover, the
Company  could  be  adversely  impacted  by Year  2000  issues  faced  by  major
distributors,  suppliers, customers, vendors and financial service organizations
with which the Company interacts.

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

                                       19
<PAGE>
significant number of companies, including existing customers of the Company, to
reevaluate their current communications  platform, IP network telephony or voice
processing  software needs, and as a result consider  switching to other systems
or suppliers.

Concentration of Ownership

As of June 30, 1998, Steven G. Mihaylo,  the Company's  Chairman of the Board of
Directors,   Chief   Executive   Officer  and   President   beneficially   owned
approximately 20% of the outstanding shares of the Common Stock. As a result, he
has the ability to exercise  significant  influence  over all matters  requiring
shareholder approval. In addition, the concentration of ownership could have the
effect of delaying or preventing a change in control of the Company.

Any of the foregoing could result in a material  adverse effect on the Company's
business, financial condition and operating results.

INTER-TEL, INCORPORATED AND SUBSIDIARIES

PART II.   OTHER INFORMATION

ITEM l.   LEGAL PROCEEDINGS--Not Applicable

ITEM 2.   CHANGES IN SECURITIES--Not Applicable

ITEM 3.   DEFAULTS ON SENIOR SECURITIES--Not Applicable

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

          1.   On  April  23,  1998,   at  the  Company's   annual   meeting  of
               shareholders,   the  shareholders  of  the  Company  elected  the
               following directors, each of whom was a nominee of the Company:

          Name                         Votes For         Votes Withheld
          ----                         ---------         --------------
          Steven G. Mihaylo            22,705,275            27,550
          J. Robert Anderson           22,696,653            36,172
          Gary D. Edens                22,699,953            32,872
          Maurice H. Esperseth         22,702,322            30,503
          C. Roland Haden              22,705,497            27,328
          Norman Stout                 22,701,953            30,872

ITEM 5.   OTHER INFORMATION

          Pursuant to Rule  14a-4(c)(1)  under the  Securities  Exchange  Act of
          1934, in connection with the Company's annual meeting of shareholders,
          if a stockholder of the Company fails to notify the Company at lest 45
          days prior to the month and day of mailing of the prior  year's  proxy
          statement,  then the  proxies  of  management  would be allowed to use
          their discretionary  voting authority when any such proposal is raised
          at  the  Company's  annual  meeting  of   stockholders,   without  any
          discussion of the matter in the proxy statement.

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<PAGE>
ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K

          Exhibits:

          Exhibit  27.1 -  Financial  Data  Schedule  for June 30,  1998
          Exhibit  27.2 - Restated Financial Data Schedule for March 31, 1998 
          Exhibit  27.3 - Restated Financial Data Schedule for December 31, 1997

          Reports on Form 8-K -- None


                                   SIGNATURES

Pursuant  to the  requirements  of the  Securities  Exchange  Act of  1934,  the
registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned thereunto duly authorized.

                             INTER-TEL, INCORPORATED


Date August 14, 1998             /s/ Steven G. Mihaylo
    ----------------             -------------------------------------
                                 Steven G. Mihaylo,
                                 Chairman of the Board,
                                 Chief Executive Officer and President


Date August 14, 1998             /s/ Kurt R. Kneip
    ----------------             -------------------------------------
                                 Kurt R. Kneip,
                                 Vice President
                                 and Chief Financial Officer

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