** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

**FORM 10 - Q**

**x****        QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended September 30, 2006**

**or**

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the transition period from                  to                  **

**Commission file number  000-28180**

**SPECTRALINK CORPORATION**

(Exact name of registrant as specified in charter)
| **Delaware**                                                    | ** ** | **84-1141188**          |
|-----------------------------------------------------------------|------------|-------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (IRS Employer           |
|                                                            |       | Identification  Number) |
|                                                            |       |                    |
| **5755  Central Avenue, Boulder, Colorado**                     | ** ** | **80301-2848**          |
| (Address of  principal executive office)                        |       | (Zip code)              |

 

**303-440-5330**

(Issuer’s telephone number)

 

(Former name, former address and former fiscal year,if changed from last report)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.Yes x   No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer (asdefined in Rule 12b-2 of the Exchange Act).
| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated filer o |
|---------------------------|--------|---------------------|--------|-------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12-b-2 of the Exchange Act).Yes o   Nox

Applicable only to corporate issuers:

As of October 31, 2006,there were 19,485,670 shares outstanding of SpectraLink Corporation’s CommonStock - par value per share $0.01.

 

----

**SPECTRALINK CORPORATION AND SUBSIDIARIES**

**INDEX**
| Part I     |     | Financial  Statements                                                                                                                                                      |   |   |
|------------|----------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|       |     |                                                                                                                                                                       |   |   |
|       | Item  1  | Condensed  Consolidated Financial Statements                                                                                                                               |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       |     | Condensed Consolidated Balance Sheets at September 30,  2006 and December 31, 2005 (Unaudited)                                                                             |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       |     | Condensed Consolidated Statements of Operations and  Other Comprehensive Income (Loss) for the Three Months and Nine Months Ended  September 30, 2006 and 2005 (Unaudited) |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       |     | Condensed Consolidated Statements of Cash Flows for  the Nine Months Ended September 30, 2006 and 2005 (Unaudited)                                                         |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       |     | Notes to Condensed Consolidated Financial Statements  (Unaudited)                                                                                                          |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       | Item 2   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       | Item 3   | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                                |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       | Item 4   | Controls and  Procedures                                                                                                                                                   |   |   |
|       |     |                                                                                                                                                                       |   |   |
| Part II    |     | Other Information                                                                                                                                                          |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       | Item  1A | Risk  Factors                                                                                                                                                              |   |   |
|       |     |                                                                                                                                                                       |   |   |
|       | Item  6  | Exhibits                                                                                                                                                                   |   |   |
|       |     | (a)  Exhibits                                                                                                                                                              |   |   |
|       |     |                                                                                                                                                                       |   |   |
| Signatures |     |                                                                                                                                                                       |   |

 

2

----

**Part I-Financial Statements**

**Item I. Condensed Consolidated FinancialStatements**

**SpectraLink Corporation andSubsidiaries**

**CondensedConsolidated Balance Sheets**

**(In thousands)**

**(Unaudited)**
| ** **                                                                                                                                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                       | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                                                                                       | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current Assets:                                                                                                                                                  |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                       |       | $                      | 4,459      |                  | $          | 16,703 |   |
| Cash held in  escrow for acquisition (Note 2)                                                                                                                    |       | —                 |       | 55,148                |       |
| Investment in  marketable securities - current                                                                                                                   |       | 10,615                 |       | 14,088                |       |
| Trade accounts  receivable, net of allowance of $282 and $343, respectively                                                                                      |       | 26,780                 |       | 22,574                |       |
| Inventories:                                                                                                                                                     |       |                   |       |                  |       |
| Raw materials                                                                                                                                                    |       | 12,694                 |       | 4,783                 |       |
| Work in progress                                                                                                                                                 |       | 318                    |       | 5                     |       |
| Finished goods                                                                                                                                                   |       | 7,475                  |       | 4,727                 |       |
| Less allowance  for obsolete inventory                                                                                                                           |       | (996                   | )          | (575                  | )          |
| Total  inventories                                                                                                                                               |       | 19,491                 |       | 8,940                 |       |
| Deferred income  taxes                                                                                                                                           |       | 1,532                  |       | 1,626                 |       |
| Prepaids and  other                                                                                                                                              |       | 1,915                  |       | 1,201                 |       |
| Total current  assets                                                                                                                                            |       | 64,792                 |       | 120,280               |       |
|                                                                                                                                                             |       |                   |       |                  |       |
| Property and equipment,  net of accumulated depreciation of $13,745 and $11,110, respectively                                                                    |       | 13,998                 |       | 8,422                 |       |
| Intangible assets, net  of accumulated amortization of $3,655 and $272, respectively                                                                             |       | 30,906                 |       | 318                   |       |
| Goodwill                                                                                                                                                         |       | 23,944                 |       | —                |       |
| Other non-current  assets                                                                                                                                        |       | 670                    |       | 1,772                 |       |
| Total assets                                                                                                                                                     |       | $                      | 134,310    |                  | $          | 130,792 |   |
|                                                                                                                                                             |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current Liabilities:                                                                                                                                             |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                 |       | $                      | 4,230      |                  | $          | 1,478 |   |
| Accrued payroll,  commissions and employee benefits                                                                                                              |       | 5,692                  |       | 4,500                 |       |
| Other accrued  expenses and liabilities                                                                                                                          |       | 7,649                  |       | 6,380                 |       |
| Deferred  revenue—current portion                                                                                                                           |       | 10,063                 |       | 7,503                 |       |
| Current portion  long-term debt                                                                                                                                  |       | 6,000                  |       | 15,000                |       |
| Total current  liabilities                                                                                                                                       |       | 33,634                 |       | 34,861                |       |
|                                                                                                                                                             |       |                   |       |                  |       |
| Long-term debt                                                                                                                                                   |       | 9,050                  |       | 18,050                |       |
| Long-term  deferred tax liabilities                                                                                                                              |       | 8,090                  |       | —                |       |
| Other long-term  liabilities                                                                                                                                     |       | 973                    |       | 900                   |       |
| Total  liabilities                                                                                                                                               |       | 51,747                 |       | 53,811                |       |
| Commitments and  contingencies                                                                                                                                   |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                       |       |                   |       |                  |       |
| Preferred stock,  5,000 shares authorized, none issued and outstanding                                                                                           |       | —                 |       | —                |       |
| Common stock,  $0.01 par value, 50,000 shares authorized, 24,212 and 23,838 shares issued,  respectively, and 19,480 and 19,106 shares outstanding, respectively |       | 242                    |       | 238                   |       |
| Additional  paid-in capital                                                                                                                                      |       | 87,403                 |       | 81,751                |       |
| Retained  earnings                                                                                                                                               |       | 31,771                 |       | 32,383                |       |
| Other  comprehensive income                                                                                                                                      |       | 538                    |       | —                |       |
| Treasury stock,  4,732 shares, at cost                                                                                                                           |       | (37,391                | )          | (37,391               | )          |
| Total stockholders’  equity                                                                                                                                 |       | 82,563                 |       | 76,981                |       |
|                                                                                                                                                             |       |                   |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                  |       | $                      | 134,310    |                  | $          | 130,792 |   |

 

**Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.**

3

----

**SpectraLinkCorporation and Subsidiaries**

**Condensed ConsolidatedStatements of Operations and**

**Other Comprehensive Income (Loss)**

**(In thousands, except per shareamounts)**

**(Unaudited)**
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **September 30,**           | ** ** | **September  30,**    | ** ** |
| ** **                                               | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Sales:                                                   |       |                             |       |                            |       |   |   |   |   |
| Product sales                                            |       | $                                | 29,843     |                            | $          | 18,954 |   | $ | 84,644 |   | $ | 51,024 |   |
| Service sales                                            |       | 8,108                            |       | 5,808                           |       | 22,615 |   | 16,437 |   |
| Net sales                                                |       | 37,951                           |       | 24,762                          |       | 107,259 |   | 67,461 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Cost of sales:                                           |       |                             |       |                            |       |   |   |   |   |
| Cost of product  sales                                   |       | 12,439                           |       | 5,417                           |       | 34,745 |   | 14,635 |   |
| Cost of service  sales                                   |       | 4,092                            |       | 3,010                           |       | 11,536 |   | 8,723 |   |
| Total cost of  sales                                     |       | 16,531                           |       | 8,427                           |       | 46,281 |   | 23,358 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Gross profit                                             |       | 21,420                           |       | 16,335                          |       | 60,978 |   | 44,103 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Operating expenses:                                      |       |                             |       |                            |       |   |   |   |   |
| Research and  development                                |       | 4,759                            |       | 2,702                           |       | 16,400 |   | 7,648 |   |
| Marketing and  selling                                   |       | 8,934                            |       | 6,674                           |       | 26,538 |   | 19,237 |   |
| General and  administrative                              |       | 3,485                            |       | 1,704                           |       | 11,280 |   | 4,783 |   |
| Acquired  in-process research and development            |       | —                           |       | —                          |       | 2,021 |   | — |   |
| Amortization of  intangible assets                       |       | 1,130                            |       | 4                               |       | 3,385 |   | 54 |   |
| Total operating  expenses                                |       | 18,308                           |       | 11,084                          |       | 59,624 |   | 31,722 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Income from operations.                                  |       | 3,112                            |       | 5,251                           |       | 1,354 |   | 12,381 |   |
| Other (expense) income,  net:                            |       |                             |       |                            |       |   |   |   |   |
| Interest  (expense) income, net                          |       | (267                             | )          | 387                             |       | (1,244 | ) | 1,131 |   |
| Other (expense)  income, net                             |       | (49                              | )          | (38                             | )          | 88 |   | (143 | ) |
| Total other  (expense) income, net                       |       | (316                             | )          | 349                             |       | (1,156 | ) | 988 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Income before income  taxes                              |       | 2,796                            |       | 5,600                           |       | 198 |   | 13,369 |   |
| Income tax expense                                       |       | (1,047                           | )          | (1,994                          | )          | (810 | ) | (4,946 | ) |
| Net income (loss)                                        |       | $                                | 1,749      |                            | $          | 3,606 |   | $ | (612 | ) | $ | 8,423 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Other comprehensive  income (loss), net of tax           |       |                             |       |                            |       |   |   |   |   |
| Foreign currency  translation adjustments                |       | $                                | 67         |                            | $          | — |   | $ | 575 |   | $ | — |   |
| Unrealized gain  (loss) on available for sale securities |       | 15                               |       | —                          |       | (37 | ) | — |   |
| Comprehensive income  (loss)                             |       | $                                | 1,831      |                            | $          | 3,606 |   | $ | (74 | ) | $ | 8,423 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Basic earnings (loss)  per share                         |       | $                                | 0.09       |                            | $          | 0.19 |   | $ | (0.03 | ) | $ | 0.44 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Basic weighted average  shares outstanding               |       | 19,390                           |       | 18,940                          |       | 19,300 |   | 19,070 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Diluted earnings (loss)  per share                       |       | $                                | 0.09       |                            | $          | 0.19 |   | $ | (0.03 | ) | $ | 0.43 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Diluted weighted average shares                          |       | 19,440                           |       | 19,190                          |       | 19,300 |   | 19,380 |   |

 

**Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.**

4

----

**SpectraLink Corporation andSubsidiaries**

**Condensed Consolidated Statements of Cash Flows**

**(In thousands)**

**(Unaudited)**
| ** **                                                                                        | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                        | ** ** | **September 30,**          | ** ** |
| ** **                                                                                        | ** ** | **2006**                        | ** ** | **2005** | ** ** |
|                                                                                              |       |                            |       |   |   |
| Cash flows from  operating activities:                                                            |       |                            |       |   |   |
| Net (loss)  income                                                                                |       | $                               | (612       | ) | $ | 8,423 |   |
| Adjustments to  reconcile net (loss) income to net cash provided by operating activities:         |       |                            |       |   |   |
| Depreciation and  amortization                                                                    |       | 6,477                           |       | 1,266 |   |
| Acquired  in-process research and development                                                     |       | 2,021                           |       | — |   |
| Income tax  benefit from the exercise of stock options                                            |       | —                          |       | 475 |   |
| Deferred income  taxes                                                                            |       | (1,627                          | )          | 92 |   |
| Stock-based  compensation                                                                         |       | 2,586                           |       | — |   |
| Changes in operating  assets and liabilities and other, net of effects of acquiring subsidiary    |       | (3,274                          | )          | 1,353 |   |
| Net cash  provided by operating activities                                                        |       | 5,571                           |       | 11,609 |   |
|                                                                                              |       |                            |       |   |   |
| Cash flows from  investing activities:                                                            |       |                            |       |   |   |
| Cash expended to  acquire business, net of cash acquired and escrow released to sellers (Note  2) |       | (3,662                          | )          | — |   |
| Acquisition  costs (Note 2)                                                                       |       | (1,349                          | )          | — |   |
| Purchases of  property and equipment                                                              |       | (5,670                          | )          | (3,474 | ) |
| Sales  (purchases) of investments in marketable securities, net                                   |       | 7,714                           |       | (6,511 | ) |
| Other                                                                                             |       | 47                              |       | — |   |
| Net cash used in  investing activities                                                            |       | (2,920                          | )          | (9,985 | ) |
|                                                                                              |       |                            |       |   |   |
| Cash flows from  financing activities:                                                            |       |                            |       |   |   |
| Principal  payments under long-term borrowings                                                    |       | (18,000                         | )          | — |   |
| Proceeds from  issuances of stock under stock plans                                               |       | 2,650                           |       | 2,373 |   |
| Dividends paid                                                                                    |       | —                          |       | (5,760 | ) |
| Income tax  benefit from the exercise of stock options                                            |       | 359                             |       | — |   |
| Payment of debt  issuance costs and other                                                         |       | (20                             | )          | (25 | ) |
| Purchases of  treasury stock                                                                      |       | —                          |       | (4,995 | ) |
| Net cash used in  financing activities                                                            |       | (15,011                         | )          | (8,407 | ) |
|                                                                                              |       |                            |       |   |   |
| Decrease in cash and  cash equivalents                                                            |       | (12,360                         | )          | (6,783 | ) |
| Cash and cash  equivalents, beginning of period                                                   |       | 16,703                          |       | 14,625 |   |
| Effect of exchange rate  changes on cash and cash equivalents                                     |       | 116                             |       | — |   |
| Cash and cash  equivalents, end of period                                                         |       | $                               | 4,459      |   | $ | 7,842 |   |

 

**Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.**

5

----

**SpectraLinkCorporation and Subsidiary**

**Notes to Unaudited Condensed Consolidated Financial Statements**

**1.  Basis of Presentation**

The accompanyingunaudited, condensed consolidated financial statements have been prepared fromthe books and records of SpectraLink Corporation and its wholly ownedsubsidiaries: SpectraLink International Corporation, SpectraLink Denmark ApS,and KIRK telecom A/S (“KIRK”) (together “SpectraLink” or “the Company”).SpectraLink designs, manufactures and sells on-premises wireless telephonesystems to customers worldwide that complement existing telephone systems byproviding mobile communications in a building or campus environment.SpectraLink wireless telephone systems increase the efficiency of employees byenabling them to remain in telephone contact while moving throughout theworkplace.

In management’s opinion,these financial statements include all adjustments, consisting only of normalrecurring adjustments, necessary to fairly present SpectraLink’s financialposition, results of operations and cash flows for the periods presented. Theresults of operations for the period ended September 30, 2006, are notnecessarily indicative of the results to be expected for any subsequent quarteror for the entire fiscal year ending December 31, 2006. The financialstatements should be read in conjunction with the audited financial statementsand notes thereto as of, and for the year ended, December 31, 2005, which areincluded in SpectraLink’s Annual Report on Form 10-K. Except as discussed inNote 3, the accounting policies utilized in the preparation of the financialstatements herein presented are the same as set forth in SpectraLink’s annualfinancial statements.

The December 31, 2005,condensed balance sheet data was derived from audited financial statements.

***Principles of Consolidation***

The consolidatedfinancial statements include the accounts of the Company and its subsidiaries,all of which are wholly owned. All significant intercompany transactions andbalances have been eliminated.

***Foreign Currency Translation***

The Company’s foreignoperating subsidiaries use as their functional currency the local currency ofthe countries in which they operate. Their assets and liabilities aretranslated into U.S. Dollars at the exchange rates in effect at the balancesheet date. Revenue, expenses, and cash flows are translated at the averagerates of exchange prevailing during the period. Translation gains and lossesare included in comprehensive income (loss) within stockholders’ equity.Realized and unrealized transaction gains and losses resulting from theremeasurement of non-functional currency financial instruments are included inthe determination of net income (loss). Net transaction gains for the three andnine months ended September 30, 2006, were insignificant.

***Use of Estimates***

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions. Such estimates and assumptions affect the reported amounts ofassets and liabilities, as well as disclosure of contingent assets andliabilities, at the date of the financial statements, and the reported amountsof revenue and expenses during the reporting period. Actual results coulddiffer from those estimates. Significant estimates used in the accompanyingfinancial statements include: allowance for doubtful accounts, reserve forobsolete or otherwise unrealizable inventory, estimated warranty costs, estimatedannual tax rates and valuations of tangible and intangible assets acquired andliabilities assumed.

***Reclassifications***

Certain reclassificationshave been made to the prior year financial statements to conform to the currentyear presentation.

6

----

***Revenue Recognition and DeferredRevenue***

We derive our revenueprincipally from the sale of products and/or services for wireless telephonesystems. For multiple element arrangements, we establish the fair value ofthese products and services based primarily on sales prices when the productsand services are sold separately. We recognize revenue on each element of anarrangement when there is persuasive evidence of an arrangement, delivery hasoccurred, collection is probable, and the fee is fixed or determinable. Revenuefrom product sales is recorded upon transfer of title, which is generally uponshipment of product. Revenue is deferred if there are significant post deliveryobligations, if collection is not reasonably assured at the time of sale, or ifthe fee is not fixed or determinable. When significant post deliveryobligations exist, revenue is deferred until such obligations are fulfilled. Weoffer products and services such as installation, support, education andtraining, maintenance and extended warranty coverage. Revenue from installationand training services is deferred and recognized when the services areperformed. Revenue from maintenance services is deferred and recognized overthe term of the maintenance agreement. We recognize amounts billed to customersfor shipping and handling costs as revenue when the related products areshipped. Costs of shipping and handling are included in cost of sales.

***Changein Fiscal Year***

On May 16, 2006, theBoard of Directors authorized our management to decide whether to change ourfiscal reporting year-end from December 31 to January 31. OnMay 22, 2006, our management made the decision to change our fiscalyear-end from December 31 of each year to January 31 of each year.  We believe that this change in our fiscalyear will help align the seasonal patterns of demand in our business with ourreporting cycle, and better align the Company’s sales with those of our keycustomers and vertical markets, notably the retail market and our distributionchannels.  We have elected to reportinformation with respect to the one month transition period beginning onJanuary 1, 2007, and ending on January 31, 2007, on our Form 10-Q forthe quarter ending April 30, 2007, pursuant to Rule 13A-10(D). Thefirst changed fiscal year shall be from February 1, 2007, toJanuary 31, 2008.

**2.  Acquisition of KIRK telecomA/S**

On January 3, 2006,pursuant to a stock purchase agreement dated December 12, 2005, SpectraLinkacquired KIRK from the stockholders of KIRK by purchasing 100% of itsoutstanding common stock. KIRK, based in Denmark, is a manufacturer of onsitewireless communications products. The purchase price for the transaction wasapproximately 389 million Danish Kroner or approximately U.S. $62 million,which was paid in cash, and approximately $2 million of acquisition costs.  We funded the acquisition price withapproximately $31 million of our own cash and funds provided by a creditfacility (Note 9). We escrowed $55.1 million in December 2005, which wasreleased to the selling stockholders on January 3, 2006, along with anadditional $6.9 million, which was the balance of the purchase price.

***Reasons for the Acquisition***

With the addition ofKIRK’s DECT-based products, we now offer a complete product portfolio thatincorporates all major enterprise wireless voice technologies: Wi-Fi, DECT andproprietary systems. The acquisition of KIRK also significantly increases ourinternational reach and augments our distribution channels and geographicalmarket penetration, further extending our leadership in workplace wirelesstelephony. Furthermore, the acquisition enables us to compete in new small tomedium business markets in the Americas with KIRK’s DECT products.

***Pro Forma Results***

The results of KIRK havebeen included in the consolidated financial statements since January 3,2006.  The following pro formainformation shows the results of our operations, as if the acquisition hadoccurred at the beginning of each period presented:

7

----

 
|                                      | ** ** | **Three months ended September  30,**        | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                                              | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(Actual)**                                                          | ** ** | **(Pro forma)**                                    | ** ** | **(Actual)** | ** ** | **(Pro forma)** | ** ** |
| ** **                           | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net sales                            |       | $                                                                     | 37,951     |                                                    | $          | 35,605 |   | $ | 107,259 |   | $ | 97,233 |   |
| Pretax income  (loss)                |       | 2,796                                                                 |       | 5,996                                                   |       | 198 |   | 9,929 |   |
| Net income  (loss)                   |       | 1,749                                                                 |       | 2,366                                                   |       | (612 | ) | 3,871 |   |
| Net income  (loss) per common share: |       |                                                                  |       |                                                    |       |   |   |   |   |
| Basic                                |       | $                                                                     | 0.09       |                                                    | $          | 0.12 |   | $ | (0.03 | ) | $ | 0.20 |   |
| Diluted                              |       | $                                                                     | 0.09       |                                                    | $          | 0.12 |   | $ | (0.03 | ) | $ | 0.20 |   |

 

We reported in our Form8-K/A filed on March 17, 2006, that the functional currency for our Danishholding company would be the Danish Krone based upon the expectations we had atthat time of the future activities of the holding company. Upon further review,we have concluded that the holding company will be used solely for the purposeof holding our investment in KIRK and the functional currency for the holdingcompany will be U.S. Dollars.

***Purchase Accounting***

The following representsthe allocation of the aggregate purchase price to the net assets of KIRKacquired on January 3, 2006, (in thousands).
| Total current assets                                                     |   | $      | 16,632 |   |
|--------------------------------------------------------------------------|--------|--------|--------|--------|
| Property and equipment                                                   |   | 3,007  |   |
| Amortizable intangible  assets                                           |   | 33,992 |   |
| In-process research and  development                                     |   | 2,021  |   |
| Goodwill                                                                 |   | 23,939 |   |
| Other assets                                                             |   | 160    |   |
| Total assets acquired                                                    |   | 79,751 |   |
| Total liabilities  assumed                                               |   | (6,145 | )      |
| Deferred taxes                                                           |   | (9,888 | )      |
| Net assets acquired                                                      |   | 63,718 |   |
| Less: Acquisition costs  paid                                            |   | (1,885 | )      |
| Amount paid in cash,  including the release of $55,148 of escrowed funds |   | $      | 61,833 |   |

 

Identifiable intangibleassets acquired on January 3, 2006, represent technology owned by KIRK plusother identifiable intangible assets such as acquired contractual relationshipswhich are subject to amortization over various periods of time, using methodswhich approximate the periodic decreases in value, with the weighted averageamortization period being 8 years. Since these assets are deductible forfinancial reporting purposes but not tax purposes, a deferred tax liability wasrecorded as of the acquisition date. Future estimated amortization expense isshown in Note 7. The following table summarizes the identifiable intangibleassets:
|                         | ** ** | **Estimated  Fair Value** | ** ** | **Useful  Life** | ** ** |
|-------------------------|------------|--------------------------------|------------|------------------|------------|
| ** **              | ** ** | **(In thousands)**        | ** ** | **(Years)**      | ** ** |
| Existing  technology    |       | $                              | 17,139     |             | 5-8        |   |
| Core technology         |       | 6,939                          |       | 8                |       |
| Customer  relationships |       | 7,686                          |       | 7-11             |       |
| FCC licenses            |       | 334                            |       | 8                |       |
| Trade name              |       | 1,703                          |       | 11               |       |
| Order backlog           |       | 191                            |       | —           |       |
|                    |       | $                              | 33,992     |             |       |   |

 

In addition, we acquiredapproximately $2.0 million of in-process research and development from KIRK.In-process purchased research and development (IPRD) represents research anddevelopment regarding internet protocol technology development efforts whichhad not reached technological feasibility and have no alternative future use asof the acquisition date. IPRD was expensed in accordance with FinancialAccounting Standards Board Interpretation No. 4, “Applicability of FASBStatement No. 2 to Business Combinations Accounted for by the Purchase Method.”

8

----

Goodwill was allocated toour KIRK segment (see Note 5) and will not be tax deductible. 

The valuation ofintangible assets was determined using the excess earnings method, replacementcost approach, or relief-from-royalty approach, depending upon the type ofasset. KIRK’s net tangible assets were valued at their respective replacementvalues.

**3.****             Adoption of New Accounting Pronouncements**

The adoption of the following accountingpronouncements in the nine months ended September 30, 2006, did not have amaterial impact on our results of operations, financial condition, or cashflows:

·                  Statement of Financial AccountingStandards (“SFAS”) 151, “Inventory Costs – An Amendment of ARB No. 43, Chapter4”;

·                  SFAS No. 153, “Exchanges ofNonmonetary Assets”;

·                  SFAS No. 154, “Accounting Changes andError Corrections, which replaces APB Opinion 20, “Accounting Changes” and SFASNo. 3, “Reporting Accounting Changes in Interim Financial Statements – AnAmendment of APB Opinion No. 28”;

·                  Emerging Issues Task Force (“EITF”)Issue 05-06, “Determining the Amortization Period for Leasehold Improvements”;and

·                  FASBStaff Positions 115-1 and 124-1, “The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments.”

***Stock-Based Compensation***

In December 2004, theFASB issued Statement of Financial Accounting Standards No. 123 (revised 2004),“Share-Based Payment” (SFAS 123R). SFAS 123R requires measurement of allemployee stock-based compensation awards using a fair-value method and therecording of such expense in the consolidated financial statements. Inaddition, the adoption of SFAS 123R requires additional accounting related tothe income tax effects and disclosure regarding the cash flow effects resultingfrom share-based payment arrangements. In March 2005, the SEC issued StaffAccounting Bulletin No. 107, which provides supplemental guidance for theimplementation of SFAS 123R. On January 1, 2006 (the first day of our 2006fiscal year), we adopted SFAS 123R using the modified prospective method aspermitted under SFAS 123R.  Under thistransition method, compensation cost recognized in the nine months ended  September 30, 2006 includes: (a) compensationcost for all share-based payments granted prior to but not yet vested as ofDecember 31, 2005, based on the grant-date fair value estimated in accordancewith the provisions of SFAS 123, and (b) compensation cost for all share-basedpayments granted or modified subsequent to December 31, 2005, based on thegrant-date fair value estimated in accordance with the provisions of SFAS123R.  In accordance with the modifiedprospective method of adoption, our results of operations and financialposition for prior periods have not been restated.

We used the gradedattribution method to recognize expense for all options granted prior to theadoption of SFAS 123R.  Upon adoption ofSFAS 123R on January 1, 2006, we adopted the straight-line attribution methodto recognize expense for options granted after December 31, 2005.  The expense associated with the unvestedportion of the pre-adoption grants will continue to be expensed using the gradedattribution method.

The amount of stock-basedcompensation recognized during a period is based on the value of the portion ofthe awards that are ultimately expected to vest. SFAS 123R requires forfeituresto be estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates.  The term “forfeitures” is distinct from“cancellations” or “expirations” and represents only the unvested portion ofthe surrendered option. Based on an analysis of historical forfeitures, we haveapplied an annual forfeiture rate of 9% to all unvested options as of September30, 2006. This analysis will be re-evaluated quarterly and the forfeiture ratewill be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period willonly be for those shares that vest. Forfeited or otherwise cancelled optionsare returned to the pool of options authorized for issuance under ourstock-based compensation plans. It is our policy to issue new shares, asopposed to treasury shares upon exercise or purchase under our stock-basedcompensation plans. See Note 13.

**4.****                                      RecentlyIssued Accounting Pronouncements**

***FASB Interpretation No. 48 (FIN48), “Accounting for Uncertainty in Income Taxes***–***An Interpretation of FASB Statement No. 109”***

FIN 48 was issued in July 2006.  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, “Accounting for Income Taxes.”  FIN 48 also prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position 

9

----

taken or expected to be taken in a tax return.  The new standard also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition.  Theprovisions of FIN 48 are effective for fiscal years beginning after December15, 2006.  The provisions of FIN 48 areto be applied to all tax positions upon initial adoption of this standard.  Only income tax positions that meet themore-likely-than-not recognition threshold at the effective date may berecognized or continue to be recognized upon adoption of FIN 48.  The cumulative effect of applying theprovisions of FIN 48 would be reported as an adjustment to the opening balanceof retained earnings for that fiscal year. We have not yet quantified the effect of adoption of FIN 48, which weexpect to do after our year ending December 31, 2006.

***SFAS No. 155 (SFAS 155),“Accounting for Certain Hybrid Financial Instruments, an Amendment of FASBStatements No. 133 and 140”***

SFAS 155 was issued in February 2006 and will beeffective for us after our year ending December 31, 2006. Among otherthings, SFAS 155 permits fair value remeasurement for any hybrid financialinstrument that contains an embedded derivative that otherwise would requirebifurcation. We do not believe that the adoption of SFAS 155 will have amaterial impact on our financial statements.

***SFAS No. 156 (SFAS 156),“Accounting for Servicing of Financial Assets, an amendment to SFAS No. 140”***

SFAS 156 was issued in March 2006 and will beeffective for us after our year ending December 31, 2006. SFAS 156 simplifiescertain aspects of accounting for separately recognized servicing assets andliabilities and clarifies when to separately recognize servicing obligations.We do not believe that the adoption of SFAS 156 will have an impact on ourfinancial statements.

***SFAS No. 157 (SFAS 157), “FairValue Measurements”***

SFAS 157 wasissued in September 2006 and will be effective for us after our year endingDecember 31, 2006.  SFAS 157 defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles, and expands disclosures about fair value measurements.  SFAS 157 applies under other accountingpronouncements that require or permit fair value measurements.  We will adopt SFAS 157 on a prospective basisin our fiscal 2008, and depending upon the context, believe that SFAS 157 couldmaterially impact the way we perform valuations in the future.

***SECStaff Accounting Bulletin No. 108 (SAB 108), “Considering the Effects of PriorYear Misstatements when Quantifying Misstatements in Current Year FinancialStatements”***

SAB 108 was issuedin September 2006 and provides SEC Staff guidance on the consideration of theeffects of prior year misstatements in determining whether or not current yearfinancial statements are materially misstated. In practice, unadjusted errors in prior period financial statements areevaluated for their impact on the current period financial statements.   Two methods are commonly used to determinematerial misstatements caused by unadjusted errors:  (a) the “rollover” method, which determinesthe impact of current year misstatements and “rolls” immaterial errors onto thebalance sheet indefinitely; and (b) the “iron curtain” method, which recordscumulatively material misstatements to the balance sheet due to unadjustederrors as adjustments to the current period income statement.   As either method can result in a materialmisstatement to the current period financials, the SEC Staff expects that theimpact of applying both methods should be evaluated for materiality to thecurrent period financial statements.   We do not believe that our financial statements will be significantlyimpacted by applying the guidance of SAB 108.

***FASB Staff Position, No. AUGAIR-1, (FSP AUG AIR-1), “Accounting for Planned Major Maintenance Activities”***

FSP AUG AIR-1 was issued in September 2006 and will beeffective for us after our year ending December 31, 2006.  FSP AUG AIR-1 prohibits companies from usingan “accrue-in-advance” method for recognizing planned major maintenance onplant and equipment.    We do not believethat FSP AUG AIR-1 will have a significant impact on our Company, as we do notpractice this method of recognizing maintenance expense.   

**5.****                                      SegmentInformation**

Inaccordance with SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” we define operating segments as components of anenterprise for which separate financial information is available. Thisinformation is reviewed regularly by our chief operating decision-maker, toevaluate performance and to make operating decisions. We have identified ourChief Executive Officer as our chief operating decision-maker. The chiefoperating decision-maker reviews revenue and overall results of operations bysegment.

10

----

During the nine monthsended  September 30, 2006, we operatedour business across two operating segments, based on the legal structures ofSpectraLink and KIRK. Prior to the fiscal year 2006, and the acquisition of KIRK,we operated as one segment.   In thethird quarter of 2006, management determined that certain costs related to theacquisition of KIRK would not be allocated to operating results of eithersegment, which is a change from our segment presentation in previous quarterlyreports.  Management continues to reviewthe structure of the Company and may modify our segment structure again in theensuing quarters.   We have presentedbelow the prior quarters’ segment results without acquisition-relatedunallocated costs for comparative purposes.

The SpectraLink segmentprimarily consists of our Americas operations and corporate activities,including ongoing global corporate support functions such as executive offices,legal, finance and treasury. The SpectraLink segment also includes branch salesand sales support personnel located in the United Kingdom and Australia.

The KIRK segment iscomprised of the operations and corporate activities of KIRK acquired onJanuary 3, 2006 (See Note 2). KIRK designs, manufactures and sells wirelessonsite adjunct communication solutions. KIRK also includes two subsidiaries:KIRK telecom, Inc., which in 2005 was a distribution sales and supportsubsidiary in the United States; and KIRK scantel A/S, which designs, contractmanufactures and sells wired and wireless telephones under the KIRK brand nameto the residential market, primarily in the Scandinavian countries. KIRKtelecom, Inc. had minimal activity in 2006, as its staff was hired by SpectraLink.

Unallocated costsprimarily consist of costs incident to the acquisition of KIRK, including debtservice, amortization of intangible assets, purchased in-process research anddevelopment and foreign currency changes.

We had one customer inthe nine months ending September 30, 2006, from which revenue exceeded 10% ofour consolidated net revenue. Both segment results include sales from thiscustomer, which totaled $3.9 million and $14.6 million for the threeand nine months ended September 30, 2006, respectively. We had no customersrepresenting greater than 10% of revenues in the comparable 2005 periods.

11

----

Thefollowing summarizes our results and total assets by segment (in thousands):
| **Three months ended:** | ** ** | **SpectraLink**                                                     | ** ** | **KIRK**                                                                       | ** ** | **Unallocated**                                                                                               | ** ** | **Eliminations (1)**                                                                            | ** ** | **Total**                                                           | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| September 30, 2006                |       |                                                                |       |                                                                           |       |                                                                                                          |       |                                                                                                 |       |                                                                |       |
| Revenue                           |       | $          29,410 |       | $            8,622 |       | $                 — |       | $                (81 | )          | $          37,951 |       |
| Income (loss)  from operations    |       | 3,234                                                               |       | 1,017                                                                          |       | (1,130                                                                                                        | )          | (9                                                                                                   | )          | 3,112                                                               |       |
| September 30, 2005                |       |                                                                |       |                                                                           |       |                                                                                                          |       |                                                                                                 |       |                                                                |       |
| Revenue                           |       | 24,762                                                              |       | —                                                                         |       | —                                                                                                        |       | —                                                                                               |       | 24,762                                                              |       |
| Income (loss) from  operations    |       | 5,255                                                               |       | —                                                                         |       | (4                                                                                                            | )          | —                                                                                               |       | 5,251                                                               |       |

 
| **Three months ended:** | ** ** | **SpectraLink**                                                     | ** ** | **KIRK**                                                                       | ** ** | **Unallocated**                                                                                               | ** ** | **Eliminations (1)**                                                                 | ** ** | **Total**                                                           | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| June 30, 2006                     |       |                                                                |       |                                                                           |       |                                                                                                          |       |                                                                                      |       |                                                                |       |
| Revenue                           |       | $          27,116 |       | $            8,501 |       | $                 — |       | $              (278 | )          | $          35,339 |       |
| Income (loss) from operations     |       | 1,520                                                               |       | 186                                                                            |       | (1,130                                                                                                        | )          | (152                                                                                      | )          | 424                                                                 |       |
| June 30, 2005                     |       |                                                                |       |                                                                           |       |                                                                                                          |       |                                                                                      |       |                                                                |       |
| Revenue                           |       | 22,111                                                              |       | —                                                                         |       | —                                                                                                        |       | —                                                                                    |       | 22,111                                                              |       |
| Income (loss) from operations     |       | 3,967                                                               |       | —                                                                         |       | (28                                                                                                           | )          | —                                                                                    |       | 3,939                                                               |       |

 
| **Three months ended:** | ** ** | **SpectraLink**                                                     | ** ** | **KIRK**                                                                       | ** ** | **Unallocated**                                                                                               | ** ** | **Eliminations (1)**                                                                                     | ** ** | **Total**                                                           | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| March 31, 2006                    |       |                                                                |       |                                                                           |       |                                                                                                          |       |                                                                                                          |       |                                                                |       |
| Revenue                           |       | $          26,319 |       | $            7,650 |       | $                 — |       | $                 — |       | $          33,969 |       |
| Income (loss) from operations     |       | 1,483                                                               |       | (519                                                                           | )          | (3,146                                                                                                        | )          | —                                                                                                        |       | (2,182                                                              | )          |
| March 31, 2005                    |       |                                                                |       |                                                                           |       |                                                                                                          |       |                                                                                                          |       |                                                                |       |
| Revenue                           |       | 20,588                                                              |       | —                                                                         |       | —                                                                                                        |       | —                                                                                                        |       | 20,588                                                              |       |
| Income (loss) from operations     |       | 3,213                                                               |       | —                                                                         |       | (22                                                                                                           | )          | —                                                                                                        |       | 3,191                                                               |       |

 
| **Nine months ended:** | ** ** | **SpectraLink**                                                     | ** ** | **KIRK**                                                            | ** ** | **Unallocated**                                                                                               | ** ** | **Eliminations (1)**                                                                 | ** ** | **Total**                                                | ** ** |
|----------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| September 30,  2006              |       |                                                                |       |                                                                |       |                                                                                                          |       |                                                                                      |       |                                                     |       |
| Revenue                          |       | $          82,845 |       | $          24,773 |       | $                 — |       | $              (359 | )          | $        107,259 |       |
| Income (loss) from operations    |       | 6,237                                                               |       | 684                                                                 |       | (5,406                                                                                                        | )          | (161                                                                                      | )          | 1,354                                                    |       |
| September 30,  2005              |       |                                                                |       |                                                                |       |                                                                                                          |       |                                                                                      |       |                                                     |       |
| Revenue                          |       | 67,461                                                              |       | —                                                              |       | —                                                                                                        |       | —                                                                                    |       | 67,461                                                   |       |
| Income (loss) from operations    |       | 12,435                                                              |       | —                                                              |       | (54                                                                                                           | )          | —                                                                                    |       | 12,381                                                   |       |
| ** **                       | ** ** | ** **                                                          | ** ** | ** **                                                          | ** ** | ** **                                                                                                    | ** ** | ** **                                                                                | ** ** | ** **                                               | ** ** |
| Assets as of:                    |       |                                                                |       |                                                                |       |                                                                                                          |       |                                                                                      |       |                                                     |       |
| September 30, 2006 (2)           |       | $          65,623 |       | 37,781                                                              |       | 30,906                                                                                                        |       | —                                                                                    |       | $        134,310 |       |
| June 30, 2006 (2)                |       | 64,543                                                              |       | 37,986                                                              |       | 31,970                                                                                                        |       | —                                                                                    |       | 134,499                                                  |       |
| March 31, 2006 (2)               |       | 66,152                                                              |       | 38,054                                                              |       | 33,043                                                                                                        |       | —                                                                                    |       | 137,249                                                  |       |
| December 31, 2005                |       | 130,474                                                             |       |                                                                |       | 318                                                                                                           |       | —                                                                                    |       | 130,792                                                  |       |

 

----

(1) Sales commenced between segments in the second quarter of 2006.

(2) Intercompany balanceshave been eliminated.

**6.  Earnings Per Share**

Basicearnings per share is computed by dividing the income (loss) by the weightedaverage number of shares of common stock outstanding for the period.  Diluted earnings per share is determined bydividing the income by the sum of the weighted average number of common sharesoutstanding, and if not anti-dilutive, the effect of outstanding stock optionsand/or other common stock equivalents as determined utilizing the treasurystock method.  Potentially dilutivecommon stock options, totaling 3.4 million and 1.8 million for the three monthsended September 30, 2006 and 2005, respectively, and 2.9 million and 1.7million for the nine months ended September 30, 2006 and 2005, respectively,were excluded from the calculation because they were anti-dilutive.  Weighted average options, restricted stockawards, and rights to purchase 0.1 million shares of common stock were excludedfrom the diluted share calculation for the nine months ended September 30,2006, as their effect would have been anti-dilutive as a result of the net lossfor the period.  In accordance with debtcovenants, we have not declared dividends in the nine months ended September30, 2006.  See Note 9.  A reconciliation of the numerators anddenominators used in computing earnings per share is as follows:

12

----

 
| ** **                      | ** ** | **Three months ended September 30,**              | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                      | ** ** | **(In thousands, except per share amounts)** | ** ** |
| ** **                      | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **Income**                                                            | ** ** | **Shares** | ** ** | **Per Share** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| Basic EPS—                 |       | $   1,749                                              |       | 19,390 |   | $     0.09 |   | $   3,606 |   | 18,940 |   | $     0.19 |   |
| Effect of  dilutive securities: |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Stock purchase plan             |       | —                                                                |       | 20 |   | — |   | — |   | 12 |   | — |   |
| Restricted stock awards         |       | —                                                                |       | 11 |   | — |   | — |   | — |   | — |   |
| Stock options outstanding       |       | —                                                                |       | 19 |   | — |   | — |   | 238 |   | — |   |
| Diluted EPS—               |       | $   1,749                                              |       | 19,440 |   | $     0.09 |   | $   3,606 |   | 19,190 |   | $     0.19 |   |

 
| ** **                      | ** ** | **Nine months ended September 30,**               | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                      | ** ** | **(In thousands, except per share amounts)** | ** ** |
| ** **                      | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **Loss**                                                              | ** ** | **Shares** | ** ** | **Per Share** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| Basic EPS—                 |       | $     (612                                   | )          | 19,300 |   | $    (0.03 | ) | $   8,423 |   | 19,070 |   | $     0.44 |   |
| Effect of  dilutive securities: |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Stock purchase plan             |       | —                                                                |       | — |   | — |   | — |   | 18 |   | — |   |
| Restricted stock awards         |       | —                                                                |       | — |   | — |   | — |   | — |   | — |   |
| Stock options outstanding       |       | —                                                                |       | — |   | — |   | — |   | 292 |   | (0.01 | ) |
| Diluted EPS—               |       | $     (612                                   | )          | 19,300 |   | $    (0.03 | ) | $   8,423 |   | 19,380 |   | $     0.43 |   |

 

**7.****  Goodwill and Other Intangibles**

Thefollowing table presents details of our intangible assets, other than goodwill,as of September 30, 2006:
|                                      | ** ** | **Useful Life** | ** ** | **Gross  Amount**                                                  | ** ** | **Accumulated  Amortization**                                                      | ** ** | **Net**                                                                            | ** ** |
|--------------------------------------|------------|----------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(Years)**          | ** ** | ** **                                                         | ** ** | **(In thousands)**                                                            | ** ** | ** **                                                                         | ** ** |
| International  and domestic licenses |       | 1-5                  |       | $          1,060 |       | $             393 |       | $             667 |       |
| Patents and  technology              |       | 5-8                  |       | 24,077                                                             |       | 2,652                                                                              |       | 21,425                                                                             |       |
| Customer  relationships              |       | 7-11                 |       | 7,686                                                              |       | 500                                                                                |       | 7,186                                                                              |       |
| Other                                |       | 11                   |       | 1,738                                                              |       | 110                                                                                |       | 1,628                                                                              |       |
| Total                                |       |                 |       | $        34,561            |       | $          3,655                 |       | $        30,906                            |       |

 

The following table presents details of our intangibleassets, as of December 31, 2005:
|                         | ** ** | **Useful Life** | ** ** | **Gross Amount**                                                              | ** ** | **Accumulated  Amortization**                                                      | ** ** | **Net**                                                                            | ** ** |
|-------------------------|------------|----------------------|------------|------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **              | ** ** | **(Years)**          | ** ** | ** **                                                                         | ** ** | **(In thousands)**                                                            | ** ** | ** **                                                                         | ** ** |
| International  licenses |       | 1-5                  |       | $             589 |       | $             272 |       | $             317 |       |
| Other                   |       | Indefinite           |       | 1                                                                                  |       | —                                                                             |       | 1                                                                                  |       |
| Total                   |       |                 |       | $             590 |       | $             272 |       | $             318 |       |

 

Theestimated future amortization expense of intangible assets is as follows:
| Fiscal Year | ** ** | **Amount**                                                         | ** ** |
|------------------|------------|--------------------------------------------------------------------|------------|
| ** **       | ** ** | **(In thousands)**                                            | ** ** |
| 2006 (remaining) |       | $          1,129 |       |
| 2007             |       | 4,812                                                              |       |
| 2008             |       | 4,647                                                              |       |
| 2009             |       | 4,413                                                              |       |
| 2010             |       | 4,125                                                              |       |
| Thereafter       |       | 11,780                                                             |       |
|             |       | $        30,906            |       |

 

Amortization expense of intangible assets was $1.1million and $3.4 million for the three and nine months ended September 30,2006, respectively, and insignificant for the comparable periods in 2005.

As a result of acquiring KIRK (Note 2), we allocated$23.9 million to goodwill , which was completely allocated to our KIRK segmentat September 30, 2006.   See Note 2 forthe detailed listing of values assigned to KIRK intangibles and goodwill.

13

----

**8.****                                      DerivativeFinancial Instruments**

We do not hold or issue derivative financialinstruments for speculative trading purposes. We account for derivativefinancial instruments in accordance with SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities,” as amended by SFAS No. 149, “Amendmentof Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 133”).SFAS 133 requires that all derivative instruments be recorded on theconsolidated balance sheet at fair value. The accounting for changes in thefair value (i.e., gains or losses) of a derivative instrument is dependent uponwhether the derivative has been designated and qualifies as part of a hedgingrelationship and further, on the type of hedging relationship. For derivativeinstruments that are designated and qualify as a fair value hedge, the gain orloss on the derivative instrument as well as the offsetting gain or loss on thehedged item attributable to the hedged risk are recognized in the results ofoperations. For derivative instruments that are designated and qualify as acash flow hedge, the effective portion of the gain or loss on the derivativeinstrument is reported as a component of other comprehensive income (loss) andreclassified into earnings in the same period or periods during which thehedged transaction affects earnings. Any ineffective portion of the gain orloss on the derivative instrument is recorded in the results of operationsimmediately. For derivative instruments not designated as hedging instruments,the gain or loss is recognized in our results of operations immediately.

We are exposed to foreign currency exchange risk inthe normal operation of our business. Our primary currency risks result fromour investment in KIRK, which is a Danish Krone functional currency business,and through certain KIRK inventory purchases denominated in U.S. Dollars andEuros. To mitigate this risk, KIRK purchases forward currency contracts, whichdo not qualify for hedge accounting. Forward currency contract activity wasinsignificant in the nine months ended September 30, 2006.

**9.****             Debt**

Debt consisted of thefollowing:
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **As of:**                                                                                                                             | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **September 30, 2006**                                                                                                            | ** ** | **December 31, 2005** | ** ** |
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **(in thousands)**                                                                                                                     | ** ** |
| Term loan  payable to bank, quarterly principal installments of $1.25 million  beginning on March 31, 2006, with final maturity in December 2008; variable  quarterly interest payments, (interest at 8.25% as of December 31, 2005),  collateralized by substantially all assets of the Company  |       | $                      — |       | $                15,000 |   |
|                                                                                                                                                                                                                                                                                                   |       |                                                                                                                                        |       |   |   |
| Term loan  payable to bank, quarterly principal installments of $1.25 million  beginning on September 30, 2006, with final maturity in June 2008; variable  quarterly interest payments, (interest at 7.38% as of September 30, 2006),  collateralized by substantially all assets of the Company |       | 8,750                                                                                                                                       |       | — |   |
|                                                                                                                                                                                                                                                                                                   |       |                                                                                                                                        |       |   |   |
| Revolving line  of credit, principal due and payable in December 2008, variable quarterly  interest payments at 7.38% and 8.25% as of September 30, 2006, and December  31, 2005, respectively, collateralized by substantially all assets of the  Company                                             |       | 6,300                                                                                                                                       |       | 18,050 |   |
|                                                                                                                                                                                                                                                                                                   |       |                                                                                                                                        |       |   |   |
| Total Long-Term  Debt                                                                                                                                                                                                                                                                                  |       | $                15,050                                     |       | $                33,050 |   |
| Less: Current  Portion of Long-Term Debt                                                                                                                                                                                                                                                               |       | (6,000                                                                                                                                      | )          | (15,000 | ) |
| Total Non-current  Long-Term Debt                                                                                                                                                                                                                                                                      |       | $                  9,050                          |       | $                18,050 |   |

 

OnDecember 9, 2005, we entered into a credit facility (the “Credit Facility”)with a group of banks, led by JP Morgan, to provide funds for the acquisitionof KIRK in 2006 (Note 2). The Credit Facility consisted of a three-year termloan of $15.0 million and a revolving line of credit commitment for borrowingsup to $25.0 million of which $20.0 million was available prior to July 1,2006 that also matures in three years. As of March 28, 2006, we repaid the original term loan in its entirety,and $0.3 million of related debt issuance costs were expensed immediately.  Effective June 30, 2006, we borrowed $10.0million as a new term loan under our Credit Facility which we used to reduceour revolver balance.

Borrowingsunder the revolving line of credit and the new term loan bear interest ateither the JP Morgan Prime rate plus 1% or at a LIBO rate plus a spreaddetermined by our leverage ratio, which was 2% at September 30, 2006.  At September 30, 2006, the Company’s interestrate on the revolving line of credit was based upon LIBO plus 2% (7.38%). AtDecember 31, 2005, our interest was based upon the JP Morgan prime plus 1%(8.25%). The initial interest rate for the new term loan was set at 9.25% andconverted to 7.38% on August 7, 2006. The amount available for borrowings under the revolving line of creditare determined based on the borrowing base calculation as defined in the CreditFacility beginning with the month ended June 2006. As of September 30, 2006,approximately $12.1 million was available for additional borrowings under theline of credit. We are obligated to pay annual commitment fees of up to amaximum of 0.5% of the unused amount of the revolving credit line. Amounts dueunder the Credit 

14

----

Facility aresecured by a first security interest in substantially all of the Company’sassets.

Thenew term loan must be repaid in quarterly installments of $1.25 million,beginning on September 30, 2006, and can be prepaid without penalty.   The revolving line of credit may also beprepaid at any time without penalty.  Weprepaid $1.75 million of the revolving line of credit balance in the nine monthsended September 30, 2006. It is management’s intention to prepay $1.0 millionof the outstanding line of credit with funds available in addition to the termloan installments totaling $5.0 million over the next twelve months. Therefore,$6.0 million of our total debt balance has been classified as current as ofSeptember 30, 2006.

Underthe Credit Facility, we are required to comply with certain financial andnon-financial covenants. Among the financial covenants are requirements relatedto consolidated net worth, a quarterly leverage ratio and a quarterly fixedcharge ratio. The Credit Facility also limits our ability to: enter intosecured and unsecured borrowing arrangements, issue dividends to stockholders(the Company was permitted to pay a dividend in December 2005), repurchase our stock,acquire and dispose of businesses, and issue additional shares of our stock,among other requirements, as defined in the Credit Facility. We were incompliance with all covenants related to the Credit Facility at September 30,2006, and as of the date of this report.

Future maturities oflong-term debt (reflecting contractual maturities and management’s intent) areas follows as of September 30, 2006:
| 2006 (remaining) |   | $      1,250 |   |
|------------------|--------|--------------------------------------------|--------|
| 2007             |   | 6,000                                      |   |
| 2008             |   | 7,800                                      |   |
|             |   | $    15,050            |   |

 

**10.****          IncomeTaxes**

Consolidatedincome tax expense was $1.0 million, or an effective tax rate of 37.4%, for thethree months ended September 30, 2006, compared to income tax expense of $2.0million, or an effective tax rate of 35.6%, for the same period last year. Forthe nine months ended September 30, 2006, consolidated income tax expense was$0.8 million, or an effective tax rate of 409%, compared to income tax expenseof $4.9 million, or an effective tax rate of 37.0%, for the same period lastyear.

Our2006 effective tax rate is impacted by the mix of domestic versus foreign incomeand the absence of the research and development tax credit thus far in2006.   Further, a nondeductiblein-process research and development write-off in the first quarter of 2006 andthird quarter 2006 adjustments as a result of finalizing our 2005 tax return,have caused our quarterly tax rates to fluctuate.  Excluding the impact of the non-deductiblein-process research and development charge, our 2006 effective tax rate isestimated to range between 48% and 52%.

Weaccount for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (SFASNo. 109). Judgment is required in determining our worldwide provision forincome taxes. In the ordinary course of our business, there are numeroustransactions for which the ultimate tax outcome is uncertain. Additionally, ourincome tax provision is based on calculations and assumptions that are subjectto examination by many different tax authorities. We adjust our income taxprovision in the period it is probable that actual results will differ from ourestimates. Tax law and rate changes are reflected in the income tax provisionin the period in which such changes are enacted.

Asdiscussed in Note 2, we formed a Danish holding company, SpectraLink Denmark,ApS in December of 2005, for the purposes of acquiring KIRK. Under theaccounting guidance of APB 23 and SFAS 109, we have elected to treat theholding company’s earnings as permanently reinvested.

**11.****          Commitmentsand Contingencies**

***ProductWarranties and Service***

We providewarranties against defects in materials and workmanship for our products,generally ranging from 90 days to 24 months. At the time the product is eithermanufactured or shipped, we establish a provision for estimated expenses ofproviding service under these warranties based on historical warrantyexperience. We believe our reserves are adequate as recorded. A summary ofactivity for accrued product warranty and service is as follows:
|                                                          | ** ** | **Three months ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                                               | ** ** | **(In thousands)**                              | ** ** |
| ** **                                               | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Beginning  Balance, Accrued Product Warranty and Service |       | $    1,555                       |       | $       800 |   |
| Additions to the accrual for product warranties          |       | 314                                                  |       | 154 |   |
| Reductions for incurred warranty charges                 |       | (300                                                 | )          | (212 | ) |
| Ending Balance, Accrued  Product Warranty and Service    |       | $    1,569                       |       | $       742 |   |

 

15

----

 
|                                                            | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                             | ** ** |
| ** **                                                 | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Beginning  Balance, Accrued Product Warranty and Service   |       | $      947            |       | $      901 |   |
| Warranty reserves assumed in acquisition of KIRK  (Note 2) |       | 459                                                 |       | — |   |
| Additions to the accrual for product warranties            |       | 1,174                                               |       | 559 |   |
| Reductions for incurred warranty charges                   |       | (1,011                                              | )          | (718 | ) |
| Ending Balance, Accrued  Product Warranty and Service      |       | $   1,569                            |       | $      742 |   |

 

16

----

 

***Indemnifications***

Weprovide indemnifications of varying scope and size to certain customers againstclaims of intellectual property infringement made by third parties arising fromthe use of our products. We evaluate estimated losses for such indemnificationsunder SFAS 5, “Accounting for Contingencies”, as interpreted by FASBInterpretation 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others.” Weconsider such factors as the degree of probability of an unfavorable outcomeand the ability to make a reasonable estimate of the amount of loss. To date,we have not encountered material costs as a result of such obligations and havenot accrued any liabilities related to such indemnifications in our financialstatements.

***LegalProceedings***

We arenot presently a party to any material pending legal proceedings of which we areaware.

***12.         *Stockholders’Equity**

Duringthe third quarter of 2005, we paid a quarterly cash dividend of $0.10 per sharetotaling $1.9 million to holders of common stock.  For the nine months endedSeptember 30, 2005, we paid three quarterly cash dividends of $0.10 per sharefor a total of $5.8 million. No treasury stock was repurchased in the thirdquarter of 2005.  For the nine monthsended September 30, 2005, we repurchased 462,000 of our outstanding commonstock (now classified as treasury stock) for $5.0 million.   Our credit facility has restricted us fromrepurchasing shares of our stock in 2006.

***13.         *Stock-BasedCompensation**

We have recognizedexpense related to five equity incentive plans under SFAS 123R in 2006:  the 2006Equity Incentive Plan (the “2006 EIP”), the 2006 Employee Stock Purchase Plan(the “2006 ESPP”), the 2006 International Employee Stock Purchase Plan (the“2006 IESPP), the 2000 Stock Option Plan (a successor to the Company’soriginal option plan and collectively called the (“Previous  Option Plans”) and the Employee StockPurchase Plan (the “previous ESPP”).   OnMay 23, 2006, our stockholders approved the 2006 equity incentive plans,which became effective with the filing of a Form S-8 on August 22, 2006.  No grants were made under the Previous Planssubsequent to May 23, 2006, and shares available for future grants under thePrevious Plans on May 23, 2006 became eligible for future grants under the 2006plans.

*ThePrevious Option Plans*

The PreviousOption Plans provided selected employees, officers, directors, agents,consultants and independent contractors of the Company options to purchaseshares of the Company’s common stock. Under the terms of the Previous Option Plans, the purchase price pershare of a non-qualified stock option was not less than par value per share ofthe Company’s common stock at the time of grant. The purchase price per shareof an incentive stock option was not less than 100% of the market value pershare of the Company’s common stock at the time of grant. If the grantee of anincentive stock option owned more than 10% of the total combined voting powerof all classes of stock on the date of grant, the purchase price was set to atleast 110% of the market value of a share of the Company’s common stock at thedate of grant. Options granted under the Previous Option Plans are exercisablefor periods ranging from 8 to 10 years from date of grant. Options vest at arate of 25% after 12 months from the date of grant, and ratably per monththereafter, conditioned upon continued employment.  Full vesting occurs after 48 months from thedate of grant.  It is the Company’sintention to discontinue issuing any options under the 2006 EIP and no optionswere issued in the third quarter of 2006; although we continue to amortize thevalue of previously issued stock options to expense as they vest.

Theweighted-average grant date fair value of options granted was $6.50 and $7.82during the second and first quarters of 2006, respectively.   The total intrinsic value of optionsexercised during the three months ended September 30, 2006, was $22,000.  As of September 30, 2006, there was $­­­­­­5.3million of total unrecognized compensation cost from share-based compensationgranted under the Previous Options Plans, related to unvested shares. Thiscompensation is expected to be recognized over a weighted-average period ofapproximately 1.4 years.

We selected theBlack-Scholes option-pricing model as the most appropriate valuation method forour stock option awards.  The fair valueof each option grant is estimated as of the date of grant using the Black-Scholesoption pricing model with the following weighted average assumptions used forgrants. Note that for 2006 grants under the Previous Option Plans, we haveseparated the optionees into three groups: Non-employee directors, Executive Officers, and Management/Staff. Wehave determined that the exercise behavior of the three groups is distinct and;therefore, the assumptions are different for purposes of valuing their optionsusing the Black-Scholes model. Volatility for the three groups is estimated tobe approximately 69%. The risk-free interest rate and expected terms (net offorfeitures) is 5.09% and 5 years, respectively, for all groups and thedividend yield is 0%.

17

----

Stockoptions outstanding at September 30, 2006, changes during the nine monthsended  September 30, 2006, and sharesavailable for grant under the 2000 Option Plan are presented below:
| ** **                            | ** ** | **Shares  available for  grant (1)** | ** ** | **Outstanding  options** | ** ** | **Weighted-  average  exercise  price, per  common share**          | ** ** | **Remaining  contractual  life, in years** | ** ** | **Aggregate  intrinsic  value**                                                               | ** ** |
|---------------------------------------|------------|------------------------------------------------|------------|--------------------------|------------|-------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **(in thousands)**                        | ** ** | **(in thousands)**  | ** ** | ** **                                                                    | ** ** | ** **                                           | ** ** | **(in thousands)**                                                                       | ** ** |
| Outstanding as  of December 31, 2005  |       | 2,872                                          |       | 3,116                    |       | $          13.64            |       |                                                 |       |                                                                                          |       |
| Authorized                            |       | —                                         |       | —                   |       | —                                                                        |       |                                                 |       |                                                                                          |       |
| Granted                               |       | (633                                           | )          | 633                      |       | $          12.50            |       |                                                 |       |                                                                                          |       |
| Exercised                             |       | —                                         |       | (162                     | )          | $            9.18 |       |                                                 |       |                                                                                          |       |
| Forfeited/expired                     |       | 38                                             |       | (38                      | )          | $          12.87            |       |                                                 |       |                                                                                          |       |
|                                  |       |                                           |       |                     |       |                                                                          |       |                                                 |       |                                                                                          |       |
| Outstanding as  of March 31, 2006     |       | 2,277                                          |       | 3,549                    |       | $          13.65            |       |                                                 |       |                                                                                          |       |
| Authorized                            |       | —                                         |       | —                   |       | —                                                                        |       |                                                 |       |                                                                                          |       |
| Granted                               |       | (113                                           | )          | 113                      |       | $          10.58            |       |                                                 |       |                                                                                          |       |
| Exercised                             |       | —                                         |       | (19                      | )          | $            4.53 |       |                                                 |       |                                                                                          |       |
| Forfeited/expired                     |       | 78                                             |       | (78                      | )          | $          12.15            |       |                                                 |       |                                                                                          |       |
| Available for  2006 EIP               |       | (2,242                                         | )          | —                   |       |                                                                          |       |                                                 |       |                                                                                          |       |
|                                  |       |                                           |       |                     |       |                                                                          |       |                                                 |       |                                                                                          |       |
| Outstanding as  of June 30, 2006      |       | —                                         |       | 3,565                    |       | $          13.63            |       |                                                 |       |                                                                                          |       |
| Authorized                            |       | —                                         |       | —                   |       |                                                                          |       |                                                 |       |                                                                                          |       |
| Granted                               |       | —                                         |       | —                   |       |                                                                          |       |                                                 |       |                                                                                          |       |
| Exercised                             |       | —                                         |       | (8                       | )          | $            5.89 |       |                                                 |       |                                                                                          |       |
| Forfeited/expired                     |       | 292                                            |       | (292                     | )          | $          15.60            |       |                                                 |       |                                                                                          |       |
| Available for  2006 EIP               |       | (292                                           | )          |                     |       |                                                                          |       |                                                 |       |                                                                                          |       |
|                                  |       |                                           |       |                     |       |                                                                          |       |                                                 |       |                                                                                          |       |
| Outstanding as  of September 30, 2006 |       | —                                         |       | 3,265                    |       | $          13.48            |       | 7.66                                                 |       | $               87 |       |
|                                  |       |                                           |       |                     |       |                                                                          |       |                                                 |       |                                                                                          |       |
| Exercisable at  September 30, 2006    |       |                                           |       | 2,084                    |       | $          14.06            |       | 6.89                                                 |       | $               85 |       |

 

----

(1)           Shares unused under thePrevious Option Plans will be available for grant under the 2006 EIP.

A summary of additional information related to the options outstandingas of September 30, 2006, is as follows:
|                                         | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                             | ** ** |
|-----------------------------------------|------------|------------------------------|------------|--------------------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  Outstanding**      | ** ** | **Weighted  Average  Remaining  Contractual Life  (in years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| ** **                              | ** ** | **(In thousands)**      | ** ** | ** **                                                               | ** ** | ** ** | ** ** | **(In thousands)** | ** ** | ** ** | ** ** |
| $3.25 - $9.16                           |       | 417                          |       | 5.65                                                                     |       | $               8.52 |   | 355 |   | $               8.51 |   |
| $9.21 - $10.75                          |       | 412                          |       | 7.51                                                                     |       | 10.37 |   | 201 |   | 10.26 |   |
| $10.78 - $12.61                         |       | 413                          |       | 7.85                                                                     |       | 12.12 |   | 132 |   | 11.63 |   |
| $12.63                                  |       | 426                          |       | 9.35                                                                     |       | 12.63 |   | 0 |   | 0.00 |   |
| $12.68 - $14.04                         |       | 437                          |       | 8.09                                                                     |       | 13.39 |   | 333 |   | 13.55 |   |
| $14.09 - $16.08                         |       | 372                          |       | 7.75                                                                     |       | 15.35 |   | 372 |   | 15.35 |   |
| $16.17- $16.62                          |       | 362                          |       | 8.23                                                                     |       | 16.61 |   | 302 |   | 16.61 |   |
| $16.75 -$22.00                          |       | 422                          |       | 6.95                                                                     |       | 19.25 |   | 385 |   | 19.10 |   |
| $22.30 -$24.80                          |       | 3                            |       | 4.64                                                                     |       | 23.61 |   | 3 |   | 23.61 |   |
| $27.00                                  |       | 1                            |       | 1.41                                                                     |       | 27.00 |   | 1 |   | 27.00 |   |
|                                    |       |                         |       |                                                                     |       |   |   |   |   |   |   |
| Total                                   |       | 3,265                        |       | 7.66                                                                     |       | $             13.48 |   | 2,084 |   | $             14.06 |   |

 

18

----

*The 2006Equity Incentive Plan*

The 2006 EIPprovides for various equity compensation arrangements that the CompensationCommittee may approve for grant to selected employees, executive officers,directors, agents, consultants and independent contractors of the Company.  Under the terms of the 2006 EIP, theCompensation Committee may grant either non-qualified or incentive stockoptions, as defined by the Internal Revenue Service, restricted stock awards,stock appreciation rights, and restricted stock units.  On August 30, 2006, the CompensationCommittee approved a restricted stock award program under the 2006 EIP thatreplaces the Previous Option Plans.  Restricted stock awards under the 2006 EIP program follow the samevesting schedule and are granted with a purchase price per share of $0.01.   Note that Board of Directors’ equity grantsvest at a rate of 50% after 12 months and ratably thereafter with full vestingat 24 months.  The total intrinsic valueof restricted stock awards granted during the quarter ended September 30, 2006was $0.4 million.  As of September 30,2006, there was $0.4 million of total unrecognized compensation cost fromshare-based compensation granted under the 2006 EIP, related to unvestedrestricted stock.   This compensation isexpected to be recognized over a weighted-average period of approximately 1.8years.

Restrictedstock awards outstanding at September 30, 2006, changes during the three monthsended September 30, 2006, and shares available for grant under the 2006 EIP arepresented below:
|                                              | ** ** | **Shares  available for  grant (1)** | ** ** | **Outstanding  awards** | ** ** |
|----------------------------------------------|------------|------------------------------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**                        | ** ** |
| Outstanding as of  June 30, 2006             |       | 2,242                                          |       | —                  |       |
| Authorized                                   |       | 1,500                                          |       | —                  |       |
| Shares available  from Previous Option Plans |       | 292                                            |       |                    |       |
| Granted                                      |       | (49                                            | )          | 49                      |       |
| Vested                                       |       | —                                         |       | —                  |       |
| Forfeited/expired                            |       | —                                         |       | —                  |       |
|                                         |       |                                           |       |                    |       |
| Outstanding as of  September 30, 2006        |       | 3,985                                          |       | 49                      |       |

 

----

(1)          Shares unused under the PreviousOption Plans will be available for grant under the 2006 EIP.

*2006ESPP, 2006 IESPP, and previous ESPP Plan (the “ESPP Plans”)*

Subject to certainmaximum stock ownership restrictions, employees are eligible to participate inthe ESPP plans if employed by the Company at the beginning of each offeringperiod, on a full-time or part-time basis, and regularly scheduled to work morethan 20 hours per week. Participating employees may have up to 10% of theirbase pay in effect at the commencement of each offering period withheldpursuant to the ESPP Plans.  The 2006IESSP terms vary as needed to comply with foreign tax laws.  Common stock purchased under the ESPP Plansis equal to 85% of the lower of the market value on the commencement date ortermination date of each offering period (usually six months).   We completed a six month offering period onAugust 15, 2006 under the previous ESPP Plan in which 78,000 shares were purchasedat $6.69 a share and with an intrinsic value of $92 thousand.  A new, seven-month offering period under the2006 ESPP and 2006 IESPP Plans began on August 16, 2006.    Total expense recognized during theoffering period for all ESPP Plans was $0.3 million.

We do not separateour employees into groups for purposes of valuing the ESPP Plan awards. Theassumptions we used to value the 2006 ESPP and 2006 IESPP shares under the newoffering period are as follows:  Interestrate —4.8%; Dividend yield — 0%; Expected term — 7 months; Volatility —41%. AtSeptember 30, 2006, there was $143,715 of total unrecognized compensation costrelated to our 2006 ESPP and 2006 IESPP, which will be recognized over theremaining offering period, through March 15, 2007.

19

----

Thefollowing table sets forth the total stock-based compensation expense resultingfrom stock-based compensation included in our Condensed Consolidated Statementsof Operations (in thousands):
|                                                              | ** ** | **Three months ended September 30, 2006**                      | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **Option Plan**                                                                    | ** ** | **Restricted  Stock Awards** | ** ** | **ESPP/IESPP** | ** ** |
| Cost of product and service revenue |       | $              21 |       | $              — |   | $                2 |   |
| Research and  development                                    |       | 170                                                                                     |       | 1 |   | 17 |   |
| Selling and  marketing                                       |       | 104                                                                                     |       | 1 |   | 10 |   |
| General and  administrative                                  |       | 436                                                                                     |       | 23 |   | 92 |   |
| Stock-based  compensation expense before income taxes        |       | 731                                                                                     |       | 25 |   | 121 |   |
| Income tax benefit  (1)                                      |       | (366                                                                                    | )          | (13 | ) | (61 | ) |
| Total  stock-based compensation expense after income taxes   |       | $            365            |       | $              12 |   | $              60 |   |
| Basic cost per  share                                        |       | $           0.02                 |       | $              — |   | $              — |   |
|                                                         |       |                                                                                    |       |   |   |   |   |
| Diluted cost per share                                       |       | $           0.02                 |       | $              — |   | $              — |   |

 
|                                                              | ** ** | **Nine months ended September 30, 2006**                       | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **Option Plan**                                                                    | ** ** | **Restricted  Stock Awards** | ** ** | **ESPP/IESPP** | ** ** |
| Cost of product and service revenue |       | $              95 |       | $              — |   | $              19 |   |
| Research and  development                                    |       | 549                                                                                     |       | 1 |   | 62 |   |
| Selling and  marketing                                       |       | 318                                                                                     |       | 1 |   | 51 |   |
| General and  administrative                                  |       | 1,283                                                                                   |       | 23 |   | 184 |   |
| Stock-based  compensation expense before income taxes        |       | 2,245                                                                                   |       | 25 |   | 316 |   |
| Income tax  benefit (1)                                      |       | (1,123                                                                                  | )          | (13 | ) | (158 | ) |
| Total  stock-based compensation expense after income taxes   |       | $         1,122                            |       | $              12 |   | $            158 |   |
| Basic and diluted cost  per share                            |       | $           0.06                 |       | $              — |   | $           0.01 |   |

----

 

(1)Tax effected at an estimated 50% annual effective tax rate. (See Note 10)

Priorto adoption of SFAS 123R, we applied SFAS 123, amended by SFAS 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure” (SFAS 148),which allowed companies to apply the existing accounting rules under APB 25, “Accountingfor Stock Issued to Employees,” and related interpretations. In general, nocompensation expense was recognized in periods prior to the adoption of SFAS 123Rfor our plans; however, as required by SFAS 148 prior to the adoption of SFAS123R, we provided pro forma net income (loss) and pro forma net income (loss)per common share disclosures for stock-based awards, as if the fair-value-basedmethod defined in SFAS 123 had been applied.

Thefollowing table illustrates the effect on net income (loss) after tax and netincome (loss) per common share as if we had applied the fair value recognitionprovisions of SFAS 123 to stock-based compensation during the three and ninemonths ended  September 30, 2005, (inthousands, except per share amounts):
|                                                                                                                  | ** ** | **Three months ended  September 30, 2005**                                                                      | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| Net income, as  reported                                                                                         |       | $                   3,606            |       |
| Deduct  stock-based employee compensation expense under the fair value based method,  net of related tax effect: |       |                                                                                                                                |       |
| Compensation expense for stock options (1)                                                                       |       | (350                                                                                                                                | )          |
| Compensation expense for the stock purchase plan                                                                 |       | (38                                                                                                                                 | )          |
| Net income, pro  forma                                                                                           |       | $                   3,218            |       |
| Earnings per  share:                                                                                             |       |                                                                                                                                |       |
| Basic – as reported                                                                                         |       | $                     0.19 |       |
| Basic – pro forma                                                                                           |       | $                     0.17 |       |
| Diluted – as reported                                                                                       |       | $                     0.19 |       |
| Diluted – pro  forma                                                                                        |       | $                     0.17 |       |

 

20

----

 
|                                                                                                                  | ** ** | **Nine months ended  September 30, 2005**                                                           | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|
| Net income, as  reported                                                                                         |       | $                 8,423            |       |
| Deduct  stock-based employee compensation expense under the fair value based method,  net of related tax effect: |       |                                                                                                                    |       |
| Compensation expense for stock options (1)                                                                       |       | (5,957                                                                                                                  | )          |
| Compensation expense for the stock purchase plan                                                                 |       | (114                                                                                                                    | )          |
| Net income, pro  forma                                                                                           |       | $                 2,352            |       |
| Earnings per  share:                                                                                             |       |                                                                                                                    |       |
| Basic – as reported                                                                                         |       | $                   0.44 |       |
| Basic – pro forma                                                                                           |       | $                   0.12 |       |
| Diluted – as reported                                                                                       |       | $                   0.43 |       |
| Diluted – pro  forma                                                                                        |       | $                   0.12 |       |

 

----

(1) Includescompensation expense (net of related tax effect) resulting from theacceleration of vesting of certain outstanding stock options, as described below.

For SFAS 123 purposes, the fair value of each optiongrant is estimated as of the date of grant using the Black-Scholes optionpricing model with the following weighted average assumptions used forgrants:  risk-free interest rates of4.17% and 3.77%, respectively, for the three and nine months ended September30, 2005; expected lives (net of forfeitures) of 4.08 years and 3.51 years,respectively, for the three and nine months ended September 30, 2005; a $0.10per share quarterly dividend for the three and nine months ended September 30,2005; and expected volatility of 70.5% and 73.3%, respectively,  for the three and nine months ended September30, 2005.  The fair value of eachpurchase right under the employee stock purchase plan is estimated, fordisclosure purposes, on the date of grant using the Black-Scholes model withthe following assumptions: a $0.10 per share quarterly dividend for the threeand nine months ended September 30, 2005; an expected life of eight months and6.7 months for the three and nine months ended September 30, 2005; expectedvolatility of 41.1% and 46.4%, respectively, for the three and nine monthsended September 30, 2005; and a risk-free interest rate of 3.73% and 3.56%,respectively, for the three and nine months ended September 30, 2005.

OnJune 21, 2005, the Board of Directors authorized the acceleration of thevesting of stock options outstanding under the Company’s 2000 Stock Option Planand the Company’s prior equity compensation plans that had an exercise priceper share higher than the closing price of the Company’s stock on June 21,2005, which was $10.75. Options held by directors, including John Elms, theCompany’s president and CEO, were not eligible in the vesting acceleration.Options to purchase approximately 1.1 million shares of the Company’scommon stock became exercisable immediately.

Theprimary purpose of the accelerated vesting was to eliminate future compensationexpense the Company would otherwise recognize in its income statement withrespect to these accelerated options upon the adoptionSFAS 123R.     These options were not “in-the-money”at that time, and therefore, there was no compensation expense recorded inaccordance with APB No. 25 as a result of this modification. However, inaccordance with SFAS No. 123, the Company included the remainingunamortized compensation expense of approximately $3.9 million (net of tax)related to the accelerated options in its pro forma net income (loss) andearnings (loss) per share for the three months ended June 30, 2005. Hadthis acceleration not been taken, the unamortized fair value-based compensationexpense would have been recorded in future periods through 2009, under vestingschedules in place prior to the acceleration, which generally would have resultedin fair value-based compensation expense of $88,000 for the three months ended September 30, 2005, $1.2 millionfor the remainder of 2005, $1.5 million in 2006, $0.8 million in2007, $0.3 million in 2008 and $14,000 in 2009, all without regard to theeffect of forfeitures.

Cashproceeds from the exercise of stock options were insignificant and $ 0.2million for the three months ended September 30, 2006, and 2005, respectively,and $1.6 million and $ 1.6 million for the nine months ended September 30, 2006and 2005, respectively.   Net cashproceeds from employee stock purchases were $0.5 million and $0.0 million forthe three months ended September 30, 2006 and 2005, respectively, and $1.1 millionand $0.4 million for the nine months ended September 30, 2006 and 2005,respectively.  In accordance with SFAS123R, we present excess tax benefits from the exercise of stock options, ifany, as financing cash flows in 2006 rather than operating cash flows, aspresented previously.

21

----

 

**Item 2.****           Management’s Discussionand Analysis of Financial Condition and Results of Operations**

*Certainstatements about future events and expectations in this Form 10-Q, as well asstatements made by us in periodic press releases, oral statements made by ourofficials to analysts and stockholders in the course of presentations aboutSpectraLink, and conference calls following earnings releases, constitute “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. Examples of forward-looking statements include statements we makeregarding future prospects for growth in the on-premise wireless telephonesystem and phone market, our ability to maintain or increase our market share,our ability to introduce new products successfully, success in integrating theKIRK acquisition and our future operating results. In addition, words such as “believes,”“anticipates,” “expects,” “plans,” “estimates,” “intends,” “could,” “might,”and similar expressions are intended to identify forward-looking statements.These forward-looking statements are based on assumptions, which are believedreasonable but, by their nature, are all inherently uncertain and involve risk.In all cases, results could differ materially from those projected. Certain risks and uncertainties relating to forward-looking statements are setforth below in “Management’s Discussion and Analysis of Financial Condition”and in Item 1A of this Form 10-Q under the caption “Risk Factors”. Newrisks and uncertainties come up from time to time and it is impossible for usto predict these events or how they may affect us. We undertake no obligationto revise any forward-looking statements in order to reflect events orcircumstances that may arise after the date of this report.*

**BusinessDescription and Overview**

SpectraLink commenced operations in April 1990 to design,manufacture and sell unlicensed wireless telephone communication systems forbusinesses.  Our product portfolioconsists of three types of product categories differentiated by the wirelesstechnologies implemented into the product:  The LinkTM wireless telephonesystem (Link wts) and NetLinkTM wireless telephones and the KIRK DECT telephonesystem. The Link wts uses a proprietary radio infrastructure in the 902-928 MHzradio band targeted to organizations that desire a dedicated wireless voicesolution for their on-premises mobile workforce.  TheNetLink wireless telephone products operate over IEEE 802.11-compliant wirelesslocal area networks (wireless LANs) in the2400-2483 MHz frequency band using standards-based Internet Protocol (IP)technology.  NetLink products are targeted to organizations that want botha wireless voice and wireless data solution on a single network. SpectraLink also offers an Open Application Interface (OAI), which enablesthird-party messaging applications to be integrated with our wirelesstelephones. Because of the recent advances in wirelessLAN technology, a significant portion of our development efforts will focus onour existing NetLink products as well as new products that operate on a wirelessLAN. As a result of acquiring KIRK, we began offering the KIRK DECT productswhich operate in compliance with the DECT standard.

*Acquisition of KIRK*

On January 3, 2006, SpectraLink Corporation, through itswholly-owned subsidiaries, acquired all of the stock of KIRK for 389.0 millionDanish Kroner or approximately $62.0 million, which was paid in cash, andapproximately $2.0 million of acquisition-related costs.  As a result ofthe acquisition, KIRK became a wholly owned subsidiary. We funded theacquisition price with approximately $31 million of our own cash plus fundsprovided by a Credit Facility.  KIRK is based in Horsens, Denmark anddesigns, manufactures and sells unlicensed wireless telephone systems using theDECT standard.  In addition, KIRK offers theKIRK Serial In Out (SIO) to enable third-party messaging applications tointerface with its telephone systems. 

With the addition of the KIRK DECT products, we now offer acomplete product portfolio that incorporates all major enterprise wirelessvoice technologies: Wi-Fi, DECT and proprietary systems.  Our acquisitionof KIRK also significantly increases our international reach and augments ourdistribution channels and geographical market penetration, further extendingour leadership in workplace wireless telephony.  Furthermore, theacquisition enables us to compete in new small to medium business markets inthe Americas with KIRK DECT products.  As we continue to integrate KIRK’soperations, our results of operations will continue to be significantlyimpacted to increase our sales, cost of sales, and operating expenses abovehistorical levels.

*Recent Developments*

OEM partners Nortel and NEC North America are now offering DECTsystems as part of their wireless portfolios in North America.   Internationally, NetLink wireless telephonesare being integrated into the product offerings of KIRK distributors weobtained through our purchase of KIRK telecom. We are also working with KIRK telecom’s top eight distributors, all ofwhom attended a partner conference and training session including the NetLinkproduct in the fourth quarter.

Inthe second quarter of 2006, we first started selling the new Link 6020 handset.  The Link 6020 handset includes a largerdisplay, improved battery performance, speakerphone, and new user-interface andprofile attributes to improve usability in a wide variety of enterpriseapplications. We also launched the KIRK Wireless Server 600v3, a cost-effectiveand highly scalable solution that offers wireless IP telephony via DECTinfrastructure for customers running VoIP over a Cisco CallManager, H.323 orSIP servers.

22

----

*Gross Margin*

Sales through our OEM partners and relative product miximpact our margins.  We realize lower margins on products sold through OEMrelationships because of the pricing arrangements inherent in theserelationships.  Our Link product line gross margin is approximately 7%higher than the aggregate gross margin from the sale of the NetLink productsbecause of the added infrastructure associated with Link sales.  KIRKproducts also have a lower gross margin of approximately 40% to 45%, which islower than the gross margin on our Link products.

We are continuing our transition from aNorth American-oriented niche market provider to a global supplier of workplacewireless telephone systems and handsets with our recent acquisition of KIRK, aswell as our partnerships with some of the largest telecommunicationsmanufacturers worldwide including Alcatel, Avaya, Inter-Tel, NEC America, andNortel. Because our OEM partners primarily sell NetLink wireless telephones, ifOEM sales increase, we would expect NetLink and KIRK DECTsales to also increase.   If we sell proportionately more NetLink andDECT than Link, we will continue to see pressure on our overall gross margins.

*Liquidity*

Our cash, cashequivalents and investments at September 30, 2006, decreased to $15.1 millionfrom $16.4 million at June 30, 2006, as we repaid approximately $2.0 million onour Credit Facility, and continued to purchase inventory to support our newproduct offerings.  Capital spending hasslowed in the third quarter of 2006 to $0.7 million, as compared to $5.0million in the first half of the year. We continue to invest in low-risk instruments including governmentsecurities and tax-free investments.

Our inventoryincreased to $19.5 million at September 30, 2006 compared to $18.9 million atJune 30, 2006.  This increase wasprimarily related to the build-up of parts necessary to ensure a smoothtransition to our new products introduced earlier in 2006.   It remains our goal to reduce net inventoryover the next few quarters as we work through this transitional period.

**Consolidated Results ofOperations**

For the three months ended September 30, 2006, we generatedsales of $38.0 million and net income of $1.7 million, or $0.09 dilutedearnings per share.  For the three monthsended September 30, 2006, we incurred $1.1 million of amortization expense on intangibleassets, primarily related to our acquisition of KIRK.  We also incurred approximately $0.9 millionrelated to the expensing of stock-based compensation in accordance with SFAS123R.  In comparison, for the thirdquarter of 2005, net income was $3.6 million, or $0.19 earnings per dilutedshare, on sales of $24.8 million.

For the nine months ended September 30, 2006, we generatedsales of $107.3 million and a net loss of $0.6 million, or a loss of $0.03 perdiluted share.  For the nine months endedSeptember 30, 2006, we incurred $3.4 million of amortization expense on intangibleassets, primarily related to our acquisition of KIRK and $2.0 million relatedto acquired in-process research and development expense.  We also incurred approximately $2.6 millionrelating to the expensing of stock-based compensation in accordance with SFAS123R.  In comparison, for the nine monthsended September 30, 2005, net income was $8.4 million, or $0.43 earningsper diluted share, on sales of $67.5 million.

Consolidatedsales for the three months ended September 30, 2006, increased 53% to $38.0 millionfrom $24.8 million for the same period last year. Consolidated sales for thenine months ended September 30, 2006, increased 59% to $107.3 million from$67.5 million for the same period last year. The increase in sales wasprimarily due to the acquisition of KIRK and due to increases in SpectraLink’ssales from its OEM and distribution channels as well as an increase in servicesales.  KIRK sales decreasedapproximately 20% and 17% from the comparable quarterly and year-to-date 2005consolidated proforma results, respectively, due to a decline in North AmericaOEM sales.

Our traditional distribution channels were responsible forapproximately 49% of third quarter product sales, original equipmentmanufacturer (OEM) partners contributed approximately 35% of third quarterproduct sales, and the balance of 16% was met through our direct salesteam.  For the fourth consecutivequarter, sales of our NetLink wireless telephones exceeded sales of the Link wts.  NetLink sales for the third quarter accountedfor 36% of product sales, or $10.8 million, Link sales accounted for 36% ofproduct sales, or $10.6 million, and KIRK DECT sales accounted for 28% ofproduct sales or $8.4 million. For the three and nine months endedSeptember 30, 2006, we had one customer that accounted for over 10% of ourconsolidated net sales.

For the nine months ended September 30, 2006, ourtraditional distribution channels were responsible for approximately 47% ofproduct sales, original equipment manufacturer (OEM) partners contributedapproximately 36% of product sales, and the balance of 17% was met through ourdirect sales team.  NetLink sales for thenine months ended September 30, 2006 accounted for 37% of product sales, or$31.2 million, Link sales accounted for 35% of product sales, or $29.6 million,and KIRK DECT sales accounted for 28% of product sales or $23.8 million. Duringthe third quarter of 2006, we had one customer that accounted for over 10% ofour consolidated net sales.

23

----

Consolidatedservice sales for the three months ended September 30, 2006, increased 40% to$8.1 million compared to $5.8 million for the same period last year.Consolidated service sales for the nine months ended September 30, 2006,increased 38% to $22.6 million compared to $16.4 million for the same periodlast year.  The increases in servicesales are primarily attributed to increases in maintenance contracts relatingto products previously sold to a larger installed base, installations and timeand materials services.

Overall consolidated gross margin for the three monthsended September 30, 2006, was 56% or $21.4 million compared to 66% or $16.3million for the same period last year. For the nine months ended September 30,2006, our consolidated gross margin was 57% or $61.0 million compared to 65% or$44.1 million for the same periods last year. We attribute the dilution of our gross margin primarily to the additionof KIRK DECT products to our product offerings and an increase in our NetLinksales. Both KIRK DECT and NetLink products carry a lower gross margin than ourLink product, and as product mix shifts, gross margin is affected.   Our margin also decreased because of thehigher percentage contribution from our service business in 2006 that carries alower gross margin.

Consolidatedresearch and development expense excluding acquired in-process research anddevelopment expense and amortization of intangible assets for the three monthsended and nine months ended September 30, 2006, respectively, increased 76% and114% to $4.8 million and $16.4 million from $2.7 million and $7.6 million forthe same periods last year. The increases were primarily due to the acquisitionof KIRK, additional resources required to support our new product rollouts andcompensation expense associated with the fair value of stock-based awardsrelated to the adoption of SFAS 123R.

Consolidatedmarketing and selling for the three months and nine months ended September 30,2006, respectively, increased 34% and 38% to $8.9 million and $26.5 millionfrom $6.7 million and $19.2 million for the same periods last year. Theincreases were primarily due to the acquisition of KIRK and compensationexpense associated with the fair value of stock-based awards related to theadoption of SFAS 123R.

Consolidatedgeneral and administrative expenses for the three months and nine months endedSeptember 30, 2006, respectively, increased 105% and 136% to $3.5 million and$11.3 million from $1.7 million and $4.8 million for the same periods lastyear. The increases were primarily due to the acquisition of KIRK, compensationexpense associated with the fair value of stock-based awards related to theadoption of SFAS 123R and increased professional services fees.

Net consolidatedother (expense) income was a net other expense of $0.3 million and $1.2 millionfor the three months and nine months ended September 30, 2006, respectively, compared to a net other income of $0.3million and $1.0 million for the same periods in the prior year.  For the three months and nine months endedSeptember 30, 2006, we incurred interest expense, including amortization ofdebt issuance costs, related to our credit facility of approximately $0.4 millionand $1.7 million, offset in part by interest income of $0.1 million and $0.5million, respectively.  For the threemonths and nine months ended September 30, 2005, we earned interest income of$0.4 million and $1.1 million, respectively.

Consolidatedincome tax expense was $1.0 million, or an effective tax rate of 37.4%, for thethree months ended September 30, 2006, compared to income tax expense of $2.0million, or an effective tax rate of 35.6%, for the same period last year. Forthe nine months ended September 30, 2006, consolidated income tax expense was$0.8 million, or an effective tax rate of 409%, compared to income tax expenseof $4.9 million, or an effective tax rate of 37.0%, for the same period lastyear.

Our2006 effective tax rate is impacted by the mix of domestic versus foreign incomeand the absence of the research and development tax credit thus far in2006.   Further, a nondeductiblein-process research and development write-off in the first quarter of 2006 andthird quarter 2006 adjustments as a result of finalizing our 2005 tax return,have caused our quarterly tax rates to fluctuate.  Excluding the impact of the non-deductiblein-process research and development charge, our 2006 effective tax rate isestimated to range between 48% and 52%.

**Segment Results of Operations**

Duringthe nine months ended September 30, 2006, we operated our business across twooperating segments, based on the legal structures of SpectraLink and KIRK.Prior to fiscal year 2006, and the acquisition of KIRK, we operated as onesegment.   In the third quarter of 2006,management determined that certain costs related to the acquisition of KIRKwould not be allocated to operating results of either segment, which is achange from our segment presentation in previous quarterly reports.  Management continues to review the structureof the Company and may modify our segment structure again in the ensuingquarters.   We have presented below theprior quarters’ segment results without acquisition-related unallocated costsfor comparative purposes.

TheSpectraLink segment primarily consists of our Americas operations and corporateactivities, including ongoing global corporate support functions, such asexecutive offices, legal, finance and treasury. The SpectraLink segment alsoincludes branch sales and sales support personnel located in the United Kingdomand Australia.

TheKIRK segment is comprised of the operations and corporate activities of KIRKacquired on January 3, 2006 (See Note 2 on page 7). KIRK designs, manufacturesand sells wireless onsite adjunct communication solutions. KIRK also includestwo subsidiaries: KIRK telecom, Inc., which in 2005 was a distribution salesand support subsidiary in the United States; and KIRK scantel A/S, whichdesigns, contract manufactures and sells wired and wireless telephones underthe KIRK brand name to the residential market, primarily in the Scandinaviancountries. KIRK telecom, Inc. had minimal activity in 2006 as its staff washired by SpectraLink.

24

----

Unallocatedcosts primarily consist of costs incident to the acquisition of KIRK, includingdebt service, amortization of intangible assets, purchased in-process researchand development and foreign currency changes.

We hadone customer in the three and nine months ended September 30, 2006 from which salesexceeded 10% of our consolidated net sales. Both segment results include salesfrom this customer, which totaled $3.9 million and $14.6 million forthe three and nine months ended September 30, 2006, respectively. We had nocustomers representing greater than 10% of sales in the comparable 2005 periods.

*SpectraLinkSegment*

The following includes insignificant sales to KIRK, thatare eliminated in consolidation:
|                                    | ** ** | **Three months ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|
| **(in  thousands)**                | ** ** | **2006**                                                 | ** ** | **%  Change** | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(actual)**                                             | ** ** | ** ** | ** ** | **(actual)** | ** ** |
| Net product and  service sales     |       | $                                                        | 29,410     |   | 19 | % | $ | 24,762 |   |
| Cost of product  and service sales |       | 11,957                                                   |       | 42 |   | 8,427 |   |
| Gross profit                       |       | 17,453                                                   |       | 7 |   | 16,335 |   |
| Research and  development          |       | 3,639                                                    |       | 35 |   | 2,698 |   |
| Marketing and  selling             |       | 7,783                                                    |       | 17 |   | 6,674 |   |
| General and  administrative        |       | 2,797                                                    |       | 64 |   | 1,708 |   |
| Income from operations             |       | $                                                        | 3,234      |   | (38 | ) | $ | 5,255 |   |

 
|                                    | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                                | ** ** | **%  Change** | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(actual)**                                            | ** ** | ** ** | ** ** | **(actual)** | ** ** |
| Net product and  service sales     |       | $                                                       | 82,845     |   | 23 | % | $ | 67,461 |   |
| Cost of product  and service sales |       | 32,431                                                  |       | 39 |   | 23,358 |   |
| Gross profit                       |       | 50,414                                                  |       | 14 |   | 44,103 |   |
| Research and  development          |       | 12,489                                                  |       | 63 |   | 7,644 |   |
| Marketing and  selling             |       | 23,422                                                  |       | 22 |   | 19,215 |   |
| General and administrative         |       | 8,266                                                   |       | 72 |   | 4,809 |   |
| Income from  operations            |       | $                                                       | 6,237      |   | (50 | ) | $ | 12,435 |   |

 
|                                    | ** ** | **Three months ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(actual)**                                        | ** ** | **(actual)** | ** ** |
| Net product and  service sales     |       | $                                                   | 27,116     |   | $ | 22,111 |   |
| Cost of product  and service sales |       | 10,568                                              |       | 7,628 |   |
| Gross profit                       |       | 16,548                                              |       | 14,483 |   |
| Research and  development          |       | 4,402                                               |       | 2,489 |   |
| Marketing and  selling             |       | 8,046                                               |       | 6,508 |   |
| General and  administrative        |       | 2,580                                               |       | 1,519 |   |
| Income from operations             |       | $                                                   | 1,520      |   | $ | 3,967 |   |

 
|                                    | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(actual)**                               | ** ** | **(actual)** | ** ** |
| Net product and  service sales     |       | $                                          | 26,319     |   | $ | 20,588 |   |
| Cost of product  and service sales |       | 9,906                                      |       | 7,303 |   |
| Gross profit                       |       | 16,413                                     |       | 13,285 |   |
| Research and  development          |       | 4,448                                      |       | 2,457 |   |
| Marketing and  selling             |       | 7,593                                      |       | 6,033 |   |
| General and  administrative        |       | 2,889                                      |       | 1,582 |   |
| Income from  operations            |       | $                                          | 1,483      |   | $ | 3,213 |   |

 

*NetProduct and Service Sales.*SpectraLink derives its productsales principally from the sale of wireless, on-premises telephone systems.SpectraLink derives its service sales principally from the installation andmaintenance service of wireless handsets and on-premises telephone systems. Netproduct and service sales increased 19% and 23%, respectively, for the threemonths and nine months ended September 30, 2006, compared to the same periodslast year. Product sales increased 13% and 19% to $21.5 million and $60.9million, respectively, for the three months and nine months ended September 30,2006, from $19.0 million and $51.0 million for the same periods last year. Theincrease in product sales was primarily related to an increase in our NetLinkproduct sales, which was 

25

----

largelyattributable to an increase in OEM sales and sales to our retail marketsegment. Service sales increased 37% and 33% to $7.9 million and $21.9 million,respectively, for the three months and nine months ended September 30, 2006,from $5.8 million and $16.4 million for the same periods last year. Theincrease in service sales was primarily related to an increase in maintenancecontracts, installations and time and materials services.

*Cost ofProduct and Service Sales. *Ourcost of product sales consists primarily of direct material, direct labor*,* product packaging, third-party royalties and manufacturingoverhead.  For the three months and ninemonths ended September 30, 2006, cost of product sales increased by 43% and 42%,to $7.7 million and $20.8 million, respectively, from $5.4 million and $14.6million, respectively, for the same periods last year.

Ourcost of service sales consists primarily of employee-related costs and theassociated costs incurred to provide installation, maintenance, training, andproduct repair and support.  For thethree months and nine months ended September 30, 2006, cost of service salesincreased by 40% and 33%, respectively, to $4.2 million and $11.6 million from$3.0 million and $8.7 million for the same periods last year.

*GrossProfit. *For the threemonths and nine months ended September 30, 2006, gross profit percentage (grossprofit as a percentage of net sales) decreased to 59.3% and 60.9%,respectively, from 66.0% and 65.4% for the same periods last year. The decreasein gross profit was due to stronger NetLink product sales, which carry lowermargins, and increased sales through our OEM partners which typically carryhigher discounts as well as an increase in warranty costs, manufacturingvariances and manufacturing overhead.

Grossprofit percentage from product sales for the three months ended September 30,2006, decreased to 64.0% from 71.4% for the same period last year primarily duean increase in material costs and additional manufacturing variances. Grossprofit percentage from product sales, net for the nine months ended September30, 2006, decreased to 65.8% from 71.3% for the same period last year primarilydue an increase in material costs, additional warranty costs incurred in thefirst quarter 2006 of approximately $0.3 million for field replacements relatedto an issue with a specific product, and additional material costs related to achange in product mix including the launch of a new product in the secondquarter 2006.

Grossprofit percentage from service sales for the three months and nine months endedSeptember 30, 2006, increased to 46.7% and 47.1%, respectively,  from 48.2% and 47.0%, respectively, for the same periods last year. The increase ingross profit from service sales was due to increased service sales, while costsremain relatively flat.

*Researchand Development.*Research and development expenses consistprimarily of employee costs, professional services, and supplies necessary todevelop new products, enhance existing products and reduce the cost of oursystems. Research and development expenses as a percentage of net sales were12% and 15%, respectively, for the three months and nine months ended September30, 2006, compared to 11%, for both the three months and nine months endedSeptember 30, 2005. The increase in research and development dollars spent andthe increase as a percentage of net sales, were primarily due to increases insalaries, and employee benefits related to headcount additions as well asincreased professional services fees and miscellaneous parts and supplies tosupport our new product rollouts and compensation expense associated with thefair value of stock-based awards related to the adoption of SFAS 123R.

*Marketing andSelling.*Marketing and selling expenses consistprimarily of salaries and benefits for personnel, commissions, travel, productmarketing material, tradeshows, sales meetings and market research. Marketingand selling expenses as a percentage of net sales were 26% and 28% for thethree months and nine months ended September 30, 2006, compared to 27% and 28%,respectively, for the three months and nine months ended September 30, 2005.Sales and marketing dollars spent increased due to increases in salaries andemployee benefits primarily related to headcount additions, commissions, andcompensation expense associated with the fair value of stock-based awardsrelated to the adoption of SFAS 123R.

*General andAdministrative.*General andadministrative expenses consist primarily of salaries and other expenses formanagement, finance, legal, investor relations, and human resources. Generaland administrative expenses as a percentage of net sales were 10% for both the threemonths and nine months ended September 30, 2006, compared to 7% for both thethree months and nine months ended September 30, 2005.  The increase in general and administrativedollars spent and the increase as a percentage of net sales, were each due toincreases in salaries and employee benefits primarily related to headcountadditions and merit raises as well as compensation andcompensation expense associated with the fair value of stock-based awardsrelated to the adoption of SFAS 123R. For the nine monthsended September 30, 2006, general and administrative expenses also increaseddue to increased costs for accounting, legal and outside consulting feesrelated to the acquisition of KIRK that were not capitalizable as a componentof the purchase price, and due to increased professional service fees for theimplementation of new accounting standards, including option expensing.

*KIRKSegment*

Thefollowing represents the KIRK segment’s actual results for 2006 and pro formaresults, as if the acquisition had occurred on January 1, 2005, for comparativepurposes. The Danish Krone is KIRK’s functional currency, therefore, resultsare impacted by 

26

----

fluctuations in thecurrency exchange between the Danish Krone and the U.S. Dollar.  The quarter over quarter and year over yearcomparisons as of  September 30, 2006were positively  impacted by anapproximate 5% and 2% strengthening of the Danish Krone against the US Dollar,respectively.  KIRK’s results in thesecond and third quarters of 2006 include sales to SpectraLink totalingapproximately $0.3 million for the six month period.
|                                    | ** ** | **Three months ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|
| **(in  thousands)**                | ** ** | **2006**                                                 | ** ** | **%  Change** | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(actual)**                                             | ** ** | ** ** | ** ** | **(pro forma)** | ** ** |
| Net product and  service sales     |       | $                                                        | 8,622      |   | (20 | )% | $ | 10,843 |   |
| Cost of product  and service sales |       | 4,646                                                    |       | (14 | ) | 5,380 |   |
| Gross profit                       |       | 3,976                                                    |       | (27 | ) | 5,463 |   |
| Research and  development          |       | 1,120                                                    |       | (8 | ) | 1,224 |   |
| Marketing and  selling             |       | 1,151                                                    |       | (4 | ) | 1,199 |   |
| General and  administrative        |       | 688                                                      |       | (26 | ) | 928 |   |
| Income from  operations            |       | $                                                        | 1,017      |   | (52 | ) | $ | 2,112 |   |

 
|                                    | ** ** | **Nine months ended September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                                | ** ** | **%  Change** | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(actual)**                                            | ** ** | ** ** | ** ** | **(pro forma)** | ** ** |
| Net product and  service sales     |       | $                                                       | 24,773     |   | (17 | )% | $ | 29,772 |   |
| Cost of product  and service sales |       | 14,048                                                  |       | (9 | ) | 15,368 |   |
| Gross profit                       |       | 10,725                                                  |       | (26 | ) | 14,404 |   |
| Research and  development          |       | 3,911                                                   |       | 7 |   | 3,650 |   |
| Marketing and  selling             |       | 3,116                                                   |       | (9 | ) | 3,424 |   |
| General and  administrative        |       | 3,014                                                   |       | (7 | ) | 3,225 |   |
| Income from operations             |       | $                                                       | 684        |   | (83 | ) | $ | 4,105 |   |

 
|                                    | ** ** | **Three months ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(actual)**                                        | ** ** | **(pro forma)** | ** ** |
| Net product and  service sales     |       | $                                                   | 8,501      |   | $ | 9,753 |   |
| Cost of product  and service sales |       | 4,760                                               |       | 4,898 |   |
| Gross profit                       |       | 3,741                                               |       | 4,855 |   |
| Research and  development          |       | 1,433                                               |       | 1,219 |   |
| Marketing and  selling             |       | 914                                                 |       | 991 |   |
| General and  administrative        |       | 1,208                                               |       | 1,291 |   |
| (Loss) income from  operations     |       | $                                                   | 186        |   | $ | 1,354 |   |

 
|                                    | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(actual)**                                         | ** ** | **(pro forma)** | ** ** |
| Net product and  service sales     |       | $                                                    | 7,650      |   | $ | 9,176 |   |
| Cost of product  and service sales |       | 4,642                                                |       | 5,090 |   |
| Gross profit                       |       | 3,008                                                |       | 4,086 |   |
| Research and  development          |       | 1,358                                                |       | 1,207 |   |
| Marketing and  selling             |       | 1,051                                                |       | 1,234 |   |
| General and  administrative        |       | 1,118                                                |       | 1,006 |   |
| Income from operations             |       | $                                                    | (519       | ) | $ | 639 |   |

 

*NetProduct and Service Sales.*KIRK derives its product salesprincipally from the sale of wireless, on-premises telephone systems. KIRKderives its service sales principally from the time and material repairs ofwireless, on-premises telephone systems. Net product and service salesdecreased 20% and 17%, respectively, for the three months and nine months endedSeptember 30, 2006, compared to the same periods last year. The decrease in netsales was primarily related to a decrease in KIRK’s OEM product sales,primarily from one North American customer. 

*Cost ofProduct and Service Sales.*KIRK’s cost of product salesconsists primarily of direct material, direct labor*,*product packaging, third-party royalties, and manufacturing overhead.  KIRK’s cost of service sales consistsprimarily of costs incurred to provide product repair. For the three months andnine months ended September 30, 2006, cost of sales decreased by 14% and  9%, respectively, compared to the sameperiods last year.  Decreases areprimarily due to a decrease in material costs required to service  lower OEM sales in 2006, offset by  fixed costs coverage on lower volumes.

*GrossProfit.*For the three months and nine months ended September30, 2006, the KIRK segment’s gross profit percentage 

27

----

(gross profit as apercentage of net sales) decreased to 46% and 43%, respectively, from 50% and48%, respectively,  for the same periodslast year. The decrease in gross profit was due to lower sales primarily inKIRK’s OEM channel and a fixed cost coverage on lower volumes.  Gross profit on service sales did notcontribute significantly to the change in KIRK’s total gross profit.

*Researchand Development.*Research and development expenses consistprimarily of employee costs, professional services, and supplies necessary todevelop new products and enhance our existing products. Research anddevelopment expenses as a percentage of net sales were 13% and 16%,respectively, for the three months and nine months ended September 30, 2006,compared to 11% and 12%, respectively, for the three months and nine monthsended September 30, 2005. The increase in research and development dollarsspent and the increase as a percentage of net sales, were each due to increasesin salaries, and employee benefits primarily related to increases in headcountto support development of new products and enhancements to existing products.

*Marketingand Selling.*Marketing and selling expenses consist primarilyof salaries and other expenses for personnel, travel and marketing, trade showsand promotion costs. Marketing and selling expenses as a percentage of netsales were 13% for both the three months and nine months ended September 30,2006, compared to 11% and 12%, respectively, for the three months and ninemonths ended September 30, 2005.

*Generaland Administrative.*General and administrative expensesconsist primarily of salaries and other expenses for management, finance,legal, and human resources. General and administrative expenses as a percentageof net sales were 8% and 12% for the three months and nine months endedSeptember 30, 2006, compared to 9% and 11%, respectively, for the three monthsand nine months ended September 30, 2005. The decreases in the third quarterare primarily due to lower professional and recruiting expenses, which had beenhigher earlier in 2006.

**UnallocatedCosts**

Unallocatedcosts are separately stated from our operating segment results for the firsttime in the quarter ended September 30, 2006 and are primarily costs incurredas a result of the acquisition of KIRK in 2006.   Unallocated costs include noncash acquiredin-process research and development, amortization of intangible assets, andother income (expense) related to financing and foreign currency fluctuation.  The following tables summarize ourunallocated costs, by quarter:
|                                               | ** ** | **Three months ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|
| **(in  thousands)**                           | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **(actual)**                                             | ** ** | **(pro forma)** | ** ** |
| Acquired  in-process research and development |       | $                                                        | —     |   | $ | — |   |
| Amortization of  intangible assets            |       | (1,130                                                   | )          | (1,103 | ) |
|                                          |       | $                                                        | (1,130     | ) | $ | (1,103 | ) |

 
|                                               | ** ** | **Three months ended June 30,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **(actual)**                                        | ** ** | **(pro forma)** | ** ** |
| Acquired  in-process research and development |       | $                                                   | —     |   | $ | — |   |
| Amortization of  intangible assets            |       | (1,130                                              | )          | (1,126 | ) |
|                                          |       | $                                                   | (1,130     | ) | $ | (1,126 | ) |

 

28

----

 
|                                               | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **(actual)**                                         | ** ** | **(pro forma)** | ** ** |
| Acquired  in-process research and development |       | $                                                    | (2,021     | ) | $ | (2,021 | ) |
| Amortization of  intangible assets            |       | (1,125                                               | )          | (1,120 | ) |
|                                          |       | $                                                    | (3,146     | ) | $ | (3,141 | ) |

 
|                                               | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **(actual)**                                            | ** ** | **(pro forma)** | ** ** |
| Acquired  in-process research and development |       | $                                                       | (2,021     | ) | $ | (2,021 | ) |
| Amortization of  intangible assets            |       | (3,385                                                  | )          | (3,349 | ) |
|                                          |       | $                                                       | (5,406     | ) | $ | (5,370 | ) |

 

29

----

**Liquidityand Capital Resources**

The followingsummarizes our key liquidity and capital resources metrics for the periodspresented:

|                                       | ** ** | **Nine months ended**  | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **(In thousands)**          | ** ** |
| ** **                            | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
| **Cash  Flows**                       |       |                             |       |   |   |
| Cash provided by operating activities |       | $                                | 5,571      |   | $ | 11,609 |   |
| Cash used in investing activities     |       | (2,920                           | )          | (9,985 | ) |
| Cash used in  financing activities    |       | (15,011                          | )          | (8,407 | ) |
|                                       |            |                                  |            |  |  |  |  |

 

|                                                | ** ** | **As of  September 30, 2006** | ** ** | **As of  December 31, 2005** | ** ** |
|------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------|------------|
| **Capital  Resources**                         |       |                                         |       |                                        |       |
| Cash and cash equivalents                      |       | $                                            | 4,459      |                                        | $          | 16,703 |   |
| Investments                                    |       | 10,615                                       |       | 14,088                                      |       |
| Cash held in escrow                            |       | —                                       |       | 55,148                                      |       |
| Working capital, excluding cash held in escrow |       | 31,158                                       |       | 30,271                                      |       |
| Short-term debt                                |       | 6,000                                        |       | 15,000                                      |       |
| Long-term debt                                 |       | 9,050                                        |       | 18,050                                      |       |
| Available credit                               |       | 12,127                                       |       | 1,950                                       |       |
|                                                |            |                                              |            |                                             |            |  |  |

 

Cashflows provided by operations decreased $6.0 million in the nine months ended September30, 2006, compared to nine months ended September 30, 2005.   The decrease is primarily due to increasedspending related to the development and production of a new product, additionalinterest payments from acquisition related debt and non-capitalizable costsrelated to the acquisition of KIRK.

Cashused in investing activities decreased by $7.1 million in the nine monthsended  September 30, 2006, compared to thenine months ended  September 30,2005.   This is primarily the result ofselling investments to fund part of the KIRK acquisition in 2006, as opposed topurchasing investments in 2005 with our excess cash flow, offset by significantcapital expenditures.

Cash used in financing activities increased by $6.6million for the nine months ended September 30, 2006, compared to the sameperiod last year.  This is primarily theresult of repaying $18.0 million of acquisition-related debt, offset byadditional cash proceeds $0.7 million from the issuance of stock in 2006.  For the nine months ended September 30, 2005,we paid $5.8 million of dividends and repurchased $5.0 million of treasurystock.

Ouravailable credit under our revolver at the end of September 2006 representsadditional borrowings available to us based upon receivables and inventory atSeptember 30, 2006, which is greater than the $6.3 million outstanding underthe revolver at the end of September 2006. Per the terms of the CreditFacility, we calculate our available credit at the end of each month, beginningin June 2006 under our Credit Facility (see Note 9 on page 14).  Our intent is to reduce our outstanding debtunder the revolver by $1 million over the next 12 months.   Through November  9, 2006, we have made no additionalborrowings under the revolver.

Under the Credit Facility, weare required to comply with certain financial and non-financial covenants.Among the financial covenants are requirements related to consolidated networth, a quarterly leverage ratio and a quarterly fixed charge ratio. TheCredit Facility also limits our ability to: enter into secured and unsecuredborrowing arrangements, issue dividends to stockholders (the Company waspermitted to pay a dividend in December 2005), repurchase our stock, acquireand dispose of businesses, and issue additional shares of our stock, amongother requirements, as defined in the Credit Facility. We were in compliancewith all covenants related to the Credit Facility at September 30, 2006, and asof the date of this report.

Webelieve that our current cash, cash equivalents, marketable securities,including those acquired from KIRK and cash generated from operations will besufficient, based on our presently anticipated needs, to fund necessary capitalexpenditures, to provide adequate working capital, to repay debt when it isdue, and to finance our expansion for the foreseeable future (next 12 months).There can be no assurance, however, that we will not require additionalfinancing. There can be no assurance that any additional financing will beavailable to us on acceptable terms, or at all, when required by us. Ifadditional funds were to be raised through the sale of equity securities,additional dilution to the existing stockholders would likely result.

**AggregateContractual Obligations and Commercial Commitments**

As of September 30, 2006, expected future cashpayments related to contractual obligations and commercial commitments weresignificantly impacted by the addition of KIRK (in thousands):
| Contractual Obligations    | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** | **Total** | ** ** |
|---------------------------------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------------|------------|-----------|------------|
| Debt (1)                        |       | $                               | 6,000      |               | $          | 9,050              |       | $                                | —     |      | $          | — |   | $ | 15,050 |   |
| Interest (1)                    |       | 927                             |       | 858                |       | —             |       | —                           |       | 1,785     |       |
| Operating Leases  (2)           |       | 1,119                           |       | 2,739              |       | 2,502              |       | 1,115                            |       | 7,475     |       |
| Other Purchase  Commitments (3) |       | 99                              |       | 5                  |       | —             |       | —                           |       | 104       |       |
| Total                           |       | $                               | 8,145      |               | $          | 12,652             |       | $                                | 2,502      |      | $          | 1,115 |   | $ | 24,414 |   |

 

30

----

----

(1)          Referto Note 9 to our Condensed Consolidated Financial Statements on page 14.

(2)          Welease our facilities under non-cancelable operating lease arrangements thatexpire at various dates through 2012.

(3)          Wehave purchase obligations with various vendors and suppliers for the purchaseof inventory, as well as goods and services, in the normal course of business.These obligations are generally evidenced by purchase orders with deliverydates from six to twelve months from the purchase date, and in certain cases,purchase orders that contain non-cancelable/non-returnable terms and conditionsassociated with these purchase arrangements. We are committed to acceptdelivery of such materials pursuant to such purchase orders subject to variouscontract provisions, which allow us to delay receipt of such orders. Suchorders may or may not include cancellation costs payable by us. In the past, wehave been required to take delivery of materials from our suppliers that werein excess of demand requirements, and we have previously recognized charges andexpenses related to such excess material, resulting primarily from engineeringchanges. If we are not able to adequately manage our supply chain and adjustsuch commitments for changes in demand, we may incur additional inventoryexpenses related to excess and obsolete inventory. Such expenses could have a materialadverse effect on our business, financial condition and results of operations.

We believe our existing cash balances and fundsexpected to be generated from future operations will be sufficient to satisfythese contractual obligations and commercial commitments, and that the ultimatepayments associated with these commitments will not have a material adverseeffect on our liquidity position.

**Off-BalanceSheet Arrangements**

Asapproved by the Company’s Compensation Committee, the Company entered into achange of control severance agreement (“Agreement”) with Ernest Sampiaswho became the Company’s executive vice president of finance andadministration, chief financial officer, secretary and treasurer effectiveMay 15, 2006, and members of the Company’s executive team consisting ofJohn Elms (president, chief executive officer and a director), Masood Garahi(executive vice president of engineering and chief technology officer), JohnKelley (executive vice president of operations), Jill Kenney (our former executivevice president of Americas sales, and marketing), Leah Maher (executive vicepresident and general counsel) and Gary Mead (vice president of marketdevelopment) effective April 17, 2006, all in the same form. The Companypreviously agreed to a change of control provision with Ole Lysgaard Madsen(executive vice president of international, and president and managing directorof KIRK telecom A/S) upon the Company’s acquisition of KIRK telecom A/S onJanuary 3, 2006, under different terms. According to the terms of theAgreement, in the event a change of control of the Company occurs and anexecutive’s employment is terminated or constructively terminated within twelvemonths following the change of control, the affected executive’s outstanding optionswill fully vest and the affected executive will be entitled to twelve months ofthe affected executive’s annual salary plus the affected executive’s targetbonus plan (which assumes 100% of the target bonus plan is met for the year).Additionally, in the preceding circumstance, that executive will receivebenefits until the earlier of one year following termination or the date thatexecutive receives comparable benefits from another employer. On April 10,2006, David Rosenthal resigned his position as executive vice president offinance and administration, chief financial officer, secretary and treasurer ofthe Company, thus terminating his agreement, and remained as special assistantto the chief executive officer until September 10, 2006, at his then-currentsalary. Jill Kenney’s agreement terminated effective with her resignation as anexecutive officer of the Company on August 31, 2006, and she remains as aspecial assistant to the president and chief executive officer.

31

----

**CriticalAccounting Policies and Estimates**

We have identified the most critical accountingprinciples upon which our reported financial position and results of operationsdepend. We determined the critical accounting principles by considering accountingpolicies that involve the most complex or subjective decisions or assessments.Below is a summary of our most critical accounting policies. This discussionand analysis should be read in conjunction with our condensed consolidatedfinancial statements and related notes beginning on page 3 of this reportand in conjunction with our consolidated financial statements and related notesincluded in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2005, which was filed with the Securities and ExchangeCommission on March 16, 2006.

Our discussion and analysis of our financial conditionand results of operations is based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenue and expenses, and related disclosure of contingentassets and liabilities. We evaluate our estimates, on an on-going basis,including those related to revenue recognition, receivables, product warrantyobligations, inventories and income taxes. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

We consider an accounting estimate to be critical if:

·                  It requires usto make assumptions about matters that were uncertain at the time of making theestimate, and

·                  Changes in theestimate or assumptions in the estimate could have a material impact on ourfinancial condition or results of operations.

Thefollowing table presents information about the nature and rationale for ourcritical accounting policies and estimates used in the preparation of our consolidatedfinancial statements.

32

----

 
| **Financial  Statement  Caption(s)** | ** ** | **Critical Estimate  Item**                                                                                                                                                                     | ** ** | **Nature of Estimates  Required**                                                                                                     | ** ** | **Assumptions/  Approaches Used**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** | **Key Factors**                                                |
|--------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|
| A. Sales and deferred revenue        |       | Collectibility is reasonably assured, persuasive  evidence of an arrangement exists, delivery has occurred or services rendered  and seller’s price to the buyer is fixed or determinable. |       | We are required to estimate the collectibility of  invoiced amounts based upon our assessment of the ability of the customer to  pay. |       | We determine whether collectibility is reasonably  assured based on the customer’s current financial condition and on possible  credit deterioration, the indirect and OEM channels’ ability to sell through  the products purchased and the relationship we have with our customers.   Our revenue recognition policy is based on complex and dynamic  rules established by the Securities and Exchange Commission and other  governing bodies. These rules require us to make judgments with regard  to post delivery obligations. When significant post delivery obligations  exist, revenue is deferred until such obligations are fulfilled or until we  have established sufficient history to estimate the cost of our obligation. |       | Customer ability to pay   Customer ability to sell to end-user |

 

33

----

 
| B. Accounts receivable                |   | Collectibility of invoiced amounts         |   | Estimating the collectibility of accounts receivable  requires us to make judgments about the credit quality and economic viability  of customers based on information available to us. |   | We use information available at the time of credit  issuance, such as Dunn & Bradstreet credit report, payment history,  or financial information provided by the customer.   For ongoing customers and past due balances, we have discussions with our  customers to determine if economic conditions have deteriorated, resulting in  an impairment of their ability to make payments.   We maintain a provision for estimated credit losses based upon our historical  experience and any specific customer collection issues that we have  identified. |   | Historical experience regarding payment history   Customer creditworthiness   Monitoring collections and payments from customers   Deterioration of customer’s economic condition after date of invoice   Changes in credit loss rates from historical rates used  Overall economic and industry conditions |
|---------------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                  |   |                                       |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |   |                                                                                                                                                                                                                                                                                                             |
| C. Cost of goods sold and Inventories |   | Obsolete, unmarketable or excess inventory |   | Estimating obsolete, unmarketable or excess  inventory requires us to forecast future demand and market conditions.  Changes in our product strategy can result in obsolete inventory.  |   | We base our estimate on the difference between the  cost of held inventory and the expected market value of the inventory.                                                                                                                                                                                                                                                                                                                                                                                                                                          |   | Product lifecycle   Evaluation of customer demand for various product types   Analysis of inventory on hand with no estimated future demand from customer  base                                                                                                                                                  |
|                                  |   |                                       |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |   |                                                                                                                                                                                                                                                                                                             |
| D. Deferred income taxes              |   | Recoverability of deferred tax assets      |   | We are required to estimate whether recoverability  of deferred tax assets is more likely than not based on forecasts of taxable  earnings in the related tax jurisdictions.            |   | We use historical and projected future operating  results, including a review of the eligible carry forward period, tax  planning opportunities and other relevant considerations.                                                                                                                                                                                                                                                                                                                                                                                  |   | Tax law changes   Variances in future projected profitability, including by taxing entity                                                                                                                                                                                                                        |

 

34

----

 
| E. Warranty                     |   | Warranty obligations |   | Estimating warranty liability requires us to  forecast, using historical data as a basis, future product failure rates,  material usage and service delivery costs.                                                               |   | We base our estimate on historical and current  trends of product failure rates, repair cost per unit and service delivery  costs.   We have contractual commitments to various customers that require us to incur  costs to repair an epidemic defect. Historically we have not experienced  significant costs related to epidemic failure. Costs would be accrued for an  epidemic defect when an epidemic defect is identified and the costs of repair  can be reasonably estimated. |   | Monitoring and evaluating the quality of component  suppliers   Actual historical return rates at the time of sale and updating estimates  throughout the warranty period   Monitoring our customer base for possible epidemic defects   Estimated failure rates; repair costs per unit; and service delivery costs |
|---------------------------------|--------|----------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                            |   |                 |   |                                                                                                                                                                                                                              |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                |
| F. Acquired business net assets |   | Fair values          |   | We are required to allocate the purchase price of  acquired companies to the tangible and intangible assets acquired,  liabilities assumed, as well as in-process research and development based on  their estimated fair values. |   | The valuation of the business net assets is  determined using one or more valuation methods, including excess earnings,  discounted cash flows, replacement cost, market value from published sources,  and relief-from-royalty.                                                                                                                                                                                                                                                        |   | Projected income and cash flows; comparable market  information   Weighted average cost of capital   Useful lives remaining                                                                                                                                                                                         |

 

35

----

 
| G. Stock-based Compensation Expense (allocated by  department, with some expense capitalized to ending inventory) |   | Value of Stock-based Compensation |   | Calculating the fair value of stock compensation  expense requires the input of multiple estimates, including forfeiture rate,  volatility, and expected term to exercise. |   | The fair value of each option award is estimated on  the grant date using the Black-Scholes model. Key assumptions input into the  model include:   Expected term to exercise   Forfeiture rate   Volatility   Dividend yield   Risk-free interest rate |   | We have utilized historical volatility based on  daily closing prices of our stock over periods that correlated with the  expected term of the option. We have considered implied volatility from  traded options of the company’s stock and extraordinary events that  may impact historical volatility.   The expected term of options is based on historical and expected exercise  patterns, and on the terms and conditions of the options.   We have calculated an expected forfeiture rate based upon historical data  pertinent to our company, after due consideration for historical forfeiture  experience that may not be reflective of that to be expected in the future. |
|-------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

In addition, there areother items within our financial statements that require estimation, but arenot as critical as those discussed above. Revisions to any of the discussedestimates, or other non-critical items, could have a significant effect on ourconsolidated financial statements.

**Adoptionof New Accounting Pronouncements**

The adoption of thefollowing accounting pronouncements in the nine months ended  September 30, 2006, did not have a materialimpact on our results of operations, financial condition, or cash flows:

·                  Statement ofFinancial Accounting Standards (“SFAS”) No. 151, “Inventory Costs — AnAmendment of ARB No. 43, Chapter 4”;

·                  SFAS No. 153,“Exchanges of Nonmonetary Assets”;

·                  SFAS No. 154,“Accounting Changes and Error Corrections, which replaces APB Opinion 20,“Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in InterimFinancial Statements — An Amendment of APB Opinion No. 28”;

·                  Emerging IssuesTask Force (“EITF”) Issue 05-06, “Determining the Amortization Period forLeasehold Improvements”; and

·                  FASB StaffPositions 115-1 and 124-1, “The Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments.”

 

36

----

***Stock-BasedCompensation***

 

In December 2004,the FASB issued Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R requiresmeasurement of all employee stock-based compensation awards using a fair-valuemethod and the recording of such expense in the consolidated financialstatements.  In addition, the adoption ofSFAS 123R requires additional accounting related to the income tax effects anddisclosure regarding the cash flow effects resulting from share-based paymentarrangements. In March 2005, the SEC issued Staff Accounting BulletinNo. 107, which provides supplemental implementation guidance for theimplementation of SFAS 123R. On January 1, 2006 (the first day of our 2006fiscal year), we adopted SFAS 123R using the modified prospective method aspermitted under SFAS 123R.  Under this transition method, compensationcost recognized in the first half of 2006 includes: (a) compensation cost forall share-based payments granted prior to but not yet vested as of December 31,2005, based on the grant-date fair value estimated in accordance with theprovisions of SFAS 123, and (b) compensation cost for all share-based paymentsgranted subsequent to December 31, 2005, based on the grant-date fair value estimatedin accordance with the provisions of SFAS 123R.  In accordance with themodified prospective method of adoption, our results of operations andfinancial position for prior periods have not been restated.

We used the gradedattribution method to recognize expense for all options granted prior to theadoption of SFAS 123R.  Upon adoption of SFAS 123R on January 1, 2006, weadopted the straight-line attribution method to recognize expense for optionsgranted after December 31, 2005.  The expense associated with the unvestedportion of the pre-adoption grants will continue to be expensed using thegraded attribution method.

The amount of stock-basedcompensation recognized during a period is based on the value of the portion ofthe awards that are ultimately expected to vest. SFAS 123R requires forfeituresto be estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates.  The term “forfeitures”is distinct from “cancellations” or “expirations” and represents only theunvested portion of the surrendered option. Based on an analysis of historicalforfeitures, we have applied an annual forfeiture rate of 9% to all unvestedoptions as of September 30, 2006.  This analysis will be re-evaluatedquarterly and the forfeiture rate will be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will only befor those shares that vest. Forfeited or otherwise cancelled options arereturned to the pool of options authorized for issuance under our stock-basedcompensation plans. It is our policy to issue new shares, as opposed totreasury shares upon exercise or purchase under our stock-based compensationplans.

See Note13 to the accompanying condensed consolidated financial statements onpage 17.

**RecentlyIssued Accounting Pronouncements**

***FASB Interpretation No. 48 (FIN48), “Accounting for Uncertainty in Income Taxes — An Interpretation of FASBStatement No. 109”***

FIN 48 was issued in July 2006.  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, “Accounting for Income Taxes.”  FIN 48 also prescribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position taken or expected to be taken in a taxreturn.  The new standard also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. The provisions of FIN 48 are effective for fiscal years beginning afterDecember 15, 2006.  The provisions of FIN48 are to be applied to all tax positions upon initial adoption of thisstandard.  Only income tax positions thatmeet the more-likely-than-not recognition threshold at the effective date maybe recognized or continue to be recognized upon adoption of FIN 48.  The cumulative effect of applying theprovisions of FIN 48 would be reported as an adjustment to the opening balanceof retained earnings for that fiscal year. We have not yet quantified the effect of adoption of FIN 48, which weexpect to do after our year ending December 31, 2006.

***Statement of Financial AccountingStandards No. 155 (SFAS 155), “Accounting for Certain Hybrid FinancialInstruments, an Amendment of FASB Statements No. 133 and 140”***

SFAS 155 was issued in February 2006 and will beeffective for us after our year ending December 31, 2006. Among otherthings, SFAS 155 permits fair value remeasurement for any hybrid financialinstrument that contains an embedded derivative that otherwise would requirebifurcation. We do not believe that the adoption of SFAS 155 will have amaterial impact on our financial statements.

***Statement of Financial AccountingStandards No. 156 (SFAS 156), “Accounting for Servicing of Financial Assets, anamendment to SFAS No. 140”***

SFAS 156 was issued in March 2006 and will beeffective for us after our year ending December 31, 2006. SFAS 156simplifies certain aspects of accounting for separately recognized servicingassets and liabilities and clarifies when to

37

----

separately recognize servicing obligations. We do notbelieve that the adoption of SFAS 156 will have an impact on our financialstatements.

***SFAS No. 157 (SFAS 157), “FairValue Measurements”***

SFAS 157 was issued in September 2006 and will be effective for usafter our year ending December 31, 2006. SFAS 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles, and expands disclosures aboutfair value measurements.  SFAS 157applies under other accounting pronouncements that require or permit fair valuemeasurements.  We will adopt SFAS 157 ona prospective basis in our fiscal 2008, and depending upon the context, believethat SFAS 157 could materially impact the way we perform valuations in thefuture.

***SEC Staff Accounting Bulletin No. 108 (SAB 108), “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements”***

SAB 108 was issued in September 2006 and provides SEC Staff guidance onthe consideration of the effects of prior year misstatements in determiningwhether or not current year financial statements are materially misstated.  In practice, unadjusted errors in priorperiod financial statements are evaluated for their impact on the currentperiod financial statements.   Twomethods are commonly used to determine material misstatements caused byunadjusted errors:  (a) the “rollover”method, which determines the impact of current year misstatements and “rolls”immaterial errors onto the balance sheet indefinitely; and (b) the “ironcurtain” method, which records cumulatively material misstatements to thebalance sheet due to unadjusted errors as adjustments to the current periodincome statement.   As either method canresult in a material misstatement to the current period financials, the SECStaff expects that the impact of applying both methods should be evaluated formateriality to the current period financial statements.    We donot believe that our financial statements will be significantly impacted byapplying the guidance of SAB 108.

***FASB Staff Position, No. AUGAIR-1, (FSP AUG AIR-1), “Accounting for Planned Major Maintenance Activities”***

FSP AUG AIR-1 was issued in September 2006 and will beeffective for us after our year ending December 31, 2006.  FSP AUG AIR-1 prohibits companies from usingan “accrue-in-advance” method for recognizing planned major maintenance onplant and equipment.    We do not believethat FSP AUG AIR-1 will have a significant impact on our Company, as we do notpractice this method of recognizing maintenance expense.

**Item 3.Quantitative and Qualitative Disclosures about Market Risk**

Market risk represents the risk of loss thatmay impact our financial position, results of operations or cash flows dueto adverse changes in financial and commodity market prices and rates. Weare primarily exposed to market risk due to changes in interest rates andforeign currency fluctuations. These exposures are directly related to ournormal operating and funding activities.

***Currency Risk***

Asof December 31, 2005, we entered into foreigncurrency forward contracts to reduce the foreign currency exposure related toour anticipated acquisition of KIRK. Under the terms of the stock purchaseagreement, the purchase price was to be payable in Danish Kroner at theclosing. The forward contracts were not designated as accounting hedges and thecarrying amount of the forward contracts was the fair value, which was determinedby obtaining quoted market prices, and recognized as either assets orliabilities. In the nine months ended September 30, 2006, we recognized a netrealized gain of $0.2 million that was included in other income (expense) inthe consolidated statements of operations, which was offset by the relatedunrealized losses recorded as of December 31, 2005, from the changes inthe fair value of these forward contracts of $0.2 million.

KIRK enters into foreigncurrency contracts from time-to-time to reduce its exposure to foreigncurrency-denominated inventory purchases. For the nine months ended September30, 2006, gains from KIRK’s foreign currency contracts were insignificant.  Changes in fair value of forward contractsare recognized in other income (loss), net at the end of each period.

We have not entered intoany derivatives that qualify for hedge accounting treatment under SFAS 133.

***InterestRate Risk***

Our  primary interest rate risk is related to ourborrowings under our Credit Facility.  Asof September 30, 2006, we had $15.0 million outstanding under the CreditFacility, which consisted of a term loan and a revolving line of credit. We canborrow at the JP Morgan prime rate plus 1% or at the LIBO rate plus 2%.   We have elected to borrow at the LIBO rateplus

38

----

2% or 7.4% as of September 30, 2006.   Based upon borrowings outstanding at the endof September 2006, an increase in variable interest rates of 100 basispoints would have an effect on the our annual results of operations and cashflows of approximately $0.2 million.

**Item 4.Controls and Procedures**

**Evaluation of Disclosure Controls and Procedures.**Regulationsunder the Securities Exchange Act of 1934 require public companies to maintain “disclosurecontrols and procedures,” which, as applied to us, means our controls and otherprocedures that are designed to ensure that information required to bedisclosed by us in the reports that we file or submit under the SecuritiesExchange Act of 1934 is recorded, processed, summarized and reported, withinthe time periods specified in the Securities and Exchange Commission’srules and forms and that such information is accumulated and communicatedto our management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow timely decisions regarding requireddisclosure. Our Chief Executive Officer and Chief Financial Officer, with theassistance from other members of management, have reviewed the effectiveness ofour disclosure controls and procedures as of September 30, 2006, and based ontheir evaluation, have concluded that our disclosure controls and procedureswere effective as of such date.

**Changes in Internal Controls over FinancialReporting.**Regulations under the Securities Exchange Act of1934 require public companies to evaluate any change in “internal control overfinancial reporting,” which is defined as a process to provide reasonableassurance regarding the reliability of financial reporting and preparation offinancial statements for external purposes in accordance with accountingprinciples generally accepted in the United States. In connection with theirevaluation of our disclosure controls and procedures as of  September 30, 2006, our Chief ExecutiveOfficer and Chief Financial Officer identified no changes in our internalcontrol over financial reporting during the three-month period ended September30, 2006, that affected, or are reasonably likely to affect, our internalcontrol over financial reporting.

**Part II  Other Information**

**Item 1.A  Risk Factors**

*The factors discussed below are cautionary statements that identifyimportant factors that could cause actual results to differ materially fromthose anticipated by the forward-looking statements contained in this report.For more information regarding the forward-looking statements contained in thisreport, see the introductory paragraph to Part I of this report. Youshould carefully consider the risks and uncertainties described below togetherwith all of the other information included in this report, in considering ourbusiness and prospects. The risks and uncertainties described below are not theonly ones that we face. Additional risks and uncertainties not presently knownto us also may impair our business operations. The occurrence of any ofthe following risks could affect our business, financial condition or resultsof operations.*

·                                          **We are subject to numerous risks associated with our recent acquisitionof KIRK.**On January 3, 2006, we acquired KIRK, a provider ofonsite, wireless communications products, based in Denmark. As a result of theacquisition, KIRK became a wholly owned subsidiary of SpectraLink through itsholding company SpectraLink Denmark ApS. Mergers and acquisitions oftelecommunications companies are inherently risky, and no assurance can be giventhat our acquisition of KIRK or any other future acquisitions will besuccessful and will not materially adversely affect our business, operatingresults, or financial condition. Failure to manage and successfully integrateKIRK and other acquired companies could also materially harm our business andoperating results.

Difficulties in integrating the operations,technologies, products, and personnel of KIRK or any other acquired companycould lead to the following:

·                  Diversion ofmanagement’s attention from normal daily operations of the business;

·                  Potentialdifficulties in completing projects associated with research and developmentdue to uncertainty of combined product roadmap plans;

·                  Insufficientrevenue to offset increased acquisition expenses;

·                  Recordinggoodwill and non-amortizable intangible assets that will be subject toimpairment testing on a regular basis and potential  impairment charges;

·                  Experience anincrease in the complexity of accounting issues and reporting requirementsrelated to previously inapplicable accounting pronouncements, such asaccounting polices related to foreign currency transactions;

·                  Difficulties inmanaging and integrating internal financial control systems;

·                  Risks associatedwith a privately held foreign company becoming part of a U.S. publiccompany;

·                  Complexitiesassociated with managing internal control systems in foreign subsidiaries; and

·                  Incurringadditional financial costs and personnel resources which may be requiredto timely comply

39

----

on a consolidatedbasis with Section 404, “Management’s Internal Controls and Procedures forFinancial Reporting” of the Sarbanes-Oxley Act of 2002;

·                  Be subject tothe impacts of currency fluctuations;

·                  Incurringamortization expenses related to certain intangible assets;

·                  Incur large andimmediate write-offs and restructuring and other related expenses; and

Risks related to newproduct development also apply to acquisitions. Please see the risk factorbelow entitled “If we are unable to develop and introduce new products andtransition existing products and respond to emerging technological trends and customers’ changing needs, our operating resultsand market share may suffer” for additional information.

·                  **Our foreign operations aresubject to economic, political and other risks that could adversely affect ourrevenue or financial position.**Our business operations in Denmark,the United Kingdom, Australia and any other possible foreign operations in thefuture, could result in adverse financial consequences and operational problemsnot experienced in the United States. We anticipate that our revenue from ourinternational operations may grow in the future. Accordingly, our businessis subject to risks associated with doing business internationally, including:

·                  changes in aspecific country’s or region’s political or economic conditions;

·                  laws andregulations that restrict repatriation of earnings or other funds; and

·                  difficulty inrecruiting trained personnel; and language and cultural differences.

In addition, we face risks associated with changes inforeign currency exchange rates. Due to the acquisition of KIRK, we willincrease our exposure to foreign currency exchange rates and the risksassociated therein. We have limited forward currency contracts but we have nothistorically engaged in any hedging activities relating to our non-U.S. Dollaroperations, and we may suffer future losses as a result of changes incurrency exchange rates.

·                  **Substantial leverage anddebt service obligations may adversely affect us.**Inanticipation of the KIRK acquisition, we took on a substantial amount ofindebtedness. As of September 30, 2006, we had approximately $15 million ofdebt outstanding under our Credit Facility. Our substantial level ofindebtedness increases the possibility that we may be unable to generatecash sufficient to pay when due the principal of, interest on, or other amountsdue with respect to our indebtedness. All of our outstanding indebtedness bearsinterest at floating rates. As a result, our interest payment obligations onsuch indebtedness will increase if interest rates increase. Subject to certainrestrictions under our existing indebtedness, we may also obtain additionallong-term debt and working capital lines of credit to meet future financingneeds. This would have the effect of increasing our total leverage.

Oursubstantial leverage could have significant negative consequences on ourfinancial condition and results of operations, including:

·                  impairingour ability to meet one or more of the financial ratios contained in our creditfacility agreement or to generate cash sufficient to pay interest or principal,which events could result in an acceleration of all or some of our outstandingdebt as a result of cross-default provisions;

·                  increasingour vulnerability to general adverse economic and industry conditions;

·                  requiringus to sell debt or equity securities or to sell some of our core assets,possibly on unfavorable terms, to meet payment obligations;

·                  limitingour ability to obtain additional debt or equity financing;

·                  requiringthe dedication of a substantial portion of our cash flow from operations toservice our debt, thereby reducing the amount of our cash flow available forother purposes, including capital expenditures;

·                  limitingour flexibility in planning for, or reacting to, changes in our business andthe industries in which we compete;

·                  placingus at a possible competitive disadvantage with less leveraged competitors andcompetitors that may have better access to capital resources; and

·                  causingour Danish holding company, SpectraLink Denmark ApS, to trigger thincapitalization tax consequences in Denmark due to the substantial intercompanydebt held on its books, as compared to its equity at the end of our fiscalyear.

·                  **Restrictive covenants inthe Credit Facility could adversely affect our business by limitingflexibility. **The CreditFacility contains restrictive covenants and requirements that we comply withcertain leverage and other financial tests. These limit our ability to takevarious actions, including incurring additional debt, guaranteeingindebtedness, issuing preferred stock, engaging in various types oftransactions, including mergers and sales of assets, and paying dividends,repurchasing our stock, and making distributions or other restricted payments,including investments. These covenants could have an adverse effect on ourbusiness by limiting our ability to take advantage of financing third-party productdevelopment, merger and acquisition or other opportunities.

·                  **Our ability to generate continued market growth rates may requireus to participate in industry consolidation**. As part of ourbusiness strategy and the business environment in the telecommunicationsequipment industry in general, we

40

----

may engage in further acquisitions or mergerswith other companies, or individual product lines, technologies and/orpersonnel or become the target for a merger or acquisition. Our ability to takesuch actions may be constrained by the convenants in our Credit Facility.Further, to remain competitive, we may need to partner with a largertelecommunications company to obtain access to dual-mode markets.

·                  **If we are unable to fulfill quarter end customer orders, then we couldlose revenue and customers.**The volume of customer orders for ourproducts typically increases significantly at the end of each quarter. KIRKalso has experienced uneven distribution of sales in any month, particularly inApril. We face significant challenges in meeting this demand. It is difficultto ensure that we have the resources available to meet any such increase inorder volume since it is very difficult to predict what the level of demandwill be. We may not have the personnel and/or systems necessary to fulfillthe large order volume or the ability to upgrade and develop our systems andinfrastructure to meet an increased order volume. If we are unable to meetdemand from our customers for our products in a cost effective manner, then wemight lose revenue and customers, or incur increased operating costs, either ofwhich would harm our business.

·                  **Many of the orders for our products are realized at the end of thequarter, which makes it difficult to forecast or adjust our operatingactivities quickly in response to an unexpected increase or decrease incustomer demand.**Due to the timing of orders from customers, we haveoften recognized a substantial portion of our revenue in the last month of aquarter. As a result, minor fluctuations in the timing of orders and theshipment of products may, in the future, cause operating results to varysignificantly from quarter to quarter. The demand for our products depends uponmany factors and is difficult to forecast. Further, our acquisition of KIRKmay make it more difficult for us to predict the demand in the mix for ourproducts. Significant unanticipated fluctuations in demand could cause problemsin our operations. The lead-time required to assemble our systems is oftenlonger than the lead-time our customers provide to us for delivery of theirproduct requirements. Therefore, we often must place orders in advance ofexpected purchase orders from our customers. As a result, we have only alimited ability to react to fluctuations in demand for our products, whichcould cause us to have either too much or too little inventory of a particularproduct. Further, the business relationship which we have with Offshore Groupto use a Mexico facility to assemble our products may not be able toprovide product in a timely manner. The majority of the KIRK products aremanufactured in Horsens, Denmark, and the manufacturing lines for SpectraLinkproduct are located in Boulder, Colorado. Additionally, once we receive anorder, it requires sufficient time to complete the configuration of our productto our customer’s individual phone systems.

Our inability to satisfy customer demand in a timelymanner would lead to lost sales and impede our ability to increase our revenue.Conversely, a large portion of our expenses, including rent and salaries, isfixed and difficult to reduce. Our expenses are based in part onexpectations for our revenue. If our revenue does not meet our expectations,the adverse effect of the revenue shortfall upon our operating resultsmay be acute in light of the fixed nature of our expenses.

·                  **Our revenue and earnings are seasonal.**Seasonality and otherfactors may cause significant quarterly fluctuations in our revenue andnet income*.*Our business is seasonal based onbudget cycles in various vertical markets such as healthcare and retail. Thiscauses significant quarterly fluctuations in our financial results. Generally,revenue and operating results are sequentially down in the first quarter fromthe fourth quarter, sequentially higher in the second quarter, sequentiallyflat or slightly higher or lower in the third quarter, and strongest in thefourth quarter. Actual results from operations may or may not followthese normal seasonal patterns in a given year leading to performance that isnot in alignment with expectations.

·                  **Our reliance on sole or limited sources of supply for many componentsand equipment used in our manufacturing process.** We rely on sole orlimited sources of supply for many components and equipment used in ourmanufacturing process. The delay, inability, or refusal of any of thesesuppliers to ship these components or equipment could interrupt ourmanufacturing process and ability to manufacture products in a timely manner tomeet customer demand. The limited number of sources for many of thesecomponents may also prevent us from decreasing our reliance on certainsuppliers and finding other sources at competitive prices. Unforeseen priceincreases by any of the sole or limited source suppliers could negativelyimpact product margins and our financial performance

·                  **Because many of our current and planned products are or will be highlycomplex, they may contain defects or errors that are detectable only afterdeployment in complex networks and which, if detected, could have a negativeeffect on our business, operating results or financial condition.**Many of our complex products can only be fully tested when deployed in “live”existing wireless networks. As a result, end-users may only discoverdefects or errors or experience breakdowns in their networks after the productshave been deployed. If any of these products contain defects, or havereliability, quality or compatibility problems, our reputation might be damagedsignificantly and customers might be reluctant to buy our products. Thesedefects could interrupt or delay sales. We may have to invest significantcapital and other resources to correct these problems. If we fail to providesolutions to the problems, we will also incur product recall, repair, warrantyor replacement costs. These problems might also result in claims against us byour customer or others. In addition, the occurrence of any defects or errors inthese products could result in: failure to achieve market acceptance and lossof

41

----

market share; cancellation of orders; difficulty incollecting accounts receivable; increased service and warranty costs in excessof our estimates; diversion of resources, and; increased insurance costs andother losses to our business or to end-users.

·                  **If we experience product failure that indicates either manufacturing ordesign deficiencies, we may be required to recall units in the fieldand/or stop producing and shipping such products until the deficiency isidentified and corrected.**In the event of such product failures, ourbusiness could be adversely affected resulting in reduced revenue, increasedcosts and decreased customer satisfaction. End-users have discovered errors inour products in the past and may discover errors in our products in thefuture. In addition, if our costs of remediation problems experienced by ourcustomers exceed the expectations used in developing our warranty reserves,these costs may adversely affect our operating results. Consequently, ourproduct failure could have a material adverse impact on our operations andfinancial results.

·                  **Our ability to attract and retain personnel, including key technicaland management personnel.** Much of the future success of our companydepends on the continued service and availability of skilled personnel,including technical, marketing and staff positions. Experienced personnel inthe wireless communications industry are in high demand and competition fortheir talents is intense. For example, we have appointed two chief financialofficers within two years. There can be no assurance that we will be able tosuccessfully retain and attract the key personnel we need. Many of our keypersonnel receive a total compensation package that includes stock options. Inorder to comply with changes to accounting principles generally accepted in theUnited States enacted by the Financial Accounting Standards Board and otheragencies starting in the first quarter of 2006, we recorded a charge toearnings for employee stock option grants, employee stock purchase plans andother equity incentives. In addition, applicable stock exchange listingstandards relating to obtaining stockholder approval of equity compensationplans could make it more difficult or expensive to grant options to employeesin the future. To the extent that new regulations make it more difficult orexpensive to grant options to employees, we may incur higher compensationcosts, change our equity compensation strategy or find it difficult to attract,retain and motivate employees, any of which could have a material and adverseimpact on our business.

·                  **The risk of business interruption arising from our dependence on ourmanufacturing facilities located in Boulder, Colorado, and Horsens, Denmark,and the business relationship we have with Offshore Group to use a facility inEmpalme, Sonora, Mexico which provides assembly services.**We arehighly dependent on our Boulder, Colorado, and Horsens, Denmark, manufacturingfacilities, which is where the majority of our manufacturing and repairoperations occur. We are also highly dependent upon our business relationshipwith Offshore Group to provide management services and an assembly facilitylocated in Empalme, Sonora, Mexico. Any event that may disrupt orindefinitely discontinue any of the facilities’ capacity to manufacture,assemble and repair our products could greatly impair our ability to generaterevenue, fulfill orders and attain financial goals. For instance, wemay experience delays in the receipt of assembled product from thefacility in Mexico should the border between the U.S. and Mexico close.

·                  **Our ability to respond to rapid technological changes within theon-premises wireless telephone industry.** The wireless communicationsindustry is characterized by rapid technological change, short product lifecycles, and evolving industry standards. To remain competitive, we must:

·                  develop or gain access to newtechnologies in order to increase product performance and function, reduceproduct size, and maintain cost effectiveness;

·                  develop new products for existing andemerging wireless communications markets, and introduce such products in atimely manner;

·                  implement emerging wireless standardsor multiple emerging wireless standards quickly enough to satisfy marketdemands and without significant product redesign or the need to allocateadditional resources to comply with multiple standards;

·                  develop or obtain access to advancedwireless capabilities as they become available; and

·                  design,develop and introduce competitive new products on a timely basis.

Wemay not successfully execute on our vision of product requirements becauseof errors in defining product marketing requirements, planning or timing,technical hurdles that we fail to overcome in a timely fashion, or a lack ofappropriate resources. Due to the competitive nature of our business, anyfailure by us to meet any of these challenges could render our products ortechnologies obsolete or noncompetitive and thereby materially and adverselyaffect our business, reputation, and operating results.

·                  **Potential fluctuations in our future revenue, gross margins andoperating results.**We have experienced, and may in the futurecontinue to experience, significant quarterly fluctuations in revenue, grossmargins and operating results due to numerous factors, some of which areoutside our control. Among other things, these factors include:

·                  changesin customer, geographic or product mix, including mix of configurations withineach product group;

42

----

·                  fluctuating market demand for, anddeclines in the average selling prices of, our products;

·                  the timing of, and/or delay of,significant orders from customers;

·                  seasonality in demand within ourvarious sectors;

·                  increases in material or labor costs;

·                  excess inventory;

·                  obsolescence charges;

·                  changes in shipment volume;

·                  foreign currency fluctuations;

·                  loss of cost savings due to changesin component pricing or charges incurred due to inventory holding periods ifparts ordering does not correctly anticipate product demand;

·                  increases in price competition;

·                  changes in the mix of ourdistribution channels including our OEM partners;

·                  government regulation of frequencyspectrum;

·                  increases in warranty costs; and

·                  introductionof new products and costs of entering new markets.

Forexample, historically we have not operated with a significant order backlog,and a substantial portion of our revenue in any quarter has been derived fromorders booked and shipped in that quarter. Accordingly, our revenueexpectations are based almost entirely on our internal estimates of futuredemand and not on firm customer orders. Further, our acquisition of KIRKmay make it more difficult for us to predict demand for our products.Planned expense levels are relatively fixed in the short-term and are based inlarge part on these estimates, and if orders and revenue do not meetexpectations, our revenue, gross margins and operating results could bematerially adversely affected.

·                  **The uncertainty about economic prospects in some sectors of our targetcustomer market adversely impacts their information technology spending and ourbusiness.**Our business has from time to time been adversely impactedby the uncertainty about general economic prospects in some sectors of ourtarget customer market within the United States and worldwide, because thisuncertainty has resulted in a decline in, or a failure to increase, theirinformation technology spending. Consumers of information technology in some ofthese sectors may defer, and in some cases cancel, their purchasedecisions. Our operating results may be adversely affected as a result.The adverse impacts from economic uncertainty include longer sales cycles,lower average selling prices, fewer large orders from a single customer andreduced revenue.

·                  **Changes in rules and regulations of the FCC and other regulatoryagencies.** The wireless communications industry, regulated by theFederal Communications Commission (FCC) in the United States and similargovernment agencies in other countries, is subject to changing political,economic, and regulatory influences. Regulatory changes, including changes inthe allocation of available frequency spectrum, or changing free un-licensed tofree based spectrum licensing could significantly impact our operations in theUnited States and internationally.

·                  **We are dependent on indirect sales channels for most of our revenue.**Asignificant portion of our revenue is derived from a variety of third-partybusiness partners, including OEMs, distributors and resellers. During the threemonths ended September 30, 2006, sales of our products through our indirectdistributors accounted for 49% of our product revenue and 35% of productrevenue was contributed by our OEM partners. Our contracts with third party business partners do not require thosepartners to purchase minimum quantities of our products or services. In fact,some of our third party business partners also offer the products of some ofour competitors. In addition, our OEM agreements do not restrict an OEMfrom acquiring products from a third party or independently developing productsand services that would directly compete with us. We cannot guarantee that any of our third party business partners willcontinue to market our products or devote significant resources to doing so.Furthermore, we will, from time to time, terminate or adjust some of ourrelationships with third party business partners in order to address changingmarket conditions, adapt such relationships to our business strategy, resolvedisputes, or for other reasons. Any such termination or adjustment could have anegative impact on our relationships with third party business partners and ourbusiness, and result in decreased sales through third party business partnersor threatened or actual litigation. If our third party business partners do notsuccessfully market and sell our products or services for these or any otherreasons, our sales could be adversely affected and our revenue could decline. Inaddition, our third-party business partners have confidential informationconcerning our products and services, product release schedules and sales,marketing and third-party reseller operations. Although we have nondisclosureagreements with our third-party business partners, we cannot guarantee that anythird-party business partner would not use our confidential information tocompete with us. Furthermore, since we have experienced lower gross marginsrelated to sales to our OEM partners, we may experience lower grossmargins in the future if sales to our OEM partners become a larger percentageof product sales. Our success depends in part upon our ability to maintainand expand these relationships. The loss of any major partner, the failure toattract new partners or inability to maintain the current level of revenue fromour existing partners could have an adverse effect on our business, operatingresults and financial condition.

43

----

·                  **A lower than anticipated rate of acceptance of domestic andinternational markets using the 802.11 standard may impede our growth.**Our NetLink wireless telephones are compatible with the IEEE 802.11 standardfor use on 802.11 compliant wireless LAN networks. Consequently, demand forNetLink wireless telephones depends upon the acceptance of markets utilizing802.11 compliant networks. This depends in part upon the initial adoptionof the 802.11 standard in international markets, as well as enhancements tothat standard in the U.S. and foreign markets where the standard has alreadybeen adopted. Additionally, the acceptance of 802.11 compliant networksmay move more slowly, if at all, if competing wireless networks areestablished and utilized. Additionally, the deployment of wireless voice anddata systems has been inhibited by security concerns including the potential ofunauthorized access to data and communications transmitted over or accessiblethrough a wireless system. Potential customers may choose not to purchaseour products until wireless systems are developed which provide for greatersecurity. Further, our products may not be compatible with secure wirelesssystems that may be developed in the future. If markets utilizing 802.11 compliant networks do not grow as we anticipate, our growth would beimpeded and we would not be able to factor the related revenue into our growthin the future. If the 802.11 standard does not emerge as the dominantwireless standard in our markets, or multiple standards are adopted thatrequire different technologies we may need to spend time and resources toadd functionality to meet the additional standards and many of our strategicinitiatives and investments may be of no or limited value. Further, to the extent that additional standards areadopted, our product differentiation could be minimized and our implementationmay not be interoperable with the standard, necessitating additionalproduct development to meet the standard which may cause product delays.

·                  **The market for KIRK DECT or SpectraLink proprietary technologymay decline.**If the market adoption of  802.11 standards are faster than anticipated,it may affect sales of KIRK DECT technology and Link wts. Sales of ourLink product have generally been flat in recent years. KIRK DECT solutionscould face the same competition and cause a downward trend in our sales growthand our overall gross margin.

·                  **The market for on-premises wireless telephone systems may fail togrow or to grow as quickly as we anticipate.** We derive our revenueprincipally from the sale of wireless, on-premises telephone systems andrelated installation and other services relating to those systems. Therefore,our future operating results depend on the demand for those types of services.If this market does not grow or grow quickly, our future results of operationswould be significantly harmed. In particular, increased demand for our NetLinkproduct depends on the growth of the voice over Wi-Fi-related market. AlthoughNetLink sales have grown significantly in recent periods, the market fordeployment of converged voice and data wireless networks in the generalenterprise continues to be immature. We expect that this will remain the caseunless that market moves through its acceptance of IP wireless applications,standards adoption increases to reduce complexity, and customers deploywireless IP access points more fully throughout their enterprise networks indensities required to support wireless voice traffic.

·                  **Our revenue may fluctuate because we rely on a limited number ofsignificant customers.** A portion of our revenue in the past has beenderived from a limited number of customers. We also have experiencedquarter-to-quarter variability in sales to each of our major customers andexpect this pattern to continue in the future.

·                  **We might not be able to execute on our business planif we lose key management or technical****personnel,on whose knowledge, leadership and technical expertise we rely, or if newmembers of our management team fail to work effectively together.**Oursuccess depends heavily upon the contributions of our key management andtechnical personnel, whose knowledge, leadership and technical expertise wouldbe difficult to replace. Many of these individuals have been with us forseveral years and have developed specialized knowledge and skills relating toour technology and business. Others have been promoted within, or have joined,senior management roles recently. For example, effective May 31, 2005,Gary Bliss, our executive vice president of Engineering, retired from hisposition. In October 2005, Masood Gahari was hired as our executive vice presidentof Engineering and chief technology officer. Also, effective April 10,2006, David Rosenthal, our executive vice president of Finance andAdministration, chief financial officer, corporate secretary and treasurerresigned from his position. On May 15, 2006, Ernest J. Sampias was hiredas our executive vice president of Finance and Administration, chief financial officer,corporate secretary and treasurer. On August 31, 2006, Jill Kenney, executive vicepresident of Americas Sales, and Marketing, resigned her position as anexecutive officer of the company.  Apermanent replacement has not been hired as of November 9, 2006.    In addition, during the last two years,four of the six executive officers were either new to the Company or werepromoted. Our success depends in part upon the ability of new executivesto work effectively together and with the rest of our employees to continue todevelop our technology and manage the operation and growth of our business.Excepting Ole Lysgaard Madsen, president and managing director of KIRK inDenmark, we have no employment contracts for our executive officers, and do notmaintain key person insurance on any of our executive officers. We might not beable to execute on our business plan if we were to lose the services of any ofour key personnel. If any of these individuals were to leave us unexpectedly,we could face substantial difficulty in hiring qualified successors, and couldexperience a loss in productivity while any such successor develops thenecessary training and experience.

44

----

·                  **We rely on our 802.11 technology partners to continue to provide thewireless local area network for our NetLink product, and to provide accesspoints which support SpectraLink’s Voice Priority (SVP) Technology.**Inthe absence of a wireless voice prioritization standard to ensure quality ofservice, we rely on 802.11 technology partners, such as Symbol Technologies,Cisco Systems, Trapeze Networks Inc., 3 Com, Alcatel, Nortel and Aruba WirelessNetworks to continue to provide wireless local area network support for ourNetLink product, and to provide access points that support SVP capability. Ifany of our technology partners fail to provide voice prioritization support forour products, the market opportunity for NetLink products would be reduced andour future results of operations would be materially harmed until we find new802.11 technology partners or voice prioritization standards are adopted.

·                  **If we are unable to develop and introduce new products and transitionexisting products and respond to emerging technological trends and customers’ changing needs, our operating resultsand market share may suffer.**The process of developing newtechnology is complex and uncertain, and if we fail to accurately predictcustomers’ changing needs and emerging technological trends, our business couldbe harmed. We must commit significant resources to developing new productsbefore knowing whether our investments will result in products the market willaccept. We may encounter delays in deploying new or improved products. Forinstance, our new products may not properly function with our customers’existing telephone systems, or our new products may contain defects orbugs. These incompatibilities, defects or bugs may not be detected untilour customers begin to install the products or thereafter. We may need tomodify the design of our new or improved products if they haveincompatibilities, defects or bugs, which could result in significantexpenditures as we seek to remedy the problems, delays in the purchase of theproducts or cancelled orders. We may also encounter delays in themanufacturing and production of the new products. Additionally, the new productsmay not be commercially successful. Demand for existing productsmay decrease upon the announcement of new or improved products. Further,since products under development are often announced before introduction, theseannouncements may cause customers to delay purchases of any products, evenif newly introduced, until the new or improved versions of those products areavailable. If customer orders decrease or are delayed during the producttransition, we may experience a decline in revenue and have excess inventoryon hand which could decrease gross profit margins. Our gross margins mightdecrease if customers, who may otherwise choose to purchase existingproducts, instead choose to purchase lower priced models of new products.Delays or deficiencies in the development, manufacturing, and delivery of, ordemand for, new or improved products could have a negative effect on ourbusiness, operating results or financial condition.

·                  **If we are unable to cross-sell the SpectraLink and KIRK products toeach other’s channels, we may not realize the value expected from theacquisition.**We acquiredKIRK to extend market presence in workplace wireless telephony by addinganother technology standard offering and provide a platform forinternational growth. If we do not successfully add each other’s products toour product offerings, we will not add incremental growth nor realize theeffects of leveraging KIRK’s distribution channels, causing less than expectedrevenue growth.

·                  **Our ability to manage potential expansion of operations in the U.S. andinternationally.**We intend to expand our existing domestic andinternational operations, and to enter new markets. This expansion will requiresignificant management attention and financial resources. We currently havelimited experience in marketing and distributing our products internationallyand in developing versions of products that comply with local standards. Wemay also not be able to maintain or increase international market demandfor our products. International operations are subject to other inherent risks,including foreign government regulation of technology or unexpected changes inregulatory and customs requirements, difficulty and delays in accountsreceivable collection, difficulties and costs of staffing and managing foreignoperations, reduced protection for intellectual property rights, foreigncurrency exchange rate fluctuations, and taxation consequences.

45

----

·                  **We face increasing competition in the on-premises wireless telephonesystem market.**The on-premises wireless telephone system industry iscompetitive and influenced by the introduction of new products and new entrantsinto the industry. The competitive factors affecting the market for our systemsinclude product functions and features, frequency band of operation,ease-of-use, quality of support, product quality and performance, price,network and application integration capabilities, distribution channels, andthe effectiveness of marketing and sales efforts. Most of our competitors havesignificantly greater financial, technical, research and development, andmarketing resources than us. As a result, our competitors may respond morequickly to new or emerging technologies and changes in customer requirements, ormay devote greater resources to the development, promotion, sale andsupport of their products than us. In addition, mature DECT standard-basedproducts previously marketed by large telecom companies in markets outside theU.S. are being introduced in the U.S. which is our largest market andmay be lower-priced than the Link and NetLink offerings. Enterpriseadoption of standards for wireless LAN and VoIP may lead to thecommoditization of wireless telephone technology and the availability oflow-cost alternative products. Other purchasers may prefer to buy their802.11 wireless telephone systems from a single source provider of wirelesslocal area networks, or LANs, such as Cisco Systems, who provides 802.11wireless infrastructure and wireless telephones. Because we focus on wirelesson-premises telephone communications, we cannot serve as the sole source for acomplete telephone or data communications system. There is no assurance that wewill be able to compete successfully in the future. Further, if a potentialcustomer is already using a competing product or system, that potentialcustomer may not be willing or able to make the investment necessary toreplace such a system with our wireless telephone system. In addition, theremay be potential customers who choose another technology because of costor their belief that their needs do not require the full function provided byour wireless telephone systems.

·                  **The certification and approval process for our NetLink product for usein countries that support the 802.11 standard.**Foreign countries,which support the 802.11 standard, could provide future markets for our NetLinkproducts. However, countries’ certification and approval processes for 802.11compatible products, such as ours, are typically time consuming and costly. Ifwe have difficulty obtaining certification and approval by foreign countriesfor our NetLink wireless telephone product, then we and/or our distributorchannels may not be able to gain access to the markets in these countriesin a timely fashion, if at all, which would limit international growth of ourbusiness.

·                  **Our ability to protect or enforce our intellectual property rights.**Ourfuture success depends, in part, upon our proprietary technology. We rely on acombination of patent, copyright, trade secret and trademark laws,confidentiality procedures, and nondisclosure and other contractual provisionsto protect our proprietary rights. Theselegal protections provide only limited protection and may be timeconsuming and expensive to obtain and enforce. There can be no assurancethat our issued patents will not be challenged or circumvented by competitorsor provide meaningful protection against competition. If challenged, our patentsmight not be upheld or their claims could be narrowed. If we fail to protect our proprietary rightsadequately, our competitors mightgain access to our technology. As aresult, our competitors might offersimilar products and we might not beable to compete successfully in our market. Moreover, despite our efforts to protect our proprietary rights,unauthorized parties may copy aspects of our products and obtain and use information that weregard as proprietary. Also, our competitors may independently developsimilar, but not infringing, technology, duplicate our products, or design around our patents or our other intellectual property. Inaddition, other parties may breach confidentiality agreements or otherprotective contracts with us, and wemay not be able to enforce our rightsin the event of these breaches. Furthermore, we expect that we will increase our international operations in the future,and the laws of many foreign countries do not protect our intellectual property rights to the same extentas the laws of the United States. We may berequired to spend significant resources to monitor and protect our intellectualproperty rights. Any litigation surrounding our rights could force us todivert important financial and other resources from our business operations.

·                  **The assertion of intellectual property infringement claims against us.**Ourindustry is characterized by the existence of a large number of patents andfrequent claims and related litigation regarding patent and other intellectualproperty rights. We cannot be certain that our products do not and will notinfringe upon issued patents, patents to be issued in the future, or otherintellectual property rights of others. We may in the future be notifiedthat we are infringing upon certain patent and/or other intellectual propertyrights of others. Although there are no such pending lawsuits against us thatwe are infringing upon intellectual property rights of others, there can be noassurance that infringement claims will not occur in the future. From time to time, third parties may assertexclusive patent, copyright, trademark and other intellectual property rightsto technologies and related methods that are important to us. Litigation may be necessary in the futureto defend against claims of infringement or invalidity, to determine thevalidity and scope of the proprietary rights of others, to enforce our intellectual property rights, or to protect our trade secrets. We may also be subject to claims from customers for indemnification.Any resulting litigation, regardless of our resolution, could result insubstantial costs and diversion of resources. If it were determined thatour products infringe upon the intellectualproperty rights of others, we wouldneed to obtain licenses from these parties or reengineer our products in orderto avoid infringement. We might notbe able to obtain the necessary licenses on acceptable terms or at all, or toreengineer our products successfully. Moreover, if we are sued for infringement and lose the suit, wecould be required to pay substantial damages or be enjoined from licensing orusing the infringing products or technology. Any of the foregoing could cause usto incur significant costs and prevent usfrom selling our products.

46

----

·                  **We rely on the availability of third-party licenses.**Manyof our products are designed to include software or other intellectual propertylicensed from third parties, especially through our OEM agreements. If weterminate OEM or technology partner relationships, it may be necessary inthe future to seek or renew licenses relating to various aspects of theseproducts. There can be no assurance that the necessary licenses would beavailable on acceptable terms, if at all. The inability to obtain certain licensesor other rights or to obtain such licenses or rights on favorable terms, or theneed to engage in litigation regarding these matters, could harm our business,operating results, and financial condition.

·                  **Changes in securities laws and regulations have increased our costs.**TheSarbanes-Oxley Act of 2002 that became law in July 2002, as well as newrules subsequently implemented by the SEC, has required changes in some ofour corporate governance, public disclosure and compliance practices. The Actalso required the SEC to implement additional new rules on a variety ofsubjects. In addition to rules made by the SEC, the Nasdaq Stock Markethas adopted revisions to its requirements for companies, such as us, that areNasdaq-listed. These developments have increased our legal and financialcompliance costs, and make some activities, like SEC reporting obligations,more expensive and difficult. In addition, these developments may make itmore difficult and more expensive for us to obtain director and officerliability insurance, and we may be required to accept reduced coverage orincur substantially higher costs to obtain coverage. These developments couldmake it more difficult for us to attract and retain qualified members of ourboard of directors, particularly to serve on our audit committee, and qualifiedexecutive officers. We are presently evaluating and monitoring regulatorydevelopments and are continuing to estimate the timing and magnitude of additionalcosts we may incur as a result. In addition, we will need to document,test and audit KIRK’s operations prior to year-end in 2006, which may bedifficult and expensive.

·                  **The historic volatility of our stock price, which may make it moredifficult to resell shares at prices attractive to sellers.**The market price of our common stock has beenvolatile and is likely to remain subject to wide fluctuations in the future.For example, during the nine-month period ended September 30, 2006, the closingprice of our common stock has ranged from a high of $13.83 per share to a lowof $7.43 per share. Many factors could cause the market price of our commonstock to fluctuate, including:

·                  variationsin our actual or anticipated quarterly or annual results;

·                  marketconditions in our industry, the industries of our customers and the economy asa whole;

·                  announcementsof technological innovations by us or by our competitors;

·                  introductionof new products or product enhancements or new pricing policies by us or by ourcompetitors;

·                  governmentregulation;

·                  acquisitionsor strategic alliances by us or by our competitors;

·                  recruitmentor departure of key personnel;

·                  thegain or loss of significant orders;

·                  changesin the market valuations of other telecommunications companies;

·                  theamount of liquid financial resources available to us;

·                  thegain or loss of significant customers including OEMs; and

·                  changes in the estimates of our operatingperformance or changes in recommendations by securities analysts.

In addition, the stock market in general, and themarket for technology-related stocks in particular could decline, which couldcause the market price of our common stock to fall for reasons not necessarilyrelated to our business, results of operations or financial condition. Themarket price of our stock also might decline in reaction to events that affectother companies in our industry even if these events do not directly affect us.Accordingly, you may not be able to resell your shares of common stock ator above the price you paid. Securities class action litigation is oftenbrought against a company following a period of volatility in the market priceof its securities, and we have previously been sued in several purportedsecurities class action lawsuits. Further, certain of our management anddirectors were also sued in purported stockholder derivative actions. Theconsolidated class action suit and derivative actions have all beensettled.

**Item 6.    Exhibits**

**(a) Exhibits**

The following exhibits are filed or furnishedherewith:
| Exhibit Number | ** ** | **Exhibit Title** |
|---------------------|------------|------------------------|
| 10.1                |       |                   | 2006 Equity Incentive Plan,  incorporated by reference to Form S-8, filed on August 22, 2006. |
| 10.2                |       |                   | 2006 Employee Stock Purchase  Plan, incorporated by reference to Form S-8, filed on August 22, 2006. |
| 10.3                |       |                   | 2006 International Employee  Stock Purchase Plan, incorporated by reference to Form S-8, filed on August  22, 2006. |
| 31.1 †         |       |                   | Certification by John  H. Elms pursuant to 15 U.S.C.  Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |

 

47

----

 
| 31.2 †  |   |   | Certification by Ernest  J. Sampias pursuant to 15 U.S.C.  Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  |
|--------------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.1 †* |   |   | Certification by John  H. Elms pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.       |
| 32.2 †* |   |   | Certification by Ernest  J. Sampias pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906  of the Sarbanes-Oxley Act of 2002. |

 

----

† Filed or furnished herewith.

*Inaccordance with SEC Release No. 33-8238, these exhibits are furnished withthis quarterly report on Form 10-Q and are not deemed filed with theSecurities and Exchange Commission, and are not incorporated by reference inany filing of SpectraLink Corporation under the Securities Act of 1933 or theSecurities Exchange Act of 1934, whether made before or after the date hereofand irrespective of any general incorporation language in any filings.

Exhibitsfiled with SpectraLink’s 2005 Form 10-K constitute those exhibitscurrently required to be on file. The reader should refer to the 2005Form 10-K under Part IV, Item 15, for a list of those exhibits.

48

----

**Signatures**

In accordance with the requirements of the SecuritiesExchange Act of 1934, as amended, the Registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

SPECTRALINKCORPORATION

 
| Date: November 9, 2006 | By:                                                                               | /s/ Ernest J. Sampias |   |
|------------------------|-----------------------------------------------------------------------------------|-----------------------|--------|
|                   | Ernest J. Sampias                                                                 |
|                   | Executive Vice  President of Finance and  Administration, Chief Financial Officer |

 

49

----

**Exhibit Index**
| Exhibit Number | ** ** | **Exhibit Title** |
|---------------------|------------|------------------------|
| 10.1                |       |                   | 2006 Equity Incentive Plan,  incorporated by reference to Form S-8, filed on August 22, 2006. |
| 10.2                |       |                   | 2006 Employee Stock Purchase  Plan, incorporated by reference to Form S-8, filed on August 22, 2006. |
| 10.3                |       |                   | 2006 International Employee  Stock Purchase Plan, incorporated by reference to Form S-8, filed on August  22, 2006. |
| 31.1 †         |       |                   | Certification by John  H. Elms pursuant to 15 U.S.C.  Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 †         |       |                   | Certification by Ernest  J. Sampias pursuant to 15 U.S.C.  Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1 †*        |       |                   | Certification by John  H. Elms pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2 †*        |       |                   | Certification by Ernest  J. Sampias pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

----

† Filed or furnished herewith.

*Inaccordance with SEC Release No. 33-8238, these exhibits are furnished withthis quarterly report on Form 10-Q and are not deemed filed with theSecurities and Exchange Commission, and are not incorporated by reference inany filing of SpectraLink Corporation under the Securities Act of 1933 or theSecurities Exchange Act of 1934, whether made before or after the date hereofand irrespective of any general incorporation language in any filings.

**Indicatesa management control or compensatory plan arrangement.

Exhibits filed with SpectraLink’s2005 Form 10-K constitute those exhibits currently required to be on file.The reader should refer to the 2005 Form 10-K under Part IV, Item 15,for a list of those exhibits.

50

----