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

Results of Operations

Net sales for the second quarter of 1995 increased 19.6% to $36.3 million from $30.4 million in the second quarter of 1994. Net sales increased 21.3% to $70.9 million in the first six months of 1995 from $58.5 million in the first six months of 1994. For these periods, the increases were primarily attributable to increased shipments of AXXESS systems and software products through the Company's dealer network and direct sales offices, and an increase in sales of long distance services.

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

Three Months Ended June 30, Six Months Ended June 30,

                          1995               1994         1995             1994

Net Sales                100.0%             100.0%       100.0%           100.0%
Cost of Sales             58.4               59.6         59.0             60.7
                         -----              -----        -----            -----
Gross profit              41.6               40.4         41.0             39.3
Research and development   3.9                3.7          4.0              3.7
Selling, general and
  administrative          28.8               29.0         28.7             28.7
Special charge             3.6                --           1.9              --
                         -----              -----        -----            -----
Operating income           5.3                7.7          6.4              6.9
Interest and other income  0.7                0.5          0.8              0.5
Interest expense           0.1                0.1          0.1              0.1
Income taxes               2.2                3.1          2.7              2.8
                         -----              -----        -----            -----
Net income                 3.7                5.0          4.4              4.5
                         =====              =====        =====            =====

Gross profit for the second quarter of 1995 increased 23.2% to $15.1 million from $12.3 million for the second quarter of 1994. Gross profit increased to $29.1 million, or 41.0% of net sales, in the first six months of 1995 from $23.0 million, or 39.3% of net sales, in the first six months of 1994. Gross margin increased during both periods primarily as a result of a higher percentage of sales derived from AXXESS systems and software, which was offset in part by a higher percentage of sales through dealers and increased sales of the company's long distance services.

Research and development expenses for the second quarter of 1995 increased to $1.4 million from $1.1 million for the second quarter of 1994. Research and development expenses increased to $2.9 million, or 4.0% of net sales, in the first six months of 1995 from $2.1 million, or 3.7% of net sales, in the first six months of 1994. This increase in both comparable periods was primarily attributable to expenses relating to the introduction of new products, including the AXXESS version 3.0, the Inter-Tel Axxent and AxxessoryTalk version
3.0. The Company expects that research and development expenses will continue to increase in absolute dollars as the Company continues to develop and enhance existing and new technologies and products. These expenses may vary, however, as a percentage of net sales.

Selling, general and administrative expenses for the second quarter of 1995 increased 18.6% to $10.4 million from $8.8 million for the second quarter of 1994. Selling, general and administrative expenses increased to $20.3 million, or 28.7% of net sales, in the first six months of 1995 from $16.8 million, or 28.7% of net sales, in the first six months of 1994. This increase in absolute dollars in both periods was primarily attributable to the costs associated with hiring and training sales personnel throughout Inter-Tel's 25 direct sales offices. Higher sales commissions were also paid based upon increased levels of net sales. The Company expects that selling, general and administrative expenses will increase in absolute dollars, but may vary as a percentage of net sales.

Interest and other income in both periods consisted primarily of interest income.

Net income for the second quarter was $1.3 million ($.12 per share) compared to net income of $1.5 million ($.14 per share) for the second quarter of 1994. Net income increased 17.3% to $3.1 million, or $.28 per share, in the first six months of 1995 from $2.7 million, or $.24 per share, in the first six months of 1994. Net income in both periods includes a special charge of approximately $815,000, or $.07 per share, reflecting the costs associated with integrating the operations of the two acquired companies. The special charge principally includes costs associated with redundancy in inventories, equipment abandonment, the combination and relocation of business operations, employee terminations, and the write-off of intangible assets. Without this special charge, the Company would have reported net income of $2.1 million, or $.19 per share for the second quarter, an increase of 41% over net income of $1.5 million for the second quarter of 1994, and $3.9 million, or $.35 per share, in the six months ended June 30, 1995, an increase of 48.1% over net income of $2.7 million in the first six months of 1994.

Inflation/Currency Fluctuation

Inflation and currency fluctuations have not previously had a material impact on Inter-Tel's operations. International sales and procurement agreements have traditionally been denominated in U.S. currency. Moreover, a significant amount of contract manufacturing has been or is expected to be moved to domestic sources. The expansion of international operations in the United Kingdom and Europe and anticipated sales in Japan and Asia and elsewhere could result in higher international sales as a percentage of total revenues, but international revenues are currently not significant.

Liquidity and Capital Resources

The Company continues to expand its dealer network, which has required and is expected to continue to require working capital for increased accounts receivables and inventories. During the first six months of 1995, accounts receivable and inventories increased approximately $9.1 million. This increase was principally funded by operating cash flow and existing cash balances. The Company also expended approximately $4.0 million during the first six months of 1995 for property and equipment. The Company intends to continue to make significant capital expenditures through the end of 1995, principally relating to the implementation of the Company's new MIS systems. At June 30, 1995, the Company had $10.4 million in cash and equivalents, which represents a decrease of approximately $5.0 million from December 31, 1994.

The Company has a loan agreement with Bank One, Arizona, N.A. This agreement provides for a $5.0 million, unsecured, revolving line of credit, which is being used primarily to support international letters of credit to suppliers. Outstanding balances bear interest at the bank's prime rate. In the fourth quarter of 1993, the Company repaid all long and short term debt from a portion of the net proceeds received from its 1993 public offering. The remaining proceeds were added to working capital.

The Company offers to its customers lease financing and other services, including its Totalease program, through its Inter-Tel Leasing subsidiary. The Company funds its Totalease program in part through the sale to financial institutions of rental income streams under the leases. Resold Totalease rentals totaling $27.0 million and $19.9 million remain unbilled at June 30, 1995 and December 31, 1994, 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 the Totalease program 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. If the Company is required to repurchase rental streams and realize losses thereon in amounts exceeding its reserves, its operating results will be adversely affected.

The Company believes that its working capital and credit facilities, together with the net proceeds from its recently announced pending public offering and cash generated from operations, will be sufficient to fund purchases of capital equipment, finance any cash acquisitions which the Company may consider and provide adequate working capital for the foreseeable future. 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 additional acquisitions, the Company will seek additional financing. There can be no assurance that additional financing will be available when required or on acceptable terms.

INTER-TEL, INCORPORATED AND SUBSIDIARIES