##### 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:March 31, 2006
    
    
    
    0-10211
 INTER-TEL, INCORPORATED
 Incorporated in the State of Arizona
    
    I.R.S. No. 86-0220994
 1615
S.
52 nd Street
Tempe, Arizona 85281
 (480) 449-8900
 
 Title of Class
    
    Outstanding as of March 31, 2006Common Stock, no par value
    
    26,390,401
 þ o
 o þ o
 o þ




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##### 



INDEX
 INTER-TEL, INCORPORATED AND SUBSIDIARIES
  
 PagePART I. FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (unaudited)Condensed Consolidated Balance SheetsMarch 31, 2006 and December 31, 2005
    
    
    3Condensed Consolidated Statements of Incomethree months ended March 31, 2006 and March 31, 2005
    
    
    4Condensed Consolidated Statements of Cash Flowsthree months ended March 31, 2006 and March 31, 2005
    
    
    5Notes to Condensed Consolidated Financial StatementsMarch 31, 2006
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    27Item 4.
    
    Controls and Procedures
    
    
    28PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    29Item 1A.
    
    Risk Factors
    
    
    29Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    42Item 3.
    
    Defaults Upon Senior Securities
    
    
    42Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    42Item 5.
    
    Other Information
    
    
    42Item 6.
    
    Exhibits
    
    
    42SIGNATURES
    
    
    43MANAGEMENT CERTIFICATIONS
    
    
    44Exhibit 31.1Exhibit 31.2Exhibit 32.1
  2




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PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 March 31,
    
    December 31,(in thousands, except share amounts)
    
    2006
    
    2005(Unaudited)ASSETSCURRENT ASSETSCash and equivalents
    
    $
    115,199
    
    
    $
    103,774Short-term investments
    
    
    61,099
    
    
    
    63,689TOTAL CASH AND SHORT-TERM INVESTMENTS
    
    
    176,298
    
    
    
    167,463Accounts receivable, net of allowances of $6,218
in 2006 and $6,235 in 2005
    
    
    44,283
    
    
    
    44,072Inventories
    
    
    20,712
    
    
    
    19,644Net investment in sales-leases, net of allowances
of $1,036 in 2006 and $998 in 2005
    
    
    20,969
    
    
    
    19,699Income taxes receivable
    
    
    
    
    
    
    2,062Deferred income taxes
    
    
    12,233
    
    
    
    12,590Prepaid expenses and other assets
    
    
    15,816
    
    
    
    14,253TOTAL CURRENT ASSETS
    
    
    290,311
    
    
    
    279,783PROPERTY, PLANT & EQUIPMENT
    
    
    27,021
    
    
    
    28,236GOODWILL
    
    
    29,840
    
    
    
    29,840PURCHASED INTANGIBLE ASSETS
    
    
    22,529
    
    
    
    23,651NET INVESTMENT IN SALES-LEASES, net of allowances
of $1,673 in 2006 and $1,926 in 2005
    
    
    30,420
    
    
    
    34,758TOTAL ASSETS
    
    $
    400,121
    
    
    $
    396,268LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    30,065
    
    
    $
    29,879Other current liabilities
    
    
    54,444
    
    
    
    54,386TOTAL CURRENT LIABILITIES
    
    
    84,509
    
    
    
    84,265DEFERRED TAX LIABILITY
    
    
    69,041
    
    
    
    70,439LEASE RECOURSE LIABILITY
    
    
    14,734
    
    
    
    14,199OTHER LIABILITIES
    
    
    7,233
    
    
    
    7,034SHAREHOLDERS EQUITYCommon stock, no par value-authorized 100,000,000
shares; issued27,161,823 shares;
outstanding26,390,401 at March 31, 2006 and
26,264,458 shares at December 31, 2005
    
    
    121,958
    
    
    
    120,489Retained earnings
    
    
    114,987
    
    
    
    114,653Accumulated other comprehensive income
    
    
    376
    
    
    
    (36
    )237,321
    
    
    
    235,106Less: Treasury stock at cost  771,422 shares at
March 31, 2006 and 897,365 shares at December 31,
2005
    
    
    (12,717
    )
    
    
    (14,775
    )TOTAL SHAREHOLDERS EQUITY
    
    
    224,604
    
    
    
    220,331TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    400,121
    
    
    $
    396,268
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
 (In thousands, except
    
    Three Monthsper share amounts)

    
    Ended March 31,2006
    
    2005NET SALESTelecommunications systems, software and related
    
    $
    92,243
    
    
    $
    92,659Resale of local, long distance and network services
    
    
    14,680
    
    
    
    12,959TOTAL NET SALES
    
    
    106,923
    
    
    
    105,618COST OF SALESTelecommunications systems, software and related
    
    
    44,482
    
    
    
    43,397Resale of local, long distance and network services
    
    
    9,163
    
    
    
    8,256TOTAL COST OF SALES
    
    
    53,645
    
    
    
    51,653GROSS PROFIT
    
    
    53,278
    
    
    
    53,965Research and development
    
    
    8,307
    
    
    
    8,455Selling, general and administrative
    
    
    38,533
    
    
    
    38,723Amortization of purchased intangible assets
    
    
    1,130
    
    
    
    762Write-off of in-process research and development costs
    
    
    
    
    
    
    2,600Legal settlement costs
    
    
    1,300
    
    
    
    49,270
    
    
    
    50,540OPERATING INCOME
    
    
    4,008
    
    
    
    3,425Interest and other income
    
    
    1,280
    
    
    
    947Foreign currency transaction gains (losses)
    
    
    (4
    )
    
    
    52Interest expense
    
    
    (21
    )
    
    
    (23
    )INCOME BEFORE INCOME TAXES
    
    
    5,263
    
    
    
    4,401INCOME TAXES
    
    
    2,061
    
    
    
    2,443NET INCOME
    
    $
    3,202
    
    
    $
    1,958NET INCOME PER SHARE  BASIC
    
    $
    0.12
    
    
    $
    0.07NET INCOME PER SHARE  DILUTED
    
    $
    0.12
    
    
    $
    0.07DIVIDENDS PER SHARE
    
    $
    0.08
    
    
    $
    1.08Average number of common shares outstanding  Basic
    
    
    26,308
    
    
    
    26,373Average number of common shares outstanding  Diluted
    
    
    26,980
    
    
    
    27,788
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 (In thousands)

    
    Three MonthsEnded March 31,2006
    
    2005OPERATING ACTIVITIESNet income
    
    $
    3,202
    
    
    $
    1,958Adjustments to reconcile net income to net cash provided
by (used in) operating activities:Depreciation of fixed assets
    
    
    2,231
    
    
    
    2,253Amortization of patents included in R&D expenses
    
    
    5
    
    
    
    55Amortization of purchased intangible assets
    
    
    1,130
    
    
    
    762Purchased in-process research and development
    
    
    
    
    
    
    2,600Provision for losses on receivables
    
    
    217
    
    
    
    481Provision for losses on leases
    
    
    883
    
    
    
    769Provision for inventory valuation
    
    
    339
    
    
    
    (157
    )Share based compensation expense
    
    
    1,051
    
    
    
    Excess tax benefits from stock options exercised
    
    
    (418
    )
    
    
    Increase/(decrease) in other liabilities
    
    
    14
    
    
    
    (165
    )Loss on sale of property and equipment
    
    
    16
    
    
    
    19Deferred income taxes
    
    
    (1,041
    )
    
    
    381Changes in operating assets and liabilities
    
    
    2,221
    
    
    
    (11,363
    )NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
    
    
    9,850
    
    
    
    (2,407
    )INVESTING ACTIVITIESPurchases of short-term investments
    
    
    (16,700
    )
    
    
    (10,269
    )Maturities and sales of short-term investments
    
    
    19,291
    
    
    
    11,599Additions to property, plant and equipment
    
    
    (1,036
    )
    
    
    (2,218
    )Proceeds from disposal of property, plant and equipment
    
    
    3
    
    
    
    4Cash used in acquisitions
    
    
    
    
    
    
    (27,579
    )NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES
    
    
    1,558
    
    
    
    (28,463
    )FINANCING ACTIVITIESCash dividends paid
    
    
    (2,101
    )
    
    
    (1,829
    )Payments on term debt
    
    
    (12
    )
    
    
    (11
    )Proceeds from exercise of stock options
    
    
    1,300
    
    
    
    5,740Excess tax benefits from stock options exercised
    
    
    418
    
    
    
    NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
    
    
    (395
    )
    
    
    3,900EFFECT OF EXCHANGE RATE CHANGES
    
    
    412
    
    
    
    464INCREASE (DECREASE) IN CASH AND EQUIVALENTS
    
    
    11,425
    
    
    
    (26,506
    )CASH AND EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    103,774
    
    
    
    152,330CASH AND EQUIVALENTS AT END OF PERIOD
    
    $
    115,199
    
    
    $
    125,824
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 NOTE A  BASIS OF PRESENTATION
   Share-Based Payments
   Contingencies
  6




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7




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Inventories
  Recent Accounting Pronouncements
  NOTE B  EARNINGS PER SHARE
   (In thousands, except

    
    Three Months Endedper share amounts)

    
    March 31,2006
    
    2005Numerator: Net income
    
    $
    3,202
    
    
    $
    1,958Denominator:Denominator for basic earnings per share  weighted
average shares
    
    
    26,308
    
    
    
    26,373Effect of dilutive securities:Employee and director stock options
    
    
    672
    
    
    
    1,415Denominator for diluted earnings per share  adjusted weighted
average shares and assumed conversions
    
    
    26,980
    
    
    
    27,788Basic earnings per share
    
    $
    0.12
    
    
    $
    0.07Diluted earnings per share
    
    $
    0.12
    
    
    $
    0.07Options excluded from diluted net earnings per share
calculations (1)
    
    
    657
    
    
    
    69
 (1)
    
    At March 31, 2006 and 2005, options to purchase 657,000 and 69,000 shares, respectively, of
Inter-Tel stock were excluded from the calculation of diluted net earnings per share because
the exercise price of these options was greater than the average market price of the common
shares for the respective periods, and therefore the effect would have been antidilutive.The adoption of FAS123R, effective January 1, 2006 also changed the method of computation of
dilutive shares for the first quarter of 2006. If the same method used to determine dilutive
shares in 8




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2005 was used in 2006, the dilutive shares would have been 774,000. This did not change
the diluted earning per share for the first quarter 2006. NOTE C  ACQUISITIONS AND INTANGIBLE ASSETS
 Lake.
   Intangible Assets.
 NOTE D  SEGMENT INFORMATION
   9




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Three Months Ended March 31, 2006Resale ofLocal, LongDistance and(In thousands, except per share amounts)
    
    Principal
    
    NetworkSegment
    
    Services
    
    TotalNet sales
    
    $
    92,243
    
    
    $
    14,680
    
    
    $
    106,923Gross profit
    
    
    47,761
    
    
    
    5,517
    
    
    
    53,278Legal settlement costs
    
    
    1,300
    
    
    
    
    
    
    
    1,300Operating income
    
    
    1,126
    
    
    
    2,882
    
    
    
    4,008Interest and other income
    
    
    1,231
    
    
    
    49
    
    
    
    1,280Foreign currency transaction losses
    
    
    (4
    )
    
    
    0
    
    
    
    (4
    )Interest expense
    
    
    (20
    )
    
    
    (1
    )
    
    
    (21
    )Net income
    
    $
    1,312
    
    
    $
    1,890
    
    
    $
    3,202Net income per diluted share (1)
    
    $
    0.05
    
    
    $
    0.07
    
    
    $
    0.12Weighted average diluted shares (1)
    
    
    26,980
    
    
    
    26,980
    
    
    
    26,980Goodwill
    
    $
    27,705
    
    
    $
    2,135
    
    
    $
    29,840Total assets
    
    $
    388,655
    
    
    $
    11,466
    
    
    $
    400,121Depreciation and amortization
    
    
    3,345
    
    
    
    21
    
    
    
    3,366
 Three Months Ended March 31, 2005Resale ofLocal, LongDistance and(In thousands, except per share amounts)
    
    Principal
    
    NetworkSegment
    
    Services
    
    TotalNet sales
    
    $
    92,659
    
    
    $
    12,959
    
    
    $
    105,618Gross profit
    
    
    49,262
    
    
    
    4,703
    
    
    
    53,965Write-off of in-process research and development costs
    
    
    2,600
    
    
    
    
    
    
    
    2,600Operating income
    
    
    1,768
    
    
    
    1,657
    
    
    
    3,425Interest and other income
    
    
    906
    
    
    
    41
    
    
    
    947Foreign currency transaction gains
    
    
    52
    
    
    
    
    
    
    
    52Interest expense
    
    
    (23
    )
    
    
    
    
    
    
    (23
    )Net income
    
    $
    787
    
    
    $
    1,171
    
    
    $
    1,958Net income per diluted share (1)
    
    $
    0.03
    
    
    $
    0.04
    
    
    $
    0.07Weighted average diluted shares (1)
    
    
    27,788
    
    
    
    27,788
    
    
    
    27,788Goodwill
    
    $
    27,580
    
    
    $
    2,135
    
    
    $
    29,715Total assets
    
    
    407,140
    
    
    
    7,645
    
    
    
    414,785Depreciation and amortization
    
    
    3,055
    
    
    
    15
    
    
    
    3,070
 
 (1)
    
    Options that are antidilutive because the exercise price was greater than the average
market price of the common shares are not included in the computation of diluted earnings per
share.  10




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Quarter Ended March 31, 2006
    
    Quarter Ended March 31, 2005Source of net sales
    
    $
    
    %
    
    $
    
    %Domestic
    
    
    97,704
    
    
    
    91.4
    %
    
    
    99,664
    
    
    
    94.4
    %Lake Communications
    
    
    5,874
    
    
    
    5.5
    
    
    
    2,590
    
    
    
    2.4Other International
    
    
    3,345
    
    
    
    3.1
    
    
    
    3,364
    
    
    
    3.2Total net sales
    
    
    106,923
    
    
    
    100.0
    %
    
    
    105,618
    
    
    
    100.0
    %
   NOTE E NET INVESTMENT IN SALES-LEASES
 SM
 March 31,
    
    December 31,(in thousands)
    
    2006
    
    2005Lease balances included in consolidated accounts receivable, net of
allowances of $1,014 in 2006, and $980 in 2005
    
    $
    7,609
    
    
    $
    8,860Net investment in Sales-Leases:Current portion, net of allowances of $1,036 in 2006, and $998 in 2005
    
    
    20,969
    
    
    
    19,699Long-term portion, includes residual amounts of $653 in 2006 and,
$625 in 2005, net of allowances of $1,673 in 2006, and $1,926 in 2005
    
    
    30,420
    
    
    
    34,758Total investment in Sales-Leases, net of allowances of $3,723 in 2006,
and $3,904 in 2005
    
    
    58,998
    
    
    
    63,317Sold rental payments remaining unbilled (subject to limited recourse
provisions), net of allowances of $14,734 in 2006, and $14,199 in 2005
    
    
    259,750
    
    
    
    256,143Total balance of sales-leases and sold rental payments remaining
unbilled, net of allowances
    
    $
    318,748
    
    
    $
    319,460Total allowances for entire lease portfolio (including limited recourse
liabilities)
    
    $
    18,457
    
    
    $
    18,103
 11




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Three Months Ended Year Ended(In thousands)
    
    March 31, 2006
    
    December 31, 2005Sales of rental payments
    
    $
    28,263
    
    
    $
    119,060Sold payments remaining unbilled at end of period
    
    $
    274,484
    
    
    $
    270,342
  NOTE F  SHARE BASED COMPENSATION
   12




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Three Months EndedMarch 31, 2006Cost of Revenues
    
    $
    73Research and development
    
    
    289Selling, general and administrative
    
    
    689Share-based compensation expense before income taxes
    
    
    1,051Related income tax benefits
    
    
    249Share-based compensation expense, net of taxes
    
    $
    802Net share-based compensation expense, per common share:Basic
    
    $
    0.03Diluted
    
    $
    0.03
   WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateNumber
    
    
    Exercise
    
    
    Contractual
    
    
    Intrinsicof Shares
    
    
    Price
    
    
    Term (years)
    
    
    ValueBalance at December 31, 2005
    
    
    3,855,988
    
    
    $
    16.36Granted
    
    
    15,000
    
    
    $
    20.67Exercised
    
    
    (125,943
    )
    
    $
    10.39Terminated/expired
    
    
    (26,200
    )
    
    $
    19.26Balance at March 31, 2006
    
    
    3,718,845
    
    
    $
    16.56
    
    
    
    6.2
    
    
    $
    18,147,964Exercisable at March 31, 2006
    
    
    2,460,475
    
    
    $
    16.73
    
    
    
    5.3
    
    
    $
    11,588,837
  13




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Three Months
    
    Three MonthsEnded
    
    EndedMarch 31, 2006
    
    March 31, 2005Expected dividend yield
    
    1.49%
    
    N/AExpected stock price volatility
    
    0.53
    
    N/ARisk-free interest rate
    
    4.76%
    
    N/AExpected life of options
    
    5 Years
    
    N/A
   THREE MONTHSENDEDMARCH 31, 2005Net income, as reported
    
    $
    1,958Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects
    
    
    859Pro-forma net income
    
    $
    1,099Net income per common share:Basic, as reported
    
    $
    0.07Basic, pro forma
    
    $
    0.04Diluted, as reported
    
    $
    0.07Diluted, pro forma
    
    $
    0.04
 Employee Stock Purchase Plan
  14




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ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Overview
  
    
    Inter-Tel Axxess and Inter-Tel 5000 Network Communications Solutions converged voice
and data business communication systems;
    
    integrated voice mail, voice processing and unified messaging systems;
    
    presence management, collaboration, and desk-to-desk video software applications;
    
    managed services, including voice and data network design and traffic provisioning,
custom application development, and financial solutions packages (leasing);
    
    networking applications, including the design and implementation of voice and data networks,
    
    maintenance and support services for our products;
    
    Lake Communications converged voice and data business communication systems, including
those sold in the United States under the Inter-Tel EncoreCX brand and the Sprint
Connection Central brand;
    
    local and long distance calling services and other communications services and
peripheral products;
    
    call accounting software, computer-telephone integration (CTI) applications; and
    
    contact center software applications for both Inter-Tel and other communication system providers.
  15




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##### Table of Contents



Ò
   
    
    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.
    
    Dealer and VAR sales. For shipments to dealers and other distributors, our revenue is
recognized as products are shipped to the dealers and VARs and services are rendered,
because the sales process is complete. Title to these products passes when goods are shipped
(free-on-board shipping point). However, in connection with our 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 through to third parties, at which time the revenue is recorded.
    
    Resale of long distance. We recognize revenue from long distance resale services as
services are provided.
    
    Software Sales. We recognize revenues from sales of software, such as our new Linktivity
products discussed above upon shipment to dealers or end-users.
    
    Maintenance and software support. Maintenance and software support revenue is recognized
ratably over the term of the maintenance or support agreement.
 Costs and gross margins
 16




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
    
    Customer leases generally expire at end of the month and commence at the beginning of
the month, which naturally leads to end-of-period sales. These factors apply to both
end-user and dealer sales.
    
    Internal sales compensation programs for our sales personnel are linked to revenues and
the sales commissions generally increase at accelerated rates as sales volumes increase.
Sales performance bonuses are also frequently tied to quarter-end and year-end performance
targets, providing incentives to sales personnel to close business before the end of each
quarter.
    
    Some price discounting to our dealer channel occurs during the last month of a quarter
or year, and some dealers purchase consistently to take advantage of potential pricing
discounts or end-of-quarter promotions. Dealer buying habits have been consistently
applied for years.
  Cash Flows
 17




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Axxess
 SM SM
 18




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Results of Operations
  Three Months EndedMarch 31,2006
    
    2005NET SALESTelecommunications systems, software and related
    
    
    86.3
    %
    
    
    87.7
    %Resale of local, long distance and network services
    
    
    13.7
    
    
    
    12.3TOTAL NET SALES
    
    
    100.0
    
    
    
    100.0COST OF SALESTelecommunications systems, software and related
    
    
    41.6
    
    
    
    41.1Resale of local, long distance and network services
    
    
    8.6
    
    
    
    7.8TOTAL COST OF SALES
    
    
    50.2
    
    
    
    48.9GROSS PROFIT
    
    
    49.8
    
    
    
    51.1Research and development
    
    
    7.8
    
    
    
    8.0Selling, general and administrative
    
    
    36.0
    
    
    
    36.7Amortization of intangibles
    
    
    1.1
    
    
    
    0.7Write-off of in-process research and development costs
    
    
    
    
    
    
    2.5Legal judgment and settlement
    
    
    1.2
    
    
    
    OPERATING INCOME
    
    
    3.7
    
    
    
    3.2Interest and other income
    
    
    1.2
    
    
    
    0.9Foreign currency transaction gains (losses)
    
    
    0.0
    
    
    
    0.1Interest expense
    
    
    (0.0
    )
    
    
    (0.0
    )INCOME BEFORE INCOME TAXES
    
    
    4.9
    
    
    
    4.2INCOME TAXES
    
    
    1.9
    
    
    
    2.3NET INCOME
    
    
    3.0
    %
    
    
    1.9
    %    -
 Net Sales
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Gross Profit
    Research and Development
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Selling, general and administrative (SG&A)
 Amortization of purchased intangible assets
  Write-off of in-process research and development (IPRD) costs
 Interest and Other Income
 Income Taxes
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Net Income
  Inflation/Currency Fluctuation
  Liquidity and Capital Resources
 Three Months EndedMarch 31,(In thousands)
    
    2006
    
    2005Net cash (used in) provided by operating activities
    
    $
    9,850
    
    
    $
    (2,407
    )Net cash (used in) provided by investing activities
    
    
    1,558
    
    
    
    (28,463
    )Net cash provided by financing activities
    
    
    (395
    )
    
    
    3,900Effect of exchange rate changes
    
    
    412
    
    
    
    464Increase (decrease) in cash and equivalents
    
    
    11,425
    
    
    
    (26,506
    )Cash and equivalents at beginning of period
    
    
    103,774
    
    
    
    152,330Cash and equivalents at end of period
    
    $
    115,199
    
    
    $
    125,824
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SM SM SM
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Off-Balance Sheet Arrangements
 SM
 Critical Accounting Policies and Estimates
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Revenue Recognition
   Sales-Leases
  Share Based Compensation.
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Goodwill and Other Intangible Assets. Business Combinations Goodwill and Other Intangible Assets.
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Allowance for Doubtful Accounts
 Inventories
 Contingencies
 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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SM
  
 ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of disclosure controls and procedures
  Changes in internal controls over financial reporting
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INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 1A. RISK FACTORS
 FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
 This Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended. Actual results could differ materially from those projected in the forward-looking
statements as a result of many risk factors including, without limitation, those set forth under
Factors That May Affect Future Results Of Operations below. In evaluating Inter-Tels business,
shareholders and prospective investors should consider carefully the following factors in
addition to the other information set forth in this document.
 Risks Related to Our Business
 Our operating results have historically depended on a number of factors, and these factors may
cause our operating results to fluctuate in the future.
  
    
    volume and timing of orders received during the quarter;
    
    gross margin fluctuations associated with the mix of products sold;
    
    the mix of distribution channels;
    
    general economic conditions and the condition of the markets our business addresses;
    
    patterns of capital spending by customers;
    
    the timing of new product announcements and releases by us and our competitors and other competitive factors;
    
    pricing pressures;
    
    the cost and 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 on our business of the e-Rate settlement, possible FCC debarment, and expected fines and penalties
associated with the GSA variances and noncompliance which could affect both our government business and our commercial
business;
    
    the impact on our business of settlements, continuing litigations, proceedings and other contingencies, which could
affect our business;
    
    the impact on our business of costs and uncertainties
resulting from shareholder actions, including any action initiated by
Steven G. Mihaylo, who beneficially owns approximately 19.7% of
Inter-Tel's Common Stock, and actual or potential
proxy contests or tender offers;
    
    the potential impact of new accounting pronouncements such as FAS 123R;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances.
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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.
    Our future success largely depends on increased commercial acceptance of our Inter-Tel 5000 series
and Inter-Tel 7000 Network Communications Solutions, Axxess®  system, the Lake OfficeLink
product (branded EncoreCX®  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.
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® ®
 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 Adtran, Alcatel, Altigen, Avaya, Cisco
Systems, 3Com, EADS Telecom, Iwatsu, Interactive Intelligence, Lucky Goldstar, Mitel, NEC, Nortel, Panasonic, Samsung,
ShoreTel, Siemens, Toshiba, Vertical Networks/ArtiSoft/Comdial and Vodavi;
    
    large data routing and convergence companies such as 3Com, Adtran and Cisco Systems;
    
    voice processing applications providers such as ADC, InterVoice-Brite, Active Voice (a subsidiary of NEC America),
Avaya, and Captaris (formerly AVT);
    
    web collaboration product and service providers, such as Centra, eDial (a division of Alcatel), IBM, Microsoft,
Raindance Communications, and WebEx;
    
    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 (which recently announced an agreement to be acquired by 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, Qwest, SBC, and Time-Warner Telecom; and
    
    independent leasing companies that provide telecom equipment financing.
   
    
    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;
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
    
    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;
    
    increased service and warranty costs;
    
    liabilities to our customers; and
    
    increased insurance costs.
 The complexity of our products could cause delays in the development and release of new products
and services. As a result, customer demand for our products could decline, which could harm our
business. Additionally, changes in technology could render current inventories obsolete.
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Our founder and former Chief Executive Officer controls approximately 19.7% 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.
  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; and
    
    impairment of relationships with acquired employees and customers occurring as a result of integration of the acquired
business.
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We may not be able to adequately protect our proprietary technology and may be infringing upon
third-party intellectual property rights.
   rd
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Our reliance on a limited number of suppliers for key components and our dependence on contract
manufacturers could impair our ability to manufacture and deliver our products and services in a
timely and cost-effective manner.
   We derive a substantial portion of our net sales from our dealer network and if these dealers do
not effectively promote and sell our products, our business and operating results could be harmed.
  We have been the subject of government investigations, which have resulted in convictions and civil
penalties and may cause further competitive and financial harm to our business.
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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.
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Managing our international sales efforts may expose us to additional business risks, which may
result in reduced sales or profitability in our international markets.
  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.
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The introduction of new products and services has lengthened our sales cycles, which may result in
significant sales and marketing expenses.
 â
 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.
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
    
    announcements of developments relating to our business;
    
    investors reactions to the proxy contest and/or settlement thereof;
    
    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;
    
    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, possible FCC debarment, and expected fines and penalties
associated with the GSA variances and noncompliance which could affect both our government business and our commercial
business;
    
    the 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 may adversely impact our reported operating results
prepared in accordance with generally accepted accounting principles, our stock price and our
competitiveness in the employee marketplace.
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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.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Board Authorization to Repurchase up to $75 Million of Inter-Tel Stock .
 ISSUER PURCHASES OF EQUITY SECURITIES
 (d) Maximum Number (or(a) Total
    
    
    
    
    
    (c) Total Number of
    
    Approximate Dollar Value)Number of
    
    (b) Average
    
    Shares (or Units)
    
    of Shares (or Units) thatShares (or
    
    Price Paid
    
    Purchased as Part of
    
    May Yet Be PurchasedUnits)
    
    per Share
    
    Publicly Announced
    
    Under the Plans orPeriod
    
    Purchased
    
    (or Unit)
    
    Plans or Programs
    
    Programs4/1/05 to 4/30/05
    
    None
    
    
    N/A
    
    
    None5/1/05 to 5/31/05
    
    
    716,500
    
    
    $
    19.228
    
    
    
    716,5006/1/05 to 6/30/05
    
    None
    
    
    N/A
    
    
    None7/1/05 to 3/31/06
    
    None
    
    
    N/A
    
    
    NoneTotal
    
    
    716,500
    
    
    $
    19.228
    
    
    
    716,500
    
    
    $
    61,223,240
    (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
 
 ITEM 5. OTHER INFORMATION
 
 ITEM 6. EXHIBITS:
 Exhibit 31.1:
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002Exhibit 31.2:
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002Exhibit 32.1:
    
    Certification of Chief Executive Officer 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
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SIGNATURES
  INTER-TEL, INCORPORATEDMay 10, 2006
    
    /s/ Norman StoutNorman StoutDirector and Chief Executive OfficerMay 10, 2006
    
    /s/ Kurt R. KneipKurt R. KneipSr. Vice President and Chief Financial Officer
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EXHIBIT INDEX
 Exhibit 31.1:
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002Exhibit 31.2:
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002Exhibit 32.1:
    
    Certification of Chief Executive Officer 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
 44