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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarter ended
    
    Commission File Number:March 31, 2007
    
    0-10211
 INTER-TEL (DELAWARE), INCORPORATED
 Incorporated in the State of Delaware
    
    I.R.S. No. 86-0220994
 1615 S. 52 nd Street
Tempe, Arizona 85281
 (480) 449-8900
 
 Title of Class
    
    Outstanding as of March 31, 2007Common Stock, par value $0.001
    
    27,012,962
 þ o
  o þ o
 o þ




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##### 



INDEX
 INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited)Condensed Consolidated Balance SheetsMarch 31, 2007 and December 31, 2006
    
    
    3Condensed Consolidated Statements of Incomethree months ended March 31, 2007 and
March 31, 2006
    
    
    4Condensed Consolidated Statements of Cash Flowsthree months ended March 31, 2007
and March 31, 2006
    
    
    5Notes to Condensed Consolidated Financial StatementsMarch 31, 2007
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4. Controls and Procedures
    
    
    29PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    29Item 1A. Risk Factors
    
    
    30Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    45Item 3. Defaults Upon Senior Securities
    
    
    46Item 4. Submission of Matters to a Vote of Security Holders
    
    
    46Item 5. Other Information
    
    
    46Item 6. Exhibits
    
    
    46SIGNATURES
    
    
    46MANAGEMENT CERTIFICATIONS
    
    
    47EX-31.1EX-31.2EX-32
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PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 March 31,
    
    December 31,2007
    
    2006(in thousands, except share amounts)
    
    (Unaudited)ASSETSCURRENT ASSETSCash and equivalents
    
    $
    149,520
    
    
    $
    141,899Short-term investments
    
    
    54,067
    
    
    
    64,388TOTAL CASH AND SHORT-TERM INVESTMENTS
    
    
    203,587
    
    
    
    206,287Accounts receivable, net of allowances of $6,358 in 2007 and $6,323 in 2006
    
    
    45,279
    
    
    
    49,027Inventories
    
    
    25,219
    
    
    
    25,287Net investment in sales-leases, net of allowances of $1,070 in 2007 and $1,112 in 2006
    
    
    19,194
    
    
    
    19,617Income taxes receivable
    
    
    
    
    
    
    3,035Deferred income taxes
    
    
    4,305
    
    
    
    599Prepaid expenses and other assets
    
    
    14,021
    
    
    
    12,476TOTAL CURRENT ASSETS
    
    
    311,605
    
    
    
    316,328PROPERTY, PLANT & EQUIPMENT
    
    
    25,084
    
    
    
    25,858GOODWILL
    
    
    42,865
    
    
    
    42,865PURCHASED INTANGIBLE ASSETS
    
    
    18,445
    
    
    
    19,570NET INVESTMENT IN SALES-LEASES, net of allowances of $1,675 in 2007 and $1,763 in 2006
    
    
    30,048
    
    
    
    31,113OTHER ASSETS
    
    
    1,147
    
    
    
    1,147TOTAL ASSETS
    
    $
    429,194
    
    
    $
    436,881LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIESAccounts payable
    
    $
    34,414
    
    
    $
    34,261Acquisition payable
    
    
    13,000
    
    
    
    13,000Deferred income taxes
    
    
    12,246
    
    
    
    12,246Other current liabilities
    
    
    41,820
    
    
    
    55,145TOTAL CURRENT LIABILITIES
    
    
    101,480
    
    
    
    114,652DEFERRED TAX LIABILITY
    
    
    40,853
    
    
    
    47,712LEASE RECOURSE LIABILITY
    
    
    14,654
    
    
    
    14,682LONG TERM INCOME TAXES PAYABLE
    
    
    8,623
    
    
    
    OTHER LIABILITIES
    
    
    6,908
    
    
    
    7,179STOCKHOLDERS EQUITYCommon stock, no par value-authorized 100,000,000 shares; issued27,161,823 shares;
outstanding27,012,962 at March 31, 2007 and 26,895,360 shares at December 31, 2006
    
    
    27
    
    
    
    27Additional Paid-In Capital
    
    
    128,498
    
    
    
    127,044Retained earnings
    
    
    127,838
    
    
    
    127,787Accumulated other comprehensive income
    
    
    2,756
    
    
    
    2,178259,119
    
    
    
    257,036Less: Treasury stock at cost  148,861 shares at March 31, 2007 and 266,463 shares
at December 31, 2006
    
    
    (2,443
    )
    
    
    (4,380
    )TOTAL STOCKHOLDERS EQUITY
    
    
    256,676
    
    
    
    252,656TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    429,194
    
    
    $
    436,881
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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
 Three Months(In thousands, except
    
    Ended March 31,per share amounts)
    
    2007
    
    2006NET SALESTelecommunications systems, software and related
    
    $
    93,866
    
    
    $
    92,243Resale of local, long distance and network services
    
    
    15,599
    
    
    
    14,680TOTAL NET SALES
    
    
    109,465
    
    
    
    106,923COST OF SALESTelecommunications systems, software and related
    
    
    45,946
    
    
    
    44,482Resale of local, long distance and network services
    
    
    10,129
    
    
    
    9,163TOTAL COST OF SALES
    
    
    56,075
    
    
    
    53,645GROSS PROFIT
    
    
    53,390
    
    
    
    53,278Research and development
    
    
    8,244
    
    
    
    8,307Selling, general and administrative
    
    
    41,465
    
    
    
    38,533Amortization of purchased intangible assets
    
    
    1,115
    
    
    
    1,130Proxy contest and related costs
    
    
    454
    
    
    
    Legal settlement costs
    
    
    
    
    
    
    1,30051,278
    
    
    
    49,270OPERATING INCOME
    
    
    2,112
    
    
    
    4,008Interest and other, net
    
    
    1,822
    
    
    
    1,259Foreign currency transaction gains (losses)
    
    
    18
    
    
    
    (4
    )INCOME BEFORE INCOME TAXES
    
    
    3,952
    
    
    
    5,263INCOME TAXES
    
    
    1,324
    
    
    
    2,061NET INCOME
    
    $
    2,628
    
    
    $
    3,202NET INCOME PER SHARE  BASIC
    
    $
    0.10
    
    
    $
    0.12NET INCOME PER SHARE  DILUTED
    
    $
    0.10
    
    
    $
    0.12DIVIDENDS PER SHARE
    
    $
    0.08
    
    
    $
    0.08Average number of common shares outstanding  Basic
    
    
    26,944
    
    
    
    26,308Average number of common shares outstanding  Diluted
    
    
    27,614
    
    
    
    26,980
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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 Three MonthsEnded March 31,(In thousands)
    
    2007
    
    2006OPERATING ACTIVITIESNet income
    
    $
    2,628
    
    
    $
    3,202Adjustments to reconcile net income to net cash (used in) provided by operating activities:Depreciation of fixed assets
    
    
    2,158
    
    
    
    2,231Amortization of patents included in R&D expenses
    
    
    16
    
    
    
    5Amortization of purchased intangible assets
    
    
    1,115
    
    
    
    1,130Provision for losses on receivables
    
    
    829
    
    
    
    217Provision for losses on leases
    
    
    345
    
    
    
    883Provision for inventory valuation
    
    
    506
    
    
    
    339Share based compensation expense
    
    
    1,097
    
    
    
    1,051Excess tax benefits from stock options exercised
    
    
    (357
    )
    
    
    (418
    )Increase in other liabilities
    
    
    7,939
    
    
    
    14(Gain) loss on sale of property and equipment
    
    
    (7
    )
    
    
    16Deferred income taxes
    
    
    (10,565
    )
    
    
    (1,041
    )Changes in operating assets and liabilities
    
    
    (7,500
    )
    
    
    2,221NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES
    
    
    (1,796
    )
    
    
    9,850INVESTING ACTIVITIESPurchases of short-term investments
    
    
    (9,761
    )
    
    
    (16,700
    )Maturities and sales of short-term investments
    
    
    20,082
    
    
    
    19,291Additions to property, plant and equipment
    
    
    (1,381
    )
    
    
    (1,036
    )Proceeds from disposal of property, plant and equipment
    
    
    5
    
    
    
    3NET CASH PROVIDED BY INVESTING ACTIVITIES
    
    
    8,945
    
    
    
    1,558FINANCING ACTIVITIESCash dividends paid
    
    
    (2,152
    )
    
    
    (2,101
    )Payments on term debt
    
    
    (13
    )
    
    
    (12
    )Proceeds from exercise of stock options
    
    
    1,703
    
    
    
    1,300Excess tax benefits from stock options exercised
    
    
    357
    
    
    
    418NET CASH USED IN FINANCING ACTIVITIES
    
    
    (105
    )
    
    
    (395
    )EFFECT OF EXCHANGE RATE CHANGES
    
    
    577
    
    
    
    412INCREASE IN CASH AND EQUIVALENTS
    
    
    7,621
    
    
    
    11,425CASH AND EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    141,899
    
    
    
    103,774CASH AND EQUIVALENTS AT END OF PERIOD
    
    $
    149,520
    
    
    $
    115,199
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INTER-TEL (DELAWARE), INCORPORATED AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
 March 31, 2007
 NOTE A  BASIS OF PRESENTATION
   Contingencies
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Inventories
  Recent Accounting Pronouncements
 Uncertain Tax Positions
   Fair Value Option 
 Fair value measurements 
 NOTE B  EARNINGS PER SHARE
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Three Months Ended(In thousands, except
    
    March 31,per share amounts)
    
    2007
    
    2006Numerator: Net income
    
    $
    2,628
    
    
    $
    3,202Denominator:Denominator for basic earnings per share  weighted
average shares
    
    
    26,944
    
    
    
    26,308Effect of dilutive securities:Employee and director stock options
    
    
    670
    
    
    
    672Denominator for diluted earnings per share  adjusted weighted
average shares and assumed conversions
    
    
    27,614
    
    
    
    26,980Basic earnings per share
    
    $
    0.10
    
    
    $
    0.12Diluted earnings per share
    
    $
    0.10
    
    
    $
    0.12Options excluded from diluted net earnings per share
calculations (1)
    
    
    1,736
    
    
    
    657
 (1)
    
    At March 31, 2007 and 2006, options to purchase 1,736,000 and 657,000 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.
 NOTE C  ACQUISITIONS AND INTANGIBLE ASSETS
 Lake.
  Intangible Assets.
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NOTE D  SEGMENT INFORMATION
    Three Months Ended March 31, 2007Resale ofLocal, LongDistanceandPrincipal
    
    Network(In thousands, except per share amounts)
    
    Segment
    
    Services
    
    TotalNet sales
    
    $
    93,866
    
    
    $
    15,599
    
    
    $
    109,465Gross profit
    
    
    47,920
    
    
    
    5,470
    
    
    
    53,390Operating income
    
    
    2,217
    
    
    
    (105
    )
    
    
    2,112Interest and other, net
    
    
    1,752
    
    
    
    70
    
    
    
    1,822Foreign currency transaction losses
    
    
    18
    
    
    
    
    
    
    
    18Income tax provision
    
    
    1,336
    
    
    
    (12
    )
    
    
    1,324Net income
    
    $
    2,651
    
    
    $
    (23
    )
    
    $
    2,628Net income per diluted share (1)
    
    $
    0.10
    
    
    $
    0.00
    
    
    $
    0.10Weighted average diluted shares (1)
    
    
    27,614
    
    
    
    27,614
    
    
    
    27,614Goodwill
    
    $
    40,730
    
    
    $
    2,135
    
    
    $
    42,865Total assets
    
    $
    411,290
    
    
    $
    17,904
    
    
    $
    429,194Depreciation and amortization
    
    $
    3,272
    
    
    $
    17
    
    
    $
    3,289
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Three Months Ended March 31, 2006Resale ofLocal, LongDistanceandNetwork(In thousands, except per share amounts)
    
    Principal Segment
    
    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, net
    
    
    1,211
    
    
    
    48
    
    
    
    1,259Foreign currency transaction losses
    
    
    (4
    )
    
    
    0
    
    
    
    (4
    )Income tax provision
    
    
    1,021
    
    
    
    1,040
    
    
    
    2,061Net 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
 (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.
  Quarter Ended March 31, 2007
    
    
    Quarter Ended March 31, 2006Source of net sales
    
    $
    
    
    %
    
    
    $
    
    
    %Domestic
    
    
    98,405
    
    
    
    89.9
    %
    
    
    97,704
    
    
    
    91.4
    %Lake Communications
    
    
    5,882
    
    
    
    5.4
    
    
    
    5,874
    
    
    
    5.5Other International
    
    
    5,178
    
    
    
    4.7
    
    
    
    3,345
    
    
    
    3.1Total net sales
    
    
    109,465
    
    
    
    100.0
    %
    
    
    106,923
    
    
    
    100.0
    %
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NOTE E NET INVESTMENT IN SALES-LEASES
 SM
 March 31, December 31,(in thousands)
    
    2007
    
    
    2006Lease balances included in consolidated
accounts receivable, net of allowances of $1,670
in 2007, and $1,586 in 2006
    
    $
    9,100
    
    
    $
    11,024Net investment in Sales-Leases:Current portion, net of allowances of $1,070
in 2007, and $1,112 in 2006
    
    
    19,194
    
    
    
    19,617Long-term portion, includes residual amounts
of $892 in 2007 and, $803 in 2006, net of
allowances of $1,675 in 2007, and $1,763 in
2006
    
    
    30,048
    
    
    
    31,113Total investment in Sales-Leases, net of
allowances of $4,416 in 2007, and $4,461 in 2006
    
    
    58,342
    
    
    
    61,754Sold rental payments remaining unbilled (subject
to limited recourse provisions), net of
allowances of $14,654 in 2007, and $14,682 in
2006
    
    
    257,504
    
    
    
    259,003Total balance of sales-leases and sold rental
payments remaining unbilled, net of allowances
    
    $
    315,846
    
    
    $
    320,757Total allowances for entire lease portfolio
(including limited recourse liabilities)
    
    $
    19,069
    
    
    $
    19,143
   Quarter Ended Year Ended(In thousands)
    
    March 31, 2007
    
    December 31, 2006Sales of rental payments
    
    $
    24,034
    
    
    $
    101,644Sold payments remaining unbilled at end of period
    
    $
    272,158
    
    
    $
    273,685
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NOTE F  STOCK BASED COMPENSATION
    Three Months
    
    Three MonthsEnded
    
    EndedMarch 31, 2007
    
    March 31, 2006Cost of revenues
    
    $
    61
    
    
    $
    73Research and development
    
    
    334
    
    
    
    289Selling, general and administrative
    
    
    702
    
    
    
    689Share-based compensation expense before income taxes
    
    
    1,097
    
    
    
    1,051Related income tax benefits
    
    
    141
    
    
    
    249Share-based compensation expense, net of taxes
    
    $
    956
    
    
    $
    802Net share-based compensation expense, per common
share:Basic
    
    $
    0.04
    
    
    $
    0.03Diluted
    
    $
    0.03
    
    
    $
    0.03
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WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateNumber
    
    
    Exercise
    
    
    Contractual
    
    
    Intrinsicof Shares
    
    
    Price
    
    
    Term (years)
    
    
    ValueBalance at December 31, 2006
    
    
    3,825,508
    
    
    $
    18.14Granted
    
    
    583,100
    
    
    $
    23.85Exercised
    
    
    (115,802
    )
    
    $
    14.45Terminated/expired
    
    
    (52,880
    )
    
    $
    20.66Balance at March 31, 2007
    
    
    4,239,926
    
    
    $
    18.99
    
    
    
    6.5
    
    
    $
    19,714,181Exercisable at March 31, 2007
    
    
    2,397,000
    
    
    $
    17.37
    
    
    
    4.9
    
    
    $
    15,038,021
   Three Months Ended
    
    Three Months EndedMarch 31, 2007
    
    March 31, 2006Expected dividend yield
    
    
    1.34
    %
    
    
    1.49
    %Expected stock price volatility
    
    
    0.39
    
    
    
    0.53Risk-free interest rate
    
    
    4.73
    %
    
    
    4.76
    %Expected life of options
    
    4 Years
    
    5 years
  Performance Shares
  14




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Employee Stock Purchase Plan
  NOTE G  SUBSEQUENT EVENT, MERGER AGREEMENT
  
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
 The following discussion involves forward-looking statements. Actual results could differ
materially from those projected in the forward-looking statements. For further information
regarding forward-looking statements, see Forward Looking Statements in Item IA, Risk Factors.
 Overview
  
    
    Inter-Tel 7000, Inter-Tel 5000 and Inter-Tel Axxess Network Communications
Solutions (converged voice and data business communication systems);
    
    Lake Communications converged voice and data business communication systems,
including those sold in the US under the Inter-Tel EncoreCXâ and the Embarq
Connection Central brands;
    
    integrated voice mail, voice processing and unified messaging systems;
    
    presence management, collaboration, web conference, and audio conferencing
applications,;
    
    multi-media contact center applications;
    
    call accounting software, computer-telephone integration (CTI) applications,
    
    related third-party products, applications, and services,
    
    managed services, including voice and data network design, traffic provisioning,
and financial solutions packages (leasing);
    
    local and long distance calling services, voice circuits, data circuits and other
communications services and peripheral products;
    
    networking applications, including the design and implementation of voice and data
networks, and
    
    maintenance and support services for our products.
 
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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.
Furthermore, when the initial term of the lease is concluded, customers have the option to
renew the lease at a payment and term less than the original lease.
    
    Dealer and VAR sales. For shipments to dealers, value added resellers and other
distributors, our revenue is recognized as products are shipped and services are rendered,
because at such points the sales process is complete. Title to these products passes when
goods are shipped
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(free-on-board shipping point). However, shipments to one international
dealer, with whom we established a relationship as a result of our Lake acquisition, are initially held by that dealer on a
consignment basis. Such inventory is owned by Inter-Tel 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 generally recognize revenues from sales of software upon
shipment to dealers or upon downloading of such software from the Internet by such dealers,
as applicable, or upon installation at end-user sites, depending on the distribution
channel.
    
    Maintenance and software support. Maintenance and software support revenue is
recognized ratably over the term of the maintenance or support agreement.
 Costs and gross margins
   17




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##### Table of Contents




    
    Customer leases generally expire at the 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.
    
    Quarterly sales of lease rental streams typically occur near the end of the third
month of the quarter. Additionally interest rate fluctuations may impact the gain or loss
on sale of such rental streams.
    
    Internal sales compensation programs for our sales personnel are linked to
revenues and the sales commissions generally increase at accelerated rates as sales volumes
increase. Sales performance bonuses are also frequently tied to quarter-end and year-end
performance targets, providing incentives to sales personnel to close business before the
end of each quarter.
    
    Historically, some price discounting to our dealer channel occurred during the
last month of a quarter or year, and some dealers have purchased consistently to take
advantage of potential product specific pricing discounts or end-of-quarter promotions.
However, such promotions are subject to change at any time, and discounts have been reduced
in recent periods in an effort to minimize this trend and to focus on more targeted
promotions.
  Cash Flows
   18




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SM â SM
 Results of Operations
  Three Months EndedMarch 31,2007
    
    2006NET SALESTelecommunications systems, software and related
    
    
    85.7
    %
    
    
    86.3
    %Resale of local, long distance and network services
    
    
    14.3
    
    
    
    13.7TOTAL NET SALES
    
    
    100.0
    
    
    
    100.0COST OF SALESTelecommunications systems, software and related
    
    
    42.0
    
    
    
    41.6Resale of local, long distance and network services
    
    
    9.2
    
    
    
    8.6TOTAL COST OF SALES
    
    
    51.2
    
    
    
    50.2GROSS PROFIT
    
    
    48.8
    
    
    
    49.8Research and development
    
    
    7.5
    
    
    
    7.8Selling, general and administrative
    
    
    37.9
    
    
    
    36.0Amortization of intangibles
    
    
    1.0
    
    
    
    1.1Proxy contest and related costs
    
    
    0.4
    
    
    
    Legal judgment and settlement
    
    
    
    
    
    
    1.2OPERATING INCOME
    
    
    1.9
    
    
    
    3.7Interest and other, net
    
    
    1.7
    
    
    
    1.2Foreign currency transaction gains (losses)
    
    
    0.0
    
    
    
    0.0INCOME BEFORE INCOME TAXES
    
    
    3.6
    
    
    
    4.9INCOME TAXES
    
    
    1.2
    
    
    
    1.9NET INCOME
    
    
    2.4
    %
    
    
    3.0
    %
 19




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Net Sales
  Gross Profit
   20




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Research and Development
 Selling, general and administrative (SG&A)
 Amortization of purchased intangible assets
  21




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Interest and Other Income
 Income Taxes
 Net Income
  Inflation/Currency Fluctuation
  Liquidity and Capital Resources
 Three Months EndedMarch 31,(In thousands)
    
    2007
    
    2006Net cash (used in) provided by operating activities
    
    $
    (1,796
    )
    
    $
    9,850Net cash provided by investing activities
    
    
    8,945
    
    
    
    1,558Net cash used in financing activities
    
    
    (105
    )
    
    
    (395
    )Effect of exchange rate changes
    
    
    577
    
    
    
    412Increase in cash and equivalents
    
    
    7,621
    
    
    
    11,425Cash and equivalents at beginning of period
    
    
    141,899
    
    
    
    103,774Cash and equivalents at end of period
    
    $
    149,520
    
    
    $
    115,199
  22




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SM SM SM
  23




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Off-Balance Sheet Arrangements
 SM
 Critical Accounting Policies and Estimates
  Revenue Recognition
 End-user sales through our direct sales offices and government and national accounts division
 Dealer and VAR sales
 24




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Resale of long distance
 Maintenance revenues
 Sales-Leases
  Share Based Compensation.
 Goodwill and Other Intangible Assets.
  25




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Allowance for Doubtful Accounts
 Inventories
 Contingencies
 26




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27




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    SM
 28




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ITEM 4. CONTROLS AND PROCEDURES
 Evaluation of disclosure controls and procedures
 Changes in internal controls over financial reporting
 INTER-TEL, INCORPORATED AND SUBSIDIARIES
 
 PART II. OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  29




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##### Table of Contents



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.
  
    
    public announcements, including the announcement of the Mitel merger (refer to Mitel
Merger Announcement below);
    
    volume and timing of orders received during the quarter;
    
    gross margin fluctuations associated with the mix of products and services sold and the mix
of new and recurring customers;
    
    the mix of distribution channels;
    
    general economic conditions, including interest rates and the condition of the markets our
business addresses;
    
    patterns of capital spending by customers and the relative size of our customers, in
particular at times when we are introducing new systems and software targeted to and designed
for larger customers;
    
    the timing of new product announcements and releases by us and our competitors and other
competitive factors;
    
    pricing pressures;
    
    the cost and effects of acquisitions;
    
    the availability and cost of products and components from our suppliers, including shipping
and manufacturing problems associated with subcontracted vendors;
    
    the impact of the e-Rate settlement, the one year debarment by the FCC of Inter-Tel
Technologies from e-Rate opportunities, and expected fines and penalties associated with our
former GSA variances and noncompliance, which could affect both our government business and
our commercial business;
    
    the impact of settlements, continuing litigation, proceedings and other contingencies,
which could affect our business;
    
    the impact of costs and uncertainties resulting from stockholder actions, including actual
or potential proxy contests or acquisition proposals;
    
    fluctuations in interests rates, and the timing and volume of sales of leases to third
party funding sources;
    
    the potential impact of accounting pronouncements, such as FIN 48 or FAS 123R;
    
    compliance with federal and state regulatory filings, including timely collection and
remittance of appropriate taxes and fees on such filings;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances.
  30




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Mitel Merger Announcement. The announcement of, and/or the failure to complete, the proposed
merger with Mitel Networks Corporation (Mitel) could negatively affect the market price of
Inter-Tel securities, as well as adversely affect its business.
  
    
    the receipt of the necessary approval of the Merger Agreement by Inter-Tel stockholders;
    
    the receipt of antitrust, other governmental and regulatory approvals in a timely manner or at all;
    
    the absence of a material adverse effect on the Company; and
    
    the satisfaction or waiver of other closing conditions as identified in the Merger Agreement.
    
    
    The obligation to pay a termination fee to Mitel of $20 million if the Merger Agreement is
terminated under certain circumstances (although this risk could be mitigated in the event of
payment due to Inter-Tel as a result of acceptance of a transaction that is considered by our
board of directors to be more favorable to our stockholders than the proposed Merger);
    
    The obligation to reimburse Mitel for up to $6 million in transaction expenses under
certain circumstances relating to the failure of our stockholders to adopt the Merger
Agreement, although the Merger Agreement specifies that the $20 million termination fee
discussed above would be reduced for any amounts paid to Mitel in satisfaction of such
reimbursement obligation;
    
    The market price of Inter-Tel common stock may decline to the extent that the current
market price reflects a market assumption that the Merger will be completed; and
    
    The costs relating to the Merger, including legal and accounting fees and a portion of the
investment banking fees or expenses, must be paid even if the Merger is not completed.
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Business acquisitions, business ventures, and/or dispositions entail numerous risks and may disrupt
our business, dilute stockholder value and distract management attention.
  
    
    unanticipated costs and liabilities;
    
    difficulty of assimilating or transitioning the operations, products and personnel of the
acquired business or business ventures;
    
    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
or business venture;
    
    the diversion of managements attention from the core business;
    
    inability to maintain uniform standards, controls, policies and procedures;
    
    potential disagreements and impact on the ongoing acquired operations related to the
computation of earn-outs associated with post-acquisition results;
    
    impairment of relationships or risk of loss of acquired employees and customers occurring
as a result of integration of the acquired business; and
    
    difficulties with each of the above noted items during the period between announcement and
closing of a prospective transaction, in particular the recent Mitel announcement.
  32




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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, the Lake OfficeLink product (branded
EncoreCXâ in North America), the Lake Sigma product (branded Embarq Connection
Central TM in North America), speech recognition, Interactive Voice Response, presence
management, collaboration, messaging products, Session Initiation Protocol (SIP) applications,
multi-protocol SIP endpoints, and related computer-telephony products, as well as continued
acceptance of our Axxessâ systems and software.
  33




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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 Aastra,
Adtran, Alcatel, Altigen, Avaya, Cisco Systems, 3Com, Iwatsu, Interactive
Intelligence/Vonexus, Lucky Goldstar, Mitel, NEC, Nortel, Panasonic, Samsung, ShoreTel,
Siemens, Toshiba, Vertical Networks (including acquisitions of the former Comdial and Vodavi
organizations).
    
    large data routing and convergence companies such as 3Com, Adtran and Cisco Systems;
    
    voice processing applications providers such as ADC, InterVoice-Brite, Active Voice (a
subsidiary of NEC America), Avaya, and Captaris (formerly AVT);
    
    web collaboration product and service providers, such as Centra, Citrix, eDial (a division
of Alcatel), IBM, Microsoft, Raindance Communications, and WebEx;
    
    hosting service providers such as AT&T (formerly SBC), Layered Technologies, New Global
Telecom (NGT), and Vonage using servers to host call processing functions that have
traditionally been owned by customers;
    
    long distance services providers such as AT&T, Global Crossing, MCI, Qwest, Sprint and Verizon;
    
    large computer and software corporations such as Dell, IBM, HP, Intel and Microsoft;
    
    peer-to-peer softphone services such as Skype/eBay;
    
    regional Bell operating companies, or RBOCs, competitive local exchange companies, or
CLECs; cable television companies, IP Centrex service providers, VoIP trunk replacement
providers, and satellite and other wireless and wireline broadband service providers offering
IP centrex services such as AccessLine, AT&T (formerly SBC), cBeyond, Covad, Level-3, New
Global Telecom, Qwest, Time-Warner Telecom, and Vonage; and
    
    independent leasing companies that provide telecom equipment financing.
  34




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
    
    offer broader product and service offerings;
    
    develop and expand their product and service offerings more quickly;
    
    offer greater price discounts or make substantial product promotions;
    
    adapt to new or emerging technologies and changing customer needs faster;
    
    take advantage of acquisitions and other opportunities more readily;
    
    negotiate more favorable licensing agreements with vendors;
    
    devote greater resources to the marketing and sale of their products; and
    
    address customers service-related issues more adequately.
  Our products are complex and may contain errors or defects that are detected only after their
release, which may cause us to incur significant unexpected expenses and lost sales.
  
    
    costs associated with the remediation of any problems;
    
    costs associated with design modifications;
    
    loss of or delay in revenues;
    
    loss of customers;
    
    damage to our reputation;
    
    failure to achieve market acceptance or loss of market share;
    
    increased service and warranty costs;
    
    liabilities to our customers; and
    
    increased insurance costs.
 The complexity of our products has caused delays and could cause future delays in the development
and release of new products and services. As a result, customer demand for our products could
decline, which could harm our business. Additionally, changes in technology could render current
inventories obsolete.
  35




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Our founder and former Chief Executive Officer controls approximately 19.2% of the outstanding
shares 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.
   We may not be able to adequately protect our proprietary technology and may be infringing upon
third-party intellectual property rights.
   36




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rd
  Our reliance on a limited number of suppliers for key components and our dependence on contract
manufacturers could impair our ability to manufacture and deliver our products and services in a
timely and cost-effective manner
   37




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We derive a substantial portion of our net sales from our dealer network and if these dealers do
not effectively promote and sell our products, our business and operating results could be harmed.
  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.
    39




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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.
  40




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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.
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Our stock price has been and may continue to be volatile, impairing your ability to sell your
shares at or above purchase price.
  
    
    reactions of investors, competitors, customers or suppliers to the Mitel merger
announcement;
    
    reactions of investors, competitors, customers or suppliers to the threatened 2007 proxy
contest initiated by Mr. Mihaylo, including the non-binding proposals submitted by Mr.
Mihaylo;
    
    announcements of developments relating to our business;
    
    investors reactions to actions of large stockholders;
    
    fluctuations in our operating results;
    
    the impact of our dividend announcements, repurchase program or stock transactions by
officers and directors;
    
    shortfalls in revenue or earnings relative to securities analysts expectations or
alternatively, results that exceed such 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 or disposition announcements or any forecasts of our
future results;
    
    general economic conditions in the telecommunications industry;
    
    the market for Internet-related voice and data products and services;
    
    changes in the national or worldwide economy;
    
    changes in legislation or regulation affecting the telecommunications industry;
    
    developments relating to our intellectual property rights and the intellectual property
rights of third parties;
    
    litigation or governmental investigations of our business practices;
    
    the impact on our business of the e-Rate settlement, the one year debarment of
Technologies from the e-Rate program, and expected fines and penalties associated with the
GSA variances and noncompliance which could affect both our government business and our
commercial business;
    
    the impact on our business of settlements, continuing litigations, proceedings and other
contingencies, which could affect our business;
    
    changes in our relationships with our customers and suppliers, including shipping and
manufacturing problems associated with subcontracted vendors;
    
    national and regional weather patterns; and
    
    threats of or outbreaks of war, hostilities, terrorist acts or other civil disturbances.
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Changes in stock option and equity award accounting rules have adversely impacted our reported
operating results prepared in accordance with generally accepted accounting principles, and may
affect our stock price and our competitiveness in the employee marketplace.
   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
  43




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Government regulation, including regulation of our Inter-Tel NetSolutions and Network Services
Agency subsidiaries, as well as third party long distance and network service entities on which we
rely, may harm our business.
   Consolidation within the telecommunications industry could increase competition and adversely
affect our business.
  Terrorist activities and resulting military and other actions could harm our business.
  44




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We Are Exposed To Costs And Risks Associated With Compliance With Changing Laws, Regulations And
Standards In General, and Specifically With Regulation Of Corporate Governance And Disclosure
Standards.
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 Board Authorization to Repurchase up to $75 Million of Inter-Tel Stock .
 ISSUER PURCHASES OF EQUITY SECURITIES
 (d) Maximum Number(c) Total Number of
    
    (or ApproximateShares (or Units)
    
    Dollar Value) ofPurchased as Part
    
    Shares (or Units)(a) Total Number of
    
    (b) Average Price
    
    of Publicly
    
    that May Yet BeShares (or Units)
    
    Paid per Share (or
    
    Announced Plans or
    
    Purchased Under thePeriod
    
    Purchased
    
    Unit)
    
    Programs
    
    Plans or 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 3/31/07
    
    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. 45




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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
 46




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SIGNATURES
  INTER-TEL, INCORPORATEDMay 10, 2007
    /s/  Norman StoutNorman StoutDirector and Chief Executive OfficerMay 10, 2007
    /s/  Kurt R. KneipKurt R. KneipSr. Vice President and Chief Financial Officer 47