UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                    FORM 10-Q

                  QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

  FOR THE QUARTER ENDED                                  COMMISSION FILE NUMBER:
   SEPTEMBER 30, 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
            (26,119,504 shares outstanding as of September 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  to 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--September 30, 1998
          and December 31, 1997                                              3

          Condensed consolidated statements of operations--three and
          nine months ended September 30, 1998 and September 30, 1997        4

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

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

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

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)                                   September 30,     December 31,
                                                     1998             1997
                                                     ----             ----
ASSETS
CURRENT ASSETS
  Cash and equivalents                            $  54,842        $  88,805
  Accounts receivable -- net                         37,159           32,234
  Inventories                                        21,149           21,539
  Net investment in sales-leases                     12,982            9,196
  Prepaid expenses and other assets                   6,319            5,625
                                                  ---------        ---------
       TOTAL CURRENT ASSETS                         132,451          157,399

PROPERTY & EQUIPMENT                                 27,203           19,559
OTHER ASSETS                                         25,121           18,030
                                                  ---------        ---------

                                                  $ 184,775        $ 194,988
                                                  =========        =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
  Accounts payable                                $  12,652        $  14,864
  Other current liabilities                          23,234           18,721
                                                  ---------        ---------
       TOTAL CURRENT LIABILITIES                     35,886           35,585

DEFERRED TAX LIABILITY                                7,799           11,343
OTHER LIABILITIES                                     5,066            4,555

SHAREHOLDERS' EQUITY
  Common stock                                      102,560           99,229
  Retained earnings                                  47,239           46,547
  Equity adjustment for foreign
    currency translation                               (278)            (271)
                                                  ---------        ---------
                                                    149,521          145,505
  Less:
   Treasury stock at cost                           (13,497)              --
                                                  ---------        ---------
       TOTAL SHAREHOLDERS' EQUITY                   136,024          145,505
                                                  ---------        ---------
                                                  $ 184,775        $ 194,988
                                                  =========        =========

                                       3
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

                                        Three Months            Nine Months
                                     Ended September 30,    Ended September 30,
(In thousands except                 -------------------    -------------------
per share amounts)                     1998        1997      1998       1997
                                       ----        ----      ----       ----

NET SALES                            $70,389     $56,915   $202,235   $162,061
Cost of sales                         35,543      30,617    103,613     89,191
                                     -------     -------   --------   --------
GROSS PROFIT                          34,846      26,298     98,622     72,870
                                     -------     -------   --------   --------

 Research & development                3,283       1,873      8,539      5,852
 Selling, general and administrative  22,474      17,844     65,019     51,035
 In process research and development
   and related acquisition expenses       --          --     24,229         --
                                     -------     -------   --------   --------
                                      25,757      19,717     97,787     56,887
                                     -------     -------   --------   --------

OPERATING INCOME                       9,089       6,581        835     15,983

 Interest and other income               722         106      2,568        924
 Interest expense                        (19)        (12)       (58)       (37)
                                     -------     -------   --------   --------

INCOME BEFORE TAXES                    9,792       6,675      3,345     16,870
 Income taxes                          4,023       2,697      1,744      6,798
                                     -------     -------   --------   --------

NET INCOME                           $ 5,769     $ 3,978   $  1,601   $ 10,072
                                     =======     =======   ========   ========
NET INCOME PER SHARE:
 Primary                             $  0.22     $  0.17   $   0.06   $   0.40
                                     =======     =======   ========   ========
 Fully diluted                       $  0.21     $  0.16   $   0.06   $   0.39
                                     =======     =======   ========   ========
Average number of common
shares outstanding:
 Primary                              26,754      23,397     26,791     24,912
                                     =======     =======   ========   ========
 Fully diluted                        27,489      24,682     27,941     25,918
                                     =======     =======   ========   ========

                                       4
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
                                                    Three Months          Nine Months
                                                 Ended September 30,  Ended September 30,
(In thousands)                                     1998      1997       1998      1997
                                                   ----      ----       ----      ----
<S>                                              <C>       <C>        <C>       <C>
OPERATING ACTIVITIES
  NET INCOME                                     $  5,769  $  3,978   $  1,601  $ 10,072

  Adjustments to reflect operating activities:
  Depreciation and amortization                     1,924     1,051      4,657     3,291
  Purchased in process research and development        --        --     24,229        --
  Changes in operating assets and liabilities      (3,864)   (1,044)   (11,199)   (2,488)
  Other                                             1,189     2,492     (2,443)    6,725
                                                 --------  --------   --------  --------
NET CASH PROVIDED BY
  OPERATING ACTIVITIES                              5,018     6,477     16,845    17,600

INVESTING ACTIVITIES
  Proceeds from disposal of property
   and equipment                                      105        76        112        81
  Cash used in acquisition                             --        --    (26,748)     (825)
  Additions to property and equipment              (3,494)   (1,630)   (11,613)   (8,050)
                                                 --------  --------   --------  --------
NET CASH USED IN INVESTING
 ACTIVITIES                                        (3,389)   (1,554)   (38,249)   (8,794)

FINANCING ACTIVITIES
  Payments for repurchase of common stock         (13,644)   (9,701)   (13,644)  (27,194)
  Cash dividends paid                                (262)       --       (799)       --
  Proceeds from stock issued under the
   Employee Stock Purchase Plan                        --        --        359        --
  Proceeds from exercise of stock options             428     1,293      1,525     1,640
                                                 --------  --------   --------  --------
NET CASH USED IN
 FINANCING ACTIVITIES                             (13,478)   (8,408)   (12,559)  (25,554)

 DECREASE IN CASH
  AND EQUIVALENTS                                 (11,849)   (3,485)   (33,963)  (16,748)

CASH AND EQUIVALENTS
 AT BEGINNING OF PERIOD                            66,691    25,673     88,805    38,936
                                                 --------  --------   --------  --------
CASH AND EQUIVALENTS
 AT END OF PERIOD                                $ 54,842  $ 22,188   $ 54,842  $ 22,188
                                                 ========  ========   ========  ========
</TABLE>
                                       5
<PAGE>
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 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  nine  months  ended  September  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                 Nine Months Ended
per share amounts)                    Sept. 30, 1998   Sept. 30, 1997   Sept. 30, 1998  Sept. 30, 1997
                                      --------------   --------------   --------------  --------------
<S>                                       <C>             <C>               <C>             <C>
Numerator:
 Net income                               $ 5,769         $ 3,978           $ 1,601         $10,072
                                          =======         =======           =======         =======
Denominator:
 Denominator for basic earnings per
 Share - weighted average shares           26,754          23,397            26,791          24,912

Effect of dilutive securities:
 Employee and director stock options          735           1,285             1,150           1,006
                                          -------         -------           -------         -------
Denominator for diluted earnings per
 Share - adjusted weighted average
 Shares and assumed conversions            27,489          24,682            27,941          25,918
                                          =======         =======           =======         =======

Basic earnings per share                  $  0.22         $  0.17           $  0.06         $  0.40
                                          =======         =======           =======         =======

Diluted earnings per share                $  0.21         $  0.16           $  0.06         $  0.39
                                          =======         =======           =======         =======
</TABLE>

NOTE C--ACQUISITIONS

At the end of the second quarter,  the Company  acquired all of the common stock
of Integrated Telecom Services  Corporation ("ITS") by issuing 140,000 shares of
the Company's  common stock.  At the time of the acquisition the transaction met
the  requirements for  pooling-of-interests  accounting,  and  accordingly,  the
operations of ITS were combined with those of the Company on a retroactive basis
during the period ended June 30, 1998.  During the three months ended  September
30, 1998, the Company  repurchased  shares of its common stock which resulted in
pooling-of-interests   accounting   no  longer  being   available  for  the  ITS
acquisition.  Accordingly,  during the three months ended September 30, 1998 the
Company  revised
                                       6
<PAGE>
the  accounting  for the  transaction to the purchase  accounting  method.  This
resulted in the  operations  of ITS being  included with those of the Company at
the  end of the  second  quarter  when  ITS was  acquired  and  resulted  in the
recording of goodwill of approximately  $1.36 million,  which is being amortized
over 10 years.

The change to purchase accounting from  pooling-of-interests  accounting had the
following  impact on the  operating  results  for the six months  ended June 30,
1998:
                                                       As             As
                                                    Reported       Restated
                                                    --------       --------
        Net sales                                   $136,374       $131,846
        Gross  profit                                 65,259         63,776
        Research and development                       5,256          5,256
        Selling, general and administrative           43,860         42,545
        Special charge                                   897             --
        In process research and development           24,229         24,229
        Operating income                              (8,983)        (8,254)
        Other income and expenses                      1,744          1,807
        Net loss                                      (4,601)        (4,168)
        Diluted loss per share                      $  (0.17)      $  (0.16)
        Diluted shares outstanding                    26,949         26,809

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  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,  Internet Protocol ("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   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 third quarter of 1998  increased  23.7% to $70.4 million,
compared  to $56.9  million in the third  quarter of 1997.  Net sales  increased
24.8% to $202.2  million in the first nine  months of 1998,  compared  to $162.1
million in the first nine months of 1997.  For the quarter and nine months ended
September 30, 1998,  sales from wholesale  distribution and direct sales offices
accounted for  approximately  $10.6 million and $31.4 million of the  increases,
respectively.  The remaining increases occurred in long distance sales and other
operations.
                                       7
<PAGE>
     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     Nine Months Ended
                                         September 30,          September 30,
                                      ------------------     -----------------
                                       1998       1997        1998       1997
                                       ----       ----        ----       ----
Net Sales                             100.0%     100.0%      100.0%     100.0%
Cost of Sales                          50.5       53.8        51.2       55.0
                                      -----      -----       -----      -----
Gross profit                           49.5       46.2        48.8       45.0
Research and development                4.7        3.3         4.2        3.6
Selling, general and administrative    31.9       31.4        32.2       31.5
In-process research and development
and related acquisition expenses         --         --        12.0         --
                                      -----      -----       -----      -----
Operating income                       12.9       11.5         0.4        9.9
Interest and other income               1.0        0.2         1.3        0.5
Interest expense                        0.0        0.0         0.0        0.0
Income taxes                            5.7        4.7         0.9        4.2
                                      -----      -----       -----      -----
Net income                              8.2%       7.0%        0.8%       6.2%
                                      =====      =====       =====      =====

     Gross  profit  for the  third  quarter  of 1998  increased  32.5%  to $34.8
million,  or 49.5% of net  sales,  compared  to $26.3  million,  or 46.2% of net
sales,  for the third  quarter of 1997.  Gross profit  increased  35.3% to $98.6
million,  or 48.8% of net sales,  in the first nine  months of 1998  compared to
$72.9 million,  or 45.0% of net sales,  in the first nine months of 1997.  Gross
margin increased in the third quarter of 1998 primarily as a result of increased
sales of higher margin AXXESS digital communication  platforms,  call processing
software  and voice  processing  software  as a  percentage  of net  sales.  The
increases in gross  margins were offset in part by an  increased  percentage  of
sales through dealer channels during the third quarter, which typically generate
lower gross  margins  than sales of the  Company's  products  through its direct
sales offices.

     Research and  development  expenses for the third quarter of 1998 increased
to $3.3 million, or 4.7% of net sales,  compared to $1.9 million, or 3.3% of net
sales,  for the  third  quarter  of  1997.  Research  and  development  expenses
increased  to $8.5  million,  or 4.2% of net sales,  in the first nine months of
1998 compared to $5.9 million, or 3.6% of net sales, in the first nine 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 addition of
engineering   personnel  in  connection  with  the  TMSI   acquisition  and  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
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 third quarter of 1998
increased to $22.5 million, or 31.9% of net sales, compared to $17.8 million, or
31.4% of net  sales,  for the  third  quarter  of  1997.  Selling,  general  and
administrative  expenses  increased to $65.0 million,  or 32.2% of net sales, in
the first nine months of 1998 compared to $51.0 million,  or 31.5% of net sales,
in the first nine months of 1997. The increases, both in absolute dollars and as
a percentage of sales, for the quarter and nine months ended September 30, 1998,
were  attributable in part to costs associated with the start up and building of
the  Inter-Tel.net  network and retail  distribution  of  Inter-Tel IP Telephony
products,  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,  and  additional  marketing  resources  for the  expanded  dealer
network,  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.
                                       8
<PAGE>
     In June 1998,  the Company  purchased  certain  assets and assumed  certain
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.

     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 income  for the third  quarter  was $5.8  million  ($0.21  per  diluted
share), compared to net income of $4.0 million ($0.16 per diluted share) for the
third quarter of 1997.  Net income for the nine months ended  September 30, 1998
was $1.6  million,  or $0.06 per diluted  share,  reflecting  the  write-off  of
in-process  research  and  development  costs, compared  to net  income of $10.1
million,  or $0.39 per diluted share, in the first nine months of 1997.  Without
the write-off of in-process  research and development  costs, net income for the
nine months ended September 30, 1998 would have been $16.1 million, or $0.58 per
diluted  share,  which would have  constituted  an increase of 60.2% compared to
1997. In addition,  net income per share in 1998 is based on an  additional  2.8
million and 2.0 million  average  shares  outstanding  for the third quarter and
nine months ended September 30, 1998,  respectively,  principally reflecting the
Company's  public stock  offering  consummated  in December 1997 and  additional
stock option grants to the Company's employees.

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. dollars.  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, Asia and elsewhere could result in higher  international 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  September  30,  1998,  the  Company  had  $54.8  million  in  cash  and
equivalents,  which  represents a decrease of  approximately  $34.0 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.  During the nine months ended September 30,
1998,  approximately  $26.7 million were used to purchase certain assets of TMSI
and an  additional  $13.6  million  was  expended  to  repurchase  shares of the
Company's  Common Stock.  The remaining cash balances 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 $16.8 for the nine months
ended September 30, 1998, compared to net cash provided by operating  activities
of $17.6 million for the same period in 1997.  This increase in cash provided by
operating  activities in 1998 was primarily the result of profitable  operations
(excluding the write-off of in-process research and development costs associated
with the TMSI  acquisition),  and  lower  inventory  levels,  offset  in part by
increased accounts  receivable.  During the first nine months of 1998,  accounts
receivable  increased  approximately $4.9 million,  while inventories  decreased
approximately  $390,000.  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 nine months of

                                       9
<PAGE>
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 $38.2 million and $8.8 million
for the nine months ended  September 30, 1998 and 1997,  respectively.  This net
use of cash in 1998 was primarily  the result of the purchase of certain  assets
of TMSI and the related write-off of in-process  research and development costs,
as well as  additions  to  property  and  equipment.  Cash used in  acquisitions
totaled  approximately  $26.7 million in the first nine months of 1998.  Capital
expenditures  totaled  approximately  $11.6  million  for the same  period.  The
Company anticipates  additional capital  expenditures  during 1998,  principally
relating to expenditures for equipment and management  information  systems used
in  operations,  facilities  expansion  and  anticipated  increased  volumes  of
operating  leases  offered  by the  Company  to its  customers,  which  must  be
capitalized as fixed assets by the Company.

     Net cash used in  financing  activities  totaled  $12.6 for the nine months
ended  September 30, 1998 compared to $25.6 million for the same period in 1997.
Net cash used in financing  activities  during both periods was primarily due to
the  initiation of separate stock  repurchase  programs under which the Board of
Directors authorized the repurchase of up to 2.5 million and 1.47 million shares
of the  Company's  common stock during the nine months ended  September 30, 1998
and 1997,  respectively.  The Company expended  approximately  $13.6 million and
$27.2  million  for stock  repurchases  through  the nine  month  periods  ended
September  30, 1998 and 1997,  respectively,  funded by existing  cash  balances
during each period.  The Company  reissued  treasury shares through stock option
exercises and issuances,  with the proceeds received totaling less than the cost
basis of the treasury stock reissued.  Accordingly,  the difference was recorded
during each period as a reduction to retained  earnings.  Net cash used for cash
dividends  totaled  $799,000  during the nine months ended  September  30, 1998,
which was offset by cash  provided by the  exercise  of stock  options and stock
issuances pursuant to the Company's Employee Stock Purchase Plan.

     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 $121.6
million and $99.9 million remain unbilled at September 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  were  required to  repurchase  rental  streams and
realize losses thereon in amounts exceeding its reserves,  its operating results
could be materially 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  may  seek
additional  financing.  There can be no assurance that such additional financing
will be available when required or on acceptable terms.

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

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<PAGE>
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 for its  information  systems,  billing and
collections software, and the Company's software products,  including components
manufactured  and or  developed by the  Company's  suppliers  and  vendors.  The
Company is currently in the process of updating its  information  systems  which
are designed to be Year 2000  compliant.  This decision was made in the ordinary
course of managing the  company's  information  resources  and not  specifically
implemented  to address  Year 2000  compliance  issues.  The  Company  currently
expects its  information  systems to be Year 2000 compliant by the end of fiscal
1999, and anticipates no material 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,  including components  manufactured and or
developed by the  Company's  suppliers  and vendors,  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.  The
Company also  believes that the  purchasing  patterns of customers and potential
customers  may be affected  by Year 2000 issues in a variety of ways.  If any of
the  above  systems  or  products  are not Year  2000  compliant,  however,  the
Company's  business,  financial  condition  and results of  operations  could be
materially  adversely affected.  Please refer to the section entitled "Year 2000
Compliance" in "Factors That May Affect Results of Future  Operations" below for
more detailed information.

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  commercial  acceptance 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
any of these  introduced  products and enhancements  will be successful.  In the
event that the Company  were to fail to  successfully  introduce  new  software,
products  or  services  or  upgrades  to its  existing  systems or products on a
regular and timely basis,  demand for the Company's existing software,  products
and services  could decline,  which could have a material  adverse effect on the
Company's business and operating results. Further, if the markets for IP network
products  or CTI  applications  fail to  develop,  or grow more  slowly than the

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<PAGE>
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,  and,  accordingly,
operating  results  would be adversely  affected 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,  in light  of the  competition
pressures  developing  in  this  market,  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
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

                                       12
<PAGE>
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
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.
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<PAGE>
     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 also  competes  with RBOCs,  cable  television  companies,
satellite and other wireless  broadband service  providers,  and others for long
distance business as those companies 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

                                       14
<PAGE>
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 likely faces 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.

                                       15
<PAGE>
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
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 nine 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 which the Company
issued approximately 140,000 shares of common stock, accounted for as a purchase
transaction.   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

                                       16
<PAGE>
that the Company will not  experience  such delays in the future.  The Company's
reliance on third party  manufacturers  involves a number of  additional  risks,
including reduced control over delivery schedules,  quality assurance and costs.
Any delay in delivery or shortage of supply of components or finished goods from
Varian or any other supplier,  or the Company's inability to develop in a timely
manner alternative or additional sources if and when required,  could damage the
Company's  relationships  with  current  and  prospective  customers  and  could
materially and adversely affect the Company's business,  financial condition and
operating  results.  The Company has no long term  agreements with its suppliers
that require  such  suppliers  to provide  fixed  quantities  of  components  or
finished goods at set prices. There can be no assurance that the Company will be
able to continue to obtain components or finished goods in sufficient quantities
or quality or on favorable pricing and delivery terms in the future.

PRODUCT PROTECTION AND INFRINGEMENT

     The  Company's  future  success  will  depend in part upon its  proprietary
technology.  Although the Company has applied to the U.S.  Patent and  Trademark
Office  for a patent  related  to certain  aspects  of the  Inter-Tel  Vocal'Net
technology,  the Company currently has no issued patents and relies  principally
on copyright  and trade  secret law and  contractual  provisions  to protect its
intellectual property.  There can be no assurance that any patent,  trademark or
copyright owned by 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.
                                       17
<PAGE>
DEPENDENCE ON KEY PERSONNEL

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

RISKS OF PROVIDING LONG DISTANCE AND NETWORK SERVICES

     Inter-Tel  depends  on  its  supply  of  telecommunications   services  and
information  from  several  long  distance  carriers.  Because  it does  not own
transmission facilities, the Company relies on long distance carriers to provide
network services to the Company's  customers and for billing  information.  Long
distance services are subject to extensive and uncertain governmental regulation
on both  the  federal  and  state  level.  There  can be no  assurance  that the
promulgation of certain regulations will not materially and adversely affect the
Company's business,  financial  condition and operating results.  Contracts with
the long distance  carriers from which the Company  currently  resells  services
typically  have  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

                                       18
<PAGE>
sales  for  the  first  and  third  quarters  are  frequently  less  than  those
experienced,  in the fourth and second  quarters,  respectively.  As a result of
these and other factors,  the Company has in the past experienced,  and could in
the  future  experience,  fluctuations  in  sales  and  operating  results  on a
quarterly  basis.  See  "Management's   Discussion  and  Analysis  of  Financial
Condition and Results of Operations."

VOLATILITY OF STOCK PRICE

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

YEAR 2000 COMPLIANCE

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

     The  Company  has  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  which are  designed to be Year 2000  compliant.  This
decision was made in the ordinary  course of managing the company's  information
resources  and not  specifically  implemented  to address  Year 2000  compliance
issues.  The Company has contracted to upgrade the long distance billing system,
which is  designed  to be Year 2000  compliant.  In  addition,  the  Company  is
reviewing its lease billing and collections system,  which has been warranted to
be Year  2000  compliant.  Currently,  the total  costs of each  system is being
capitalized,  and, the Company does not currently anticipate additional costs of
becoming Year 2000 compliant.  The Company expects its information systems to be
Year 2000  compliant  by the end of fiscal  1999,  and  anticipates  no material
disruptions  in the  services it provides to its  customers  as a result of Year
2000 problems. If any of the above systems are not Year 2000 compliant, however,
the Company's  business,  financial condition and results of operations could be
materially adversely affected.

     No assurance can be given that the Company's software  products,  including
components manufactured and or developed by the Company's suppliers and vendors,
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.  Our  engineers  have  tested  the  Company's  current  product
offerings for Year 2000 compliance. Products currently manufactured by Inter-Tel
are designed to be Year 2000 compliant in accordance  with our test  procedures.
Costs to develop and update the Company's products for Year 2000 compliance have
been part of the  research  and  development  efforts on an ongoing  basis.  Any
disruption in manufacturing services provided by the Company as a result of Year
2000  noncompliance  would materially  adversely affect the Company's  business,

                                       19
<PAGE>
financial condition and results of operations.  If any of the Company's products
are not Year 2000 compliant,  the Company's  business,  financial  condition and
results of operations  could be materially  adversely  affected.  Moreover,  the
Company could also be materially 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 of the Company's  customers  and  potential  customers are
requesting  information  about Year 2000  compliance of the Company's  products.
These customers and 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  customers to  accelerate  purchases  with Year
2000 compliance warranties, thereby causing an increase in short-term demand and
a consequent  decrease in long-term demand for software products.  Additionally,
Year 2000  issues  could  cause a  significant  number of  companies,  including
existing  customers of the Company,  to reevaluate their current  communications
platform,  IP network  telephony or voice  processing  software needs,  and as a
result consider switching to other systems or suppliers.  Any of the above items
for  which  the  Company  is unable to  provide  Year 2000  compliance  to these
customers could materially  adversely affect the Company's  business,  financial
condition and results of operations.

CONCENTRATION OF OWNERSHIP

     As of September 30, 1998, Steven G. Mihaylo,  the Company's Chairman of the
Board of Directors,  Chief Executive  Officer and President  beneficially  owned
approximately 21% 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 1. 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--NOT APPLICABLE

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.

                                       20
<PAGE>

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

        Exhibits:

        Exhibit 27 - Financial Data Schedule for September 30, 1998
        Exhibit 27.1 - Restated 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 November 13, 1998                     /s/ Steven G. Mihaylo
                                           -------------------------------------
                                           Steven G. Mihaylo,
                                           Chairman of the Board,
                                           Chief Executive Officer and President


Date November 13, 1998                     /s/ Kurt R. Kneip
                                           -------------------------------------
                                           Kurt R. Kneip,
                                           Vice President
                                           and Chief Financial Officer

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