**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

**FORM 10 - Q**

 

**x****        QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period endedJune 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 mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.Yes x   No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer (as defined in Rule12b-2 of the Exchange Act).

 
| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated filer o |
|---------------------------|--------|---------------------|--------|-------------------------|

 

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

 

Applicable only to corporate issuers:

As of July 31, 2006, there were 19,344,599 shares outstanding ofSpectraLink Corporation’s Common Stock - par value per share $0.01.

 

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**SPECTRALINK CORPORATION AND SUBSIDIARIES**

**INDEX**
| Part I     |    | Financial Statements                                                                                                                                                 |   |   |
|------------|---------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|       |    |                                                                                                                                                                 |   |   |
|       | Item 1  | Condensed Consolidated Financial Statements                                                                                                                          |   |   |
|       |    |                                                                                                                                                                 |   |   |
|       |    | Condensed Consolidated Balance Sheets at  June 30, 2006 and December 31, 2005 (Unaudited)                                                                            |   |   |
|       |    |                                                                                                                                                                 |   |   |
|       |    | Condensed Consolidated Statements of Operations and  Other Comprehensive Income (Loss) for the Three Months and Six Months Ended  June 30, 2006 and 2005 (Unaudited) |   |   |
|       |    |                                                                                                                                                                 |   |   |
|       |    | Condensed Consolidated Statements of Cash Flows for  the  Six Months Ended June 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 4  | Submission of Matters to a Vote of Security Holders                                                                                                                  |   |   |
|       |    |                                                                                                                                                                 |   |   |
|       | Item 6  | Exhibits                                                                                                                                                             |   |   |
|       |    | (a) Exhibits                                                                                                                                                         |   |   |
|       |    |                                                                                                                                                                 |   |   |
| Signatures |    |                                                                                                                                                                 |

 

2

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**PartI-Financial Statements**

**Item I. Condensed Consolidated FinancialStatements**

**SpectraLink Corporation andSubsidiaries**

**CondensedConsolidated Balance Sheets**

**(In thousands, except share data)**

**(Unaudited)**

 
| ** **                                                                                                                                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                       | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                                                                                       | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current Assets:                                                                                                                                                  |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                       |       | $                 | 5,855      |                  | $          | 16,703 |   |
| Cash held in  escrow for acquisition (Note 2)                                                                                                                    |       | —            |       | 55,148                |       |
| Investment in  marketable securities - current                                                                                                                   |       | 10,564            |       | 14,088                |       |
| Trade accounts  receivable, net of allowance of $342 and $343, respectively                                                                                      |       | 24,843            |       | 22,574                |       |
| Inventories:                                                                                                                                                     |       |              |       |                  |       |
| Raw materials                                                                                                                                                    |       | 11,537            |       | 4,783                 |       |
| Work in progress                                                                                                                                                 |       | 563               |       | 5                     |       |
| Finished goods                                                                                                                                                   |       | 7,493             |       | 4,727                 |       |
| Less allowance  for obsolete inventory                                                                                                                           |       | (716              | )          | (575                  | )          |
| Total  inventories                                                                                                                                               |       | 18,877            |       | 8,940                 |       |
| Deferred income  taxes                                                                                                                                           |       | 1,716             |       | 1,626                 |       |
| Prepaids and  other                                                                                                                                              |       | 2,028             |       | 1,201                 |       |
| Total current  assets                                                                                                                                            |       | 63,883            |       | 120,280               |       |
|                                                                                                                                                             |       |              |       |                  |       |
| Property and equipment,  net of accumulated depreciation of $12,556 and $11,110, respectively                                                                    |       | 13,639            |       | 8,422                 |       |
| Intangible assets, net  of accumulated amortization of $2,525 and $272, respectively                                                                             |       | 31,970            |       | 318                   |       |
| Goodwill                                                                                                                                                         |       | 24,298            |       | —                |       |
| Other non-current  assets                                                                                                                                        |       | 709               |       | 1,772                 |       |
| Total assets                                                                                                                                                     |       | $                 | 134,499    |                  | $          | 130,792 |   |
|                                                                                                                                                             |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                   | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current Liabilities:                                                                                                                                             |       |              |       |                  |       |
| Accounts payable                                                                                                                                                 |       | $                 | 6,418      |                  | $          | 1,478 |   |
| Accrued payroll,  commissions and employee benefits                                                                                                              |       | 6,176             |       | 4,500                 |       |
| Other accrued  expenses and liabilities                                                                                                                          |       | 5,454             |       | 6,380                 |       |
| Deferred revenue—current  portion                                                                                                                           |       | 10,409            |       | 7,503                 |       |
| Current portion  long-term debt                                                                                                                                  |       | 6,000             |       | 15,000                |       |
| Total current  liabilities                                                                                                                                       |       | 34,457            |       | 34,861                |       |
|                                                                                                                                                             |       |              |       |                  |       |
| Long-term debt                                                                                                                                                   |       | 11,050            |       | 18,050                |       |
| Long-term  deferred tax liabilities                                                                                                                              |       | 8,887             |       | —                |       |
| Other long-term  liabilities                                                                                                                                     |       | 892               |       | 900                   |       |
| Total  liabilities                                                                                                                                               |       | 55,286            |       | 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, 24,077 and 23,838 shares issued,  respectively, and 19,345 and 19,106 shares outstanding, respectively |       | 241               |       | 238                   |       |
| Additional  paid-in capital                                                                                                                                      |       | 85,884            |       | 81,751                |       |
| Retained  earnings                                                                                                                                               |       | 30,022            |       | 32,383                |       |
| Other  comprehensive income                                                                                                                                      |       | 457               |       | —                |       |
| Treasury stock,  4,732 shares, at cost                                                                                                                           |       | (37,391           | )          | (37,391               | )          |
| Total stockholders’  equity                                                                                                                                 |       | 79,213            |       | 76,981                |       |
|                                                                                                                                                             |       |              |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                  |       | $                 | 134,499    |                  | $          | 130,792 |   |

 

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

3

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**SpectraLinkCorporation and Subsidiaries**

**Condensed ConsolidatedStatements of Operationsand**

**Other Comprehensive Income(Loss)**

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

**(Unaudited)**
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|---------------------------|------------|
| ** **                                               | ** ** | **June 30,**                | ** ** | **June 30,**         | ** ** |
| ** **                                               | ** ** | **2006**                         | ** ** | **2005**                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Sales:                                                   |       |                             |       |                      |       |   |   |   |   |
| Product sales                                            |       | $                                | 27,734     |                      | $          | 16,614 |   | $ | 54,802 |   | $ | 32,070 |   |
| Service sales                                            |       | 7,605                            |       | 5,497                     |       | 14,506 |   | 10,629 |   |
| Net sales                                                |       | 35,339                           |       | 22,111                    |       | 69,308 |   | 42,699 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Cost of sales:                                           |       |                             |       |                      |       |   |   |   |   |
| Cost of product sales                                    |       | 11,277                           |       | 4,669                     |       | 22,306 |   | 9,218 |   |
| Cost of service sales                                    |       | 3,925                            |       | 2,959                     |       | 7,444 |   | 5,713 |   |
| Total cost of sales                                      |       | 15,202                           |       | 7,628                     |       | 29,750 |   | 14,931 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Gross profit                                             |       | 20,137                           |       | 14,483                    |       | 39,558 |   | 27,768 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Operating  expenses:                                     |       |                             |       |                      |       |   |   |   |   |
| Research and development                                 |       | 5,835                            |       | 2,489                     |       | 11,641 |   | 4,946 |   |
| Marketing and selling                                    |       | 8,960                            |       | 6,508                     |       | 17,603 |   | 12,563 |   |
| General and administrative                               |       | 3,788                            |       | 1,519                     |       | 7,796 |   | 3,079 |   |
| Acquired in-process research and development             |       | —                           |       | —                    |       | 2,021 |   | — |   |
| Amortization of intangible assets                        |       | 1,130                            |       | 28                        |       | 2,255 |   | 50 |   |
| Total operating expenses                                 |       | 19,713                           |       | 10,544                    |       | 41,316 |   | 20,638 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Income (loss)  from operations:                          |       | 424                              |       | 3,939                     |       | (1,758 | ) | 7,130 |   |
| Other (expense)  income, net                             |       |                             |       |                      |       |   |   |   |   |
| Interest (expense) income, net                           |       | (182                             | )          | 393                       |       | (977 | ) | 744 |   |
| Other (expense) income, net                              |       | (105                             | )          | (53                       | )          | 136 |   | (105 | ) |
| Total other (expense) income, net                        |       | (287                             | )          | 340                       |       | (841 | ) | 639 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Income (loss)  before income taxes                       |       | 137                              |       | 4,279                     |       | (2,599 | ) | 7,769 |   |
| Income tax  (expense) benefit                            |       | (55                              | )          | (1,626                    | )          | 238 |   | (2,952 | ) |
| Net income  (loss)                                       |       | $                                | 82         |                      | $          | 2,653 |   | $ | (2,361 | ) | $ | 4,817 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Other  comprehensive income (loss), net of tax           |       |                             |       |                      |       |   |   |   |   |
| Foreign currency translation adjustments                 |       | $                                | 290        |                      | $          | — |   | $ | 509 |   | $ | — |   |
| Unrealized gain (loss) on available for sale  securities |       | 23                               |       | —                    |       | (52 | ) | — |   |
| Comprehensive  income (loss)                             |       | $                                | 395        |                      | $          | — |   | $ | (1,904 | ) | $ | — |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Basic earnings (loss)  per share                         |       | $                                | —     |                      | $          | 0.14 |   | $ | (0.12 | ) | $ | 0.25 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Basic weighted  average shares outstanding               |       | 19,340                           |       | 19,040                    |       | 19,240 |   | 19,130 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Diluted  earnings (loss) per share                  |       | $                                | —     |                      | $          | 0.14 |   | $ | (0.12 | ) | $ | 0.25 |   |
|                                                     |       |                             |       |                      |       |   |   |   |   |
| Diluted weighted  average shares                         |       | 19,480                           |       | 19,230                    |       | 19,240 |   | 19,480 |   |

 

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

4

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**SpectraLink Corporation andSubsidiaries**

**Condensed Consolidated Statements of Cash Flows**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                                       | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                       | ** ** | **June 30,**              | ** ** |
| ** **                                                                                       | ** ** | **2006**                       | ** ** | **2005** | ** ** |
|                                                                                             |       |                           |       |   |   |
| Cash flows from  operating activities:                                                           |       |                           |       |   |   |
| Net (loss) income                                                                                |       | $                              | (2,361     | ) | $ | 4,817 |   |
| Adjustments to reconcile net (loss) income to net  cash provided by operating activities:        |       |                           |       |   |   |
| Depreciation and amortization                                                                    |       | 4,104                          |       | 819 |   |
| Acquired in-process research and development                                                     |       | 2,021                          |       | — |   |
| Income tax benefit from the exercise of stock  options                                           |       | —                         |       | 475 |   |
| Deferred income taxes                                                                            |       | (874                           | )          | 28 |   |
| Stock-based compensation                                                                         |       | 1,709                          |       | — |   |
| Changes in current assets and liabilities, net of  effects of acquiring subsidiary               |       | 375                            |       | 2,592 |   |
| Net cash provided by operating activities                                                        |       | 4,974                          |       | 8,731 |   |
|                                                                                             |       |                           |       |   |   |
| 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                                                              |       | (5,005                         | )          | (1,497 | ) |
| Sales (purchases) of investments in marketable  securities, net                                  |       | 7,742                          |       | (6,323 | ) |
| Other                                                                                            |       | (9                             | )          | — |   |
| Net cash used in investing activities                                                            |       | (2,283                         | )          | (7,820 | ) |
|                                                                                             |       |                           |       |   |   |
| Cash flows from  financing activities:                                                           |       |                           |       |   |   |
| Principal payments under long-term borrowings                                                    |       | (16,000                        | )          | (16 | ) |
| Proceeds from issuances of stock under stock plans                                               |       | 2,080                          |       | 2,204 |   |
| Dividends paid                                                                                   |       | —                         |       | (3,865 | ) |
| Income tax benefit from the exercise of stock  options                                           |       | 283                            |       | — |   |
| Purchases of treasury stock                                                                      |       | —                         |       | (4,995 | ) |
| Net cash used in financing activities                                                            |       | (13,637                        | )          | (6,672 | ) |
|                                                                                             |       |                           |       |   |   |
| Decrease in cash  and cash equivalents                                                           |       | (10,946                        | )          | (5,761 | ) |
| Cash and cash  equivalents, beginning of period                                                  |       | 16,703                         |       | 14,625 |   |
| Effect of  exchange rate changes on cash and cash equivalents                                    |       | 98                             |       | — |   |
| Cash and cash  equivalents, end of period                                                        |       | $                              | 5,855      |   | $ | 8,864 |   |

 

**The accompanying notes are an integral part of these condensedconsolidated financial statements.**

5

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**SpectraLink Corporation andSubsidiary**

**Notes to Unaudited Condensed Consolidated Financial Statements**

**1.  Basis of Presentation**

The accompanying unaudited, condensed consolidatedfinancial statements have been prepared from the books and records of SpectraLinkCorporation and its wholly owned subsidiaries: SpectraLink InternationalCorporation, SpectraLink Denmark ApS, and KIRK telecom A/S (“KIRK”) (together “SpectraLink”or “the Company”). SpectraLink designs, manufactures and sells on-premisewireless telephone systems to customers worldwide that complement existingtelephone systems by providing mobile communications in a building or campusenvironment. SpectraLink wireless telephone systems increase the efficiency ofemployees by enabling them to remain in telephone contact while movingthroughout the workplace.

In management’s opinion, these financial statementsinclude all adjustments, consisting only of normal recurring adjustments,necessary to fairly present SpectraLink’s financial position, results ofoperations and cash flows for the periods presented. The results of operationsfor the period ended June 30, 2006, are not necessarily indicative of theresults to be expected for any subsequent quarter or for the entire fiscal yearending December 31, 2006. The financial statements should be read inconjunction with the audited financial statements and notes thereto as of, andfor the year ended, December 31, 2005, which are included in SpectraLink’sAnnual Report on Form 10-K. Except as discussed in Note 3, the accountingpolicies utilized in the preparation of the financial statements hereinpresented are the same as set forth in SpectraLink’s annual financialstatements.

TheDecember 31, 2005, condensed balance sheet data was derived from audited financialstatements.

***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 andsix months ended June 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, andvaluations of tangible and intangible assets acquired and liabilities assumed.

***Reclassifications***

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

***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

6

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transfer of title, whichis generally upon shipment of product. Revenue is deferred if there aresignificant post delivery obligations, if collection is not reasonably assuredat the time of sale, or if the fee is not fixed or determinable. Whensignificant post delivery obligations exist, revenue is deferred until suchobligations are fulfilled. We offer products and services such as installation,support, education and training, maintenance and extended warranty coverage.Revenue from installation and training services are deferred and recognizedwhen the services are performed. Revenue from maintenance services is deferredand recognized over the term of the maintenance agreement. We recognize amountsbilled to customers for shipping and handling costs as revenue when the relatedproducts are shipped. Costs of shipping and handling are included in cost ofsales.

*** ***

***Change in Fiscal Year***

OnMay 16, 2006, the Board of Directors authorized our management to decidewhether to change our fiscal reporting year-end from December 31 toJanuary 31. On May 22, 2006, our management made the decision tochange our fiscal year-end from December 31 of each year to January 31 ofeach year.  We believe that this changein our fiscal year will help align the seasonal patterns of demand in our businesswith our reporting cycle, and better align the Company’s sales with those ofour key customers and vertical markets, notably the retail market and ourdistribution channels.  We have electedto report information with respect to the one month transition period beginningon January 1, 2007, and ending on January 31, 2007, on our Form 10-Qfor the quarter ending April 30, 2007, pursuant to Rule 13A-10(D).The first 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 is a manufacturer of onsite wirelesscommunications products based in Denmark. The purchase price for thetransaction was approximately 389 million Danish Kroner or approximately U.S.$62 million, which was paid in cash, and approximately $2 million ofacquisition costs.  We funded the acquisitionprice with approximately $31 million of our own cash and funds provided by acredit facility (Note 9). We escrowed $55.1 million in December 2005, which wasreleased to the selling shareholders on January 3, 2006, along with anadditional $6.9 million.

***Reasons for the Acquisition***

With the addition of KIRK’sDECT-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:
|                                      | ** ** | **Three months ended June 30,**                   | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                                              | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(Actual)**                                                          | ** ** | **(Pro forma)**                              | ** ** | **(Actual)** | ** ** | **(Pro forma)** | ** ** |
| ** **                           | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Net sales                            |       | $                                                                     | 35,339     |                                              | $          | 31,864 |   | $ | 69,308 |   | $ | 61,628 |   |
| Pretax income  (loss)                |       | 137                                                                   |       | 3,965                                             |       | (2,599 | ) | 3,933 |   |
| Net income  (loss)                   |       | 82                                                                    |       | 2,331                                             |       | (2,361 | ) | 1,503 |   |
| Net income  (loss) per common share: |       |                                                                  |       |                                              |       |   |   |   |   |
| Basic                                |       | $                                                                     | —     |                                              | $          | 0.12 |   | $ | (0.12 | ) | $ | 0.08 |   |
| Diluted                              |       | $                                                                     | —     |                                              | $          | 0.12 |   | $ | (0.12 | ) | $ | 0.08 |   |

 

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

7

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activities of the holdingcompany. Upon further review, we have concluded that the holding company willbe used solely for the purpose of holding our investment in KIRK and thefunctional currency for the holding company will be U.S. Dollars.

 

***Preliminary Purchase Accounting***

Using the most currentlyavailable information and subject to finalization, the following represents thepreliminary allocation of the aggregate purchase price to the net assets ofKIRK acquired on January 3, 2006, (in thousands).
| Total current assets                                                     |   | $      | 17,194 |   |
|--------------------------------------------------------------------------|--------|--------|--------|--------|
| Property and  equipment                                                  |   | 1,949  |   |
| Amortizable  intangible assets                                           |   | 33,992 |   |
| In-process  research and development                                     |   | 2,021  |   |
| Goodwill                                                                 |   | 24,298 |   |
| Other assets                                                             |   | 160    |   |
| Total assets  acquired                                                   |   | 79,614 |   |
| Total  liabilities assumed                                               |   | (6,148 | )      |
| Deferred taxes                                                           |   | (9,748 | )      |
| Net assets  acquired                                                     |   | 63,718 |   |
| Less:  Acquisition costs paid or accrued                                 |   | (1,885 | )      |
| Amount paid in cash,  including the release of $55,148 of escrowed funds |   | $      | 61,833 |   |

 

Identifiable intangibleassets acquired on January 3, 2006, represents 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.”

Goodwill was initiallyallocated to our KIRK segment (see Note 5) and will not be tax deductible.Management is currently evaluating potential integration activities that couldimpact our future financial reporting. Significant outstanding items include:evaluation of our organization structure, decisions on transfer pricing and allocationof goodwill among our segments.

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 initially valued at their respectivecarrying amounts, however, valuation is not complete. Completion is expected inthe third quarter of 2006.

8

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**3.  Adoption of New Accounting Pronouncements**

 

The adoption of the following accountingpronouncements in the first half of 2006 did not have a material impact on ourresults of operations, financial condition, or cash flows:

·                  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 first half of 2006includes: (a) compensation cost for all share-based payments granted prior tobut not yet vested as of December 31, 2005, based on the grant-date fair valueestimated in accordance with the provisions of SFAS 123, and (b) compensationcost for all share-based payments granted or modified subsequent to December31, 2005, based on the grant-date fair value estimated in accordance with theprovisions of SFAS 123R.  In accordancewith the modified 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 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 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 the unvested portion of the surrenderedoption. Based on an analysis of historical forfeitures, we have applied anannual forfeiture rate of 9% to all unvested options as of June 30, 2006. Thisanalysis will be re-evaluated quarterly and the forfeiture rate will beadjusted as necessary.  Ultimately, theactual expense recognized over the vesting period will only be for those sharesthat vest. Forfeited or otherwise cancelled options are returned to the pool ofoptions authorized for issuance under our stock-based compensation plans. It isour policy to issue new shares, as opposed to treasury shares upon exercise orpurchase under our stock-based compensation plans. See Note 12.

**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 presecribes 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

9

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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 be after our year ending December 31, 2006.

 

***SFAS No. 155 (SFAS 155), “Accountingfor Certain Hybrid Financial Instruments, 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.

***SFAS No. 156 (SFAS 156), “Accountingfor 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.

**5.****                                      SegmentInformation**

In accordance with SFAS No. 131, “Disclosures aboutSegments of an Enterprise and Related Information,” we define operatingsegments as components of an enterprise for which separate financialinformation is available. This information is reviewed regularly by our chiefoperating decision-maker, to evaluate performance and to make operatingdecisions. We have identified our Chief Executive Officer as our chiefoperating decision-maker. The chief operating decision maker reviews revenueand overall results of operations by segment.

During the first half of 2006, we operated ourbusiness across two operating segments, based on the legal structures ofSpectraLink and KIRK. Prior to the fiscal year 2006, and the acquisition ofKIRK, we operated as one segment. As discussed in Note 2, management isreviewing the structure of the Company and may modify our segment structure inthe ensuing quarters.

The SpectraLink segment primarily consists of ourAmericas operations and corporate activities, including global corporatesupport functions, such as executive offices, legal, finance and treasury. TheSpectraLink segment also includes branch sales and support personnel located inthe United Kingdom and Australia.

The KIRK segment is comprised of the operations andcorporate activities of KIRK acquired on January 3, 2006 (See Note 2). KIRKdesigns, manufactures and sells wireless onsite adjunct communicationsolutions. KIRK also includes two subsidiaries: KIRK telecom, Inc., which in2005 was a distribution sales and support subsidiary in the United States; andKIRK scantel A/S, which designs, contract manufactures and sells wired andwireless telephones under the KIRK brand name to the residential market,primarily in the Scandinavian countries.

We had one customer in the first half of 2006 fromwhich revenue exceeded 10% of our consolidated net revenue. Both segmentresults include sales from this customer, which totaled $5.2 million and $10.7 millionfor the three and six months ended June 30, 2006, respectively. We had nocustomers representing greater than 10% of revenues in the comparable 2005period.

Thefollowing summarizes our results and total assets by segment (in thousands):

| Three months ended:    | ** ** | **SpectraLink** | ** ** | **KIRK** | ** **                                                                                                          | **Eliminations (1)** | ** ** | **Total** | ** ** |
|----------------------------------|------------|-----------------|------------|----------|---------------------------------------------------------------------------------------------------------------------|---------------------------|------------|-----------|------------|
| June 30, 2006                    |       |            |       |     |                                                                                                                |                      |       |      |       |
| Revenue                          |       | $               | 27,116     |     | $                                                                                                                   | 8,501                     |       | $         | (278       | ) | $ | 35,339 |   |
| Income (loss) from operations    |       | 1,488           |       | (912     | )                                                                                                                   | (152                      | )          | 424       |       |
| June 30, 2005                    |       |            |       |     |                                                                                                                |                      |       |      |       |
| Revenue                          |       | $               | 21,111     |     |                    — |                      | —     |      | 21,111     |   |
| Income from operations           |       | 3,939           |       | —   |                                                                                                                | —                    |       | 3,939     |       |
|                             |       |            |       |     |                                                                                                                |                      |       |      |       |
| **Six months ended:**            |       |            |       |     |                                                                                                                |                      |       |      |       |
| June 30, 2006                    |       |            |       |     |                                                                                                                |                      |       |      |       |
| Revenue                          |       | $               | 53,435     |     | $                                                                                                                   | 16,151                    |       | $         | (278       | ) | $ | 69,308 |   |
| Income (loss) from operations    |       | 2,944           |       | (4,550   | )                                                                                                                   | (152                      | )          | (1,758    | )          |
| June 30, 2005                    |       |            |       |     |                                                                                                                |                      |       |      |       |
| Revenue                          |       | 42,699          |       | —   |                                                                                                                | —                    |       | 42,699    |       |
| Income from operations           |       | 7,130           |       | —   |                                                                                                                | —                    |       | 7,130     |       |
|                             |       |            |       |     |                                                                                                                |                      |       |      |       |
| Assets as of  June 30, 2006 (2): |       | $               | 64,909     |     | $                                                                                                                   | 69,590                    |       | $         | —     |   | $ | 134,499 |   |
| Assets as of December  31, 2005: |       | 130,792         |       | —   |                                                                                                                | —                    |       | 130,792   |       |

----

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

(2) Intercompany balanceshave been eliminated.

10

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**6.  Earnings Per Share**

Basicearnings per share is computed by dividing the net income (loss) by theweighted average number of shares of common stock outstanding for theperiod.  Diluted earnings per share isdetermined by dividing the net income by the sum of the weighted average numberof common shares outstanding, and if not anti-dilutive, the effect of outstandingstock options and/or other common stock equivalents as determined utilizing thetreasury stock method.  Potentiallydilutive common stock options, totaling 3.1 million and 1.9 million for thethree months ended June 30, 2006 and 2005, respectively, and 2.7 million and1.4 million for the six months ended June 30, 2006 and 2005, respectively, wereexcluded from the calculation because they were anti-dilutive.  Weighted average options and rights topurchase 0.2 million shares of common stock were excluded from the dilutedshare calculation for the six months ended June 30, 2006, as their effect wouldhave been anti-dilutive as a result of the net loss for the period.  In accordance with debt covenants, we havenot declared dividends in the six months ended June 30, 2006.  See Note 9. A reconciliation of the numerators and denominators used in computingearnings per share is as follows:
|                                 | ** ** | **Three months ended June 30,**                   | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                      | ** ** | **(In thousands, except per share amounts)** | ** ** |
| ** **                      | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **Income**                                                            | ** ** | **Shares** | ** ** | **Per Share** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| Basic EPS—                 |       | $                                                                     | 82         |   | 19,340 |   | $ | — |   | $ | 2,653 |   | 19,040 |   | $ | 0.14 |   |
| Effect of  dilutive securities: |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Stock purchase plan             |       | —                                                                |       | 62 |   | — |   | — |   | 10 |   | — |   |
| Stock options outstanding       |       | —                                                                |       | 78 |   | — |   | — |   | 180 |   | — |   |
| Diluted EPS—               |       | $                                                                     | 82         |   | 19,480 |   | $ | — |   | $ | 2,653 |   | 19,230 |   | $ | 0.14 |   |

 
|                                 | ** ** | **Six months ended June 30,**                     | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                      | ** ** | **(In thousands, except per share amounts)** | ** ** |
| ** **                      | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **Loss**                                                              | ** ** | **Shares** | ** ** | **Per Share** | ** ** | **Income** | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| Basic EPS—                 |       | $                                                                     | (2,361     | ) | 19,240 |   | $ | (0.12 | ) | $ | 4,817 |   | 19,130 |   | $ | 0.25 |   |
| Effect of  dilutive securities: |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Stock purchase plan             |       | —                                                                |       | — |   | — |   | — |   | 22 |   | — |   |
| Stock options outstanding       |       | —                                                                |       | — |   | — |   | — |   | 328 |   | — |   |
| Diluted EPS—               |       | $  (2,361                                                   | )          | 19,240 |   | $    (0.12 | ) | $   4,817 |   | 19,480 |   | $     0.25 |   |
|                                 |            |                                                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

Thefollowing table presents details of our intangible assets, other than goodwill,as of June 30, 2006:

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|                                      | ** ** | **Useful Life** | ** ** | **Gross  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net**    | ** ** |
|--------------------------------------|------------|----------------------|------------|-------------------|------------|-------------------------------|------------|------------|------------|
| ** **                           | ** ** | **(Years)**          | ** ** | ** **        | ** ** | **(In thousands)**       | ** ** | ** ** | ** ** |
| International  and domestic licenses |       | 1-5                  |       | $                 | 997        |                          | $          | 352        |       | $ | 645 |   |
| Patents and  technology              |       | 5-8                  |       | 24,077            |       | 1,768                         |       | 22,309     |       |
| Customer  relationships              |       | 7-11                 |       | 7,685             |       | 332                           |       | 7,353      |       |
| Other                                |       | 11                   |       | 1,736             |       | 73                            |       | 1,663      |       |
| Total                                |       |                 |       | $                 | 34,495     |                          | $          | 2,525      |       | $ | 31,970 |   |

 

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) |       | $                       | 2,258      |   |
| 2007             |       | 4,810                   |       |
| 2008             |       | 4,646                   |       |
| 2009             |       | 4,412                   |       |
| 2010             |       | 4,124                   |       |
| Thereafter       |       | 11,686                  |       |
|             |       | $                       | 31,936     |   |

 

Amortization expense of intangible assets was $1.1million and $2.3 million for the three and six months ended June 30, 2006,respectively, and insignificant for the comparable periods in 2005.

As a result of acquiring KIRK (Note 2), we initiallyallocated $24.3 million to goodwill , which was completely allocated to ourKIRK segment at June 30, 2006. As we are finalizing the valuation of certainassets and liabilities acquired with KIRK, goodwill and other intangible assetallocations are subject to change. See Note 2 for the detailed listing ofvalues assigned to KIRK intangibles and goodwill.

**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 KIRK purchases denominated in U.S. Dollars and Euros. To mitigatethis risk, we purchase forward currency contracts. Forward currency contractactivity was insignificant in the first half of 2006.

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**9.****             Debt**

 

Debt consisted of thefollowing:
|                                                                                                                                                                                                                                                                                                        | ** ** | **As of:**             | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                             | ** ** | **June 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 9.25% as of June 30, 2006),  collateralized by substantially all assets of the Company      |       | 10,000                      |       | — |   |
|                                                                                                                                                                                                                                                                                                   |       |                        |       |   |   |
| Revolving line  of credit, principal due and payable in December 2008, variable quarterly  interest payments at 7.38% and 8.25% as of June 30, 2006, and December 31,  2005, respectively, collateralized by substantially all assets of the Company                                                   |       | 7,050                       |       | 18,050 |   |
|                                                                                                                                                                                                                                                                                                   |       |                        |       |   |   |
| Total Long-Term  Debt                                                                                                                                                                                                                                                                                  |       | $                           | 17,050     |   | $ | 33,050 |   |
| Less: Current  Portion of Long-Term Debt                                                                                                                                                                                                                                                               |       | (6,000                      | )          | (15,000 | ) |
| Total Non-current  Long-Term Debt                                                                                                                                                                                                                                                                      |       | $                           | 11,050     |   | $ | 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.

We canborrow under the remaining revolving line of credit and the new term loan ateither the JP Morgan Prime rate plus 1% or at a LIBO rate plus a spreaddetermined by our leverage ratio, which was 2% at June 30, 2006.  At June 30, 2006, the Company’s interest rateon 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 7.44% 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 June 30, 2006,approximately $9.0 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 Facility are secured by a first security interest insubstantially all of the Company’s assets.

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 $1.0 million of the revolving line of credit balance in the secondquarter of 2006. It is management’s intention to prepay $1.0 million of theoutstanding line of credit with funds available in addition to the term loaninstallments over the next twelve months. Therefore, $6.0 million of our totaldebt balance has been classified as current as of June 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

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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 June 30, 2006, and as ofthe date of this report.

 

Future maturities oflong-term debt (reflecting contractual maturities and management’s intent) areas follows as of June 30, 2006:
| 2006 (remaining) |   | $     | 2,500  |   |
|------------------|--------|-------|--------|--------|
| 2007             |   | 6,000 |   |
| 2008             |   | 8,550 |   |
|             |   | $     | 17,050 |   |

 

**10.****          IncomeTaxes**

Oursecond quarter 2006 effective tax rate was 41%, compared to 38% in the secondquarter of 2005.  Our first quarter 2006results included a nondeductible in-process research and development write-offwhich is considered a discrete item for purposes of calculating our effectivetax rate, and which caused our six month effective tax rate to drop to 9%,compared to 38% in the first half of 2005. In addition to the discrete item,our 2006 effective tax rate is impacted by the mix of domestic versus foreigntaxable income and the absence of the research and development tax credit thusfar in 2006.  In light of these factors,we have estimated an effective tax rate for the year of approximately 41%.

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 numerous transactionsfor which the ultimate tax outcome is uncertain. Additionally, our income taxprovision is based on calculations and assumptions that are subject toexamination by many different tax authorities. We adjust our income tax provisionin 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  June 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| ** **                                               | ** ** | **(In thousands)**                         | ** ** |
|                                                     |       |                                            |       |   |   |
| Beginning  Balance, Accrued Product Warranty and Service |       | $                                               | 1,864      |   | $ | 908 |   |
| Additions to the accrual for product warranties          |       | 195                                             |       | 151 |   |
| Reductions for incurred warranty charges                 |       | (412                                            | )          | (259 | ) |
| Other                                                    |       | (92                                             | )          | — |   |
| Ending Balance, Accrued  Product Warranty and Service    |       | $                                               | 1,555      |   | $ | 800 |   |

 

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|                                                            | ** ** | **Six months ended  June 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            |       | 860                                           |       | 405 |   |
| Reductions for incurred warranty charges                   |       | (711                                          | )          | (506 | ) |
| Ending Balance, Accrued  Product Warranty and Service      |       | $                                             | 1,555      |   | $ | 800 |   |

 

***Indemnifications***

We provideindemnifications of varying scope and size to certain customers against claimsof intellectual property infringement made by third parties arising from theuse 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.          Stock-Based Compensation***

We have two equityincentive plans for which we recognize expense under SFAS 123R:   the 2000 Stock Option Plan (the “Option Plan”)and the Employee Stock Purchase Plan (the “ESPP”).   On May 23, 2006, our stockholdersapproved new equity incentive plans, which will be effective when the terms andconditions of the equity incentive offerings under the new plans are approved bythe Compensation Committee of the Board of Directors.   The new incentive plans are the 2006 Equity Incentive Plan, the 2006 EmployeeStock Purchase Plan, and the 2006 International Employee Stock Purchase Plan.Effective with the stockholder approval, no further options have been grantedunder the 2000 Option Plan.

The Option Planprovides selected employees, officers, directors, agents, consultants andindependent contractors of the Company options to purchase shares of theCompany’s stock. Under the terms of the Option Plan, the Board of Directors maygrant either non-qualified or incentive stock options, as defined by theInternal Revenue Service. The purchase price per share of a non-qualified stockoption will not be less than par value per share of the Company’s common stockat the time of grant. The purchase price per share of an incentive stock optionwill not be less than 100% of the market value per share of the Company’scommon stock at the time of grant. If the grantee of an incentive stock optionowns more than 10% of the total combined voting power of all classes of stockon the date of grant, the purchase price will be at least 110% of the marketvalue of a share of the Company’s common stock at the date of grant. Optionsgranted under the Option Plan expire after 10 years. Options vest at a rate of25% after 12 months from the date of grant, and ratably per month thereafter,conditioned upon continued employment. Full vesting occurs after 48 months from the date of grant.

15

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Stock optionsoutstanding at June 30, 2006, changes during the first half of 2006, and sharesavailable for grant under all of the Company’s plans are presented below:

 
| ** **                           | ** ** | **Shares  available for  grant** | ** ** | **Outstanding  options** | ** ** | **Weighted-  average  exercise  price, per  common share** | ** ** | **Remaining  contractual  life, in years** | ** ** | **Aggregate  intrinsic  value** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **(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      |                                                 |       |                            |       |   |
|                                 |       |                                  |       |                     |       |                                                                 |       |                                                 |       |                            |       |
| Outstanding as  of June 30, 2006     |       | 2,242                                 |       | 3,565                    |       | $                                                                    | 13.63      |                                                 | 7.93       |                            | $          | 209,606 |   |
|                                 |       |                                  |       |                     |       |                                                                 |       |                                                 |       |                            |       |
| Exercisable at June 30,  2006        |       |                                  |       | 2,263                    |       | $                                                                    | 14.32      |                                                 | 7.18       |                            | $          | 184,279 |   |

 

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 intrinsicvalue of options exercised during the first half of 2006 was $0.3 million.

As of June 30,2006, there was $6.0 million of total unrecognized compensation cost fromshare-based compensation granted under the Option Plan, related to unvestedshares. This compensation is expected to be recognized over a weighted-averageperiod of approximately 1.6 years.

We selected theBlack-Scholes option-pricing model as the most appropriate valuation method forour awards.  The fair value of eachoption 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 Option Plan, we have separated theoptionees into three groups: Non-employee directors, Executives, and Management/Staff. We havedetermined 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%.

Subject to certainmaximum stock ownership restrictions, employees are eligible to participate inthe ESPP if employed by the Company at the beginning of each offering period,on a full-time or part-time basis, and regularly scheduled to work more than 20hours per week. Participating employees may have up to 10% of their base pay ineffect at the commencement of each offering period withheld pursuant to theESPP. Common stock purchased under the ESPP is equal to 85% of the lower of themarket value on the commencement date or termination date of each offeringperiod (usually six months).

We do not separateour employees into groups for purposes of valuing the ESPP awards. The assumptionswe used in 2006 to value these awards were as follows:  Interest rate –4.3%; Dividend yield – 0%;Expected term – 6 months; Volatility –41%. At June 30, 2006, there was $40,000of total unrecognized compensation cost related to our ESPP, which will berecognized over the remaining offer period, through August 15, 2006.

16

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The followingtable sets forth the total stock-based compensation expense resulting fromstock-based compensation included in our Condensed Consolidated Statements ofOperations (in thousands):
|                                                              | ** ** | **Three months ended June 30, 2006** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **Option Plan**                                          | ** ** | **ESPP** | ** ** |
| Cost of product and service revenue |       | $                                                             | 22         |   | $ | 3 |   |
| Research and  development                                    |       | 193                                                           |       | 18 |   |
| Selling and  marketing                                       |       | 129                                                           |       | 12 |   |
| General and  administrative                                  |       | 478                                                           |       | 87 |   |
| Stock-based  compensation expense before income taxes        |       | 822                                                           |       | 120 |   |
| Income tax benefit                                           |       | (339                                                          | )          | (49 | ) |
| Total  stock-based compensation expense after income taxes   |       | $                                                             | 483        |   | $ | 71 |   |
| Basic and diluted cost  per share                            |       | $                                                             | 0.02       |   | $ | — |   |

 
|                                                              | ** ** | **Six months ended June 30, 2006** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **Option Plan**                                        | ** ** | **ESPP** | ** ** |
| Cost of product and service revenue |       | $                                                           | 74         |   | $ | 17 |   |
| Research and  development                                    |       | 379                                                         |       | 45 |   |
| Selling and  marketing                                       |       | 214                                                         |       | 41 |   |
| General and  administrative                                  |       | 847                                                         |       | 92 |   |
| Stock-based  compensation expense before income taxes        |       | 1,514                                                       |       | 195 |   |
| Income tax  benefit                                          |       | (623                                                        | )          | (80 | ) |
| Total  stock-based compensation expense after income taxes   |       | $                                                           | 891        |   | $ | 115 |   |
| Basic and diluted cost  per share                            |       | $                                                           | 0.05       |   | $ | 0.01 |   |

 

Prior to adoptionof SFAS 123R, we applied SFAS 123, amended by SFAS 148, “Accounting forStock-Based Compensation – Transition and Disclosure” (SFAS 148), whichallowed 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 SFAS123R for our plans; however, as required by SFAS 148 prior to the adoption ofSFAS 123R, we provided pro forma net income (loss) and pro forma net income(loss) per common share disclosures for stock-based awards, as if thefair-value-based method defined in SFAS 123 had been applied.

The followingtable illustrates the effect on net income (loss) after tax and net income(loss) per common share as if we had applied the fair value recognitionprovisions of SFAS 123 to stock-based compensation during the three and sixmonths ended June 30, 2005, (in thousands, except per share amounts):

|                                                                                                                  | ** ** | **Three months ended  June 30, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Net income, as  reported                                                                                         |       | $                                                         | 2,653      |   |
| Deduct stock-based  employee compensation expense under the fair value based method, net of related  tax effect: |       |                                                      |       |
| Compensation expense for stock options                                                                           |       | (4,767                                                    | )*         |
| Compensation expense for the stock purchase plan                                                                 |       | (38                                                       | )          |
| Net (loss), pro  forma                                                                                           |       | $                                                         | (2,152     | ) |
| Earnings (loss)  per share:                                                                                      |       |                                                      |       |
| Basic – as reported                                                                                         |       | $                                                         | 0.14       |   |
| Basic – pro forma                                                                                           |       | $                                                         | (0.11      | ) |
| Diluted – as reported                                                                                       |       | $                                                         | 0.14       |   |
| Diluted – pro  forma                                                                                        |       | $                                                         | (0.11      | ) |

 

|                                                                                                                  | ** ** | **Six months ended  June 30, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Net income, as  reported                                                                                         |       | $                                                       | 4,817      |   |
| Deduct stock-based  employee compensation expense under the fair value based method, net of related  tax effect: |       |                                                    |       |
| Compensation expense for stock options                                                                           |       | (5,607                                                  | )*         |
| Compensation expense for the stock purchase plan                                                                 |       | (76                                                     | )          |
| Net (loss), pro  forma                                                                                           |       | $                                                       | (866       | ) |
| Earnings (loss)  per share:                                                                                      |       |                                                    |       |
| Basic – as reported                                                                                         |       | $                                                       | 0.25       |   |
| Basic – pro forma                                                                                           |       | $                                                       | (0.05      | ) |
| Diluted – as reported                                                                                       |       | $                                                       | 0.25       |   |
| Diluted – pro  forma                                                                                        |       | $                                                       | (0.05      | ) |

----

*Includes compensation expense (net of related tax effect) resultingfrom the acceleration of vesting of certain outstanding stock options, asdescribed below.

17

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On June 21,2005, the Board of Directors authorized the acceleration of the vesting ofstock options outstanding under the Company’s 2000 Stock Option Plan and theCompany’s prior equity compensation plans that had an exercise price per sharehigher than the closing price of the Company’s stock on June 21, 2005,which was $10.75. Options held by directors, including John Elms, the Company’spresident and CEO, were not eligible in the vesting acceleration. Options topurchase approximately 1.1 million shares of the Company’s common stockbecame exercisable immediately.

The primarypurpose of the accelerated vesting was to eliminate future compensation expensethe Company would otherwise recognize in its income statement with respect tothese accelerated options upon the adoption SFAS 123R.     Theseoptions were not “in-the-money” at that time, and therefore, there was nocompensation expense recorded in accordance with APB No. 25 as a result ofthis modification. However, in accordance with SFAS No. 123, the Companyincluded the remaining unamortized compensation expense of approximately$3,871,000 million (net of tax) related to the accelerated options in itspro forma net income (loss) and earnings (loss) per share for thethree months ended June 30, 2005. Had this acceleration not been taken,the unamortized fair value-based compensation expense would have been recordedin future periods through 2009, under vesting schedules in place prior to theacceleration, which generally would have resulted in fair value-basedcompensation expense of $88,000 for the three months ended June 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.

Cash proceeds fromthe exercise of stock options were $0.1million and $ 0.2 million for the threemonths ended June 30, 2006, and 2005, respectively, and $1.6 million and $ 1.8million for the six months ended June 30, 2006 and 2005, respectively.   Net cash proceeds from employee stockpurchases were $0 million and $ 0.4 million for the three months ended June 30,2006 and 2005, respectively, and $ 0.5 million and $ 0.4 million for the sixmonths ended June 30, 2006 and 2005, respectively.  In accordance with SFAS 123R, we presentexcess tax benefits from the exercise of stock options, if any, as financingcash flows in 2006 rather than operating cash flows, as presented previously.

**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 and NetLinkTM wireless telephones and the KIRK DECT telephone system.Link uses a proprietary radio infrastructure in the 902-928 MHz radio bandtargeted to organizations that desire a dedicated wireless voice solution fortheir on-

18

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premisesmobile workforce.  The NetLinkwireless telephone products operate over IEEE 802.11-compliant wireless localarea networks (WLANs) in the 2400-2483 MHz frequency band using standards-basedInternet Protocol (IP) technology.  NetLink products are targeted toorganizations that want both a wireless voice and wireless data solution on asingle network.  SpectraLink also offers an Open Application Interface(OAI), which enables third-party messaging applications to be integrated with ourwireless telephones. Because of the recent advances inwireless local area network (WLAN) technology, a significant portion of ourdevelopment efforts will focus on our existing NetLink products as well as newproducts that operate on a WLAN. As a result of acquiring KIRK we beganoffering the KIRK DECT products which operate in compliance with the DECTstandard.

*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. KIRK has two wholly-owned subsidiaries, KIRKscantel A/S and KIRK telecom, Inc.

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 in theAmericas 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.

In the second quarter of 2006, we first started selling thenew Link 6020 wireless telephones.  The Link6020 includes a larger display, improved battery performance, management, speakerphone,and new user-interface and profile attributes to improve usability in a widevariety of enterprise applications. We also launched the KIRK Wireless Server600v3, a cost-effective and highly scalable solution that offers wireless IPtelephony via DECT infrastructure for customers running VoIP over the CiscoCallManager, H.323 or SIP server.

*Recent Developments*

Factors that impact gross margin are sales through our OEMpartners and product mix.  We realize lower margins on products soldthrough OEM relationships 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.  KIRK productsalso have a lower gross margin of approximately 40% to 45%, which is lower thanthe gross margin on our Link products.

We are continuing our transition from aNorth American-oriented niche market provider to a global supplier of workplacewireless systems with our recent acquisition of KIRK, as well as ourpartnerships with some of the largest telecommunications manufacturersworldwide including Nortel, Alcatel, Avaya, Inter-Tel, and NEC America. Becauseour OEM partners primarily sell NetLink wireless telephones, if OEM salesincrease, we would expect NetLink and KIRK DECT revenueto also increase.   If we sell proportionately more NetLink and DECTthan Link, we will continue to see pressure on our overall gross margins.

Our cash, cashequivalents and investments at June 30, 2006, decreased to $16.4 million from$22.0 million at March 31, 2006, as we repaid approximately $1.0 million on ourCredit Facility, we had capital expenditures of $2.1 million and we purchasedinventory to support our new product offerings. We continue to invest in low-risk instruments including governmentsecurities and tax-free investments.

Our inventoryincreased to $18.9 million at June 30, 2006 compared to $15.9 million at March31, 2006.  This increase was related toour new Link product, raw material purchases related to satisfying Restrictionof Hazardous Substances (“RoHS”) requirements, a last time buy of material tosupport service on an older NetLink product, and additional battery cellpurchases to address supplier delivery problems.

We also amended our credit facility to provide for anadditional $10.0 million term loan which was used to repay $10.0 million of therevolving line of credit, under terms consistent with the Credit Facility weentered into in December 2005.  Thisadditional term note facility and the reduction of our revolving line of creditbrings our borrowings under the revolving line of credit in line with ourborrowing capacity and our operating needs. 

 

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**Consolidated Results of Operations**

 

For the three months ended June 30, 2006, we generated$35.3 million in revenue, and net income of $82,000, or $0.00 earnings perdiluted share.  For the three monthsended June 30, 2006, we incurred $1.1 million of amortization expense for theintangible assets 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 secondquarter of 2005, net income was $2.7 million, or $0.14 earnings per fullydiluted share, on revenue of $22.1 million.

For the six months ended June 30, 2006, we generated $69.3million in revenue, and a net loss of $2.4 million, or a loss of $0.12 perdiluted share.  For the six months endedJune 30, 2006, we incurred $2.2 million of amortization expense for theintangible assets related to our acquisition of KIRK and $2.0 million relatedto acquired in-process research and development expense.  We also incurred approximately $1.7 millionrelating to the expensing of stock-based compensation in accordance with SFAS123R.  In comparison, for the six monthsended June 30, 2005, net income was $4.8 million, or $0.25 per earningsper fully diluted share, on revenue of $42.7 million.

Consolidatedrevenue for the three months ended June 30, 2006, increased 59.8% to $35.3million from $22.1 million for the same period last year. The increase inrevenue was primarily due to the acquisition of KIRK and due to an increase in SpectraLink’srevenue from its OEM channel and revenue from the retail market.  KIRK revenue decreased approximately 15.7% fromthe 2005 consolidated proforma results due to a decline in OEM revenue at KIRK.

Consolidatedrevenue for the six months ended June 30, 2006, increased 62.3% to $69.3million from $42.7 million for the same period last year.  The increase in revenue was primarily due tothe acquisition of KIRK and an increase in SpectraLink’s revenue from its OEMchannel and revenue from the retail market.

Our traditional distribution channels were responsible forapproximately 46.9% of second quarter product sales, original equipmentmanufacturer (OEM) partners contributed approximately 34.0 % of second quarterproduct sales, and the balance of 19.1 % was met through the SpectraLink directsales team. Sales of our NetLink wireless telephone systems exceeded sales ofour Link wireless telephones in the second quarter. Link accounted for 34.2 %of product sales, delivering $9.5 million in revenue. NetLink sales accountedfor 37.1% of total product sales, or $10.3 million, and KIRK DECT product saleswere 28.7% of total product sales or $7.9 million. During the second quarter of2006, we had one customer that accounted for over 10% of our consolidated netsales.

Consolidatedservice revenue for the three months ended June 30, 2006, increased 38.3% to$7.6 million compared to $5.5 million for the same period last year. Theincrease in service sales was primarily related to an increase in maintenancecontracts relating to products previously sold to a larger installed base ofour customers. The increase also related to an increase in installation andtime and materials services.

Overall consolidated gross margin for the three monthsended June 30, 2006, was 57.0% or $20.1 million compared to 65.5% or $14.5million for the same period last year. For the six months ended June 30, 2006,our consolidated gross margin was 57.1% or $39.6 million compared to 65.0% or$27.8 million for the same periods last year. We attribute the dilution of our gross margin to the addition of KIRK DECTproducts to our product offerings and an increase in our NetLink revenue. Both KIRKDECT and NetLink products carry a lower gross margin than our Link product, andas product mix shifts, gross margin is affected.   Our margin also decreased because of thehigher percentage contribution from our service business that carries a lowergross margin.

Consolidatedresearch and development expense excluding acquired in-process research anddevelopment expense and amortization of intangible assets for the three monthsended and six months ended June 30, 2006, respectively, increased 134.4% and135.4 % to $5.8 million and $11.6 million from $2.5 million and $5.0 millionfor the same periods last year. The increases were primarily due to the acquisitionof KIRK and as a result of increases in salaries, and employee benefitsprimarily related to increases in headcount and contractors to supportSpectraLink’s accelerated new product rollout schedule and compensation expenseassociated with the fair value of share-based payments to employees related tothe adoption of SFAS 123R in the first quarter of 2006.

Consolidatedmarketing and selling for the three months and six months ended June 30, 2006,respectively, increased 37.7% and 40.1% to $9.0 million and $17.6 million from$6.5 million and $12.6 million for the same periods last year. The increaseswere primarily due to the acquisition of KIRK.

Consolidatedgeneral and administrative expenses for the three months and six months endedJune 30, 2006, respectively, increased 149.4% and 153.2% to $3.8 million and$7.8 million from $1.5 million and $3.1 million for the same periods last year.The increases were primarily due to the acquisition of KIRK and it also relatedto compensation expense associated with the fair value of share-based paymentsto employees related to the adoption of SFAS 123R in the first quarter of 2006,and was also due to increased professional service fees.

20

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Consolidated other(expense), income net was a net other expense of $0.3 million and $0.8 millionfor the three months  and six monthsended  June 30, 2006, respectively,compared to a net other income of $0.3 million and $0.6 million for sameperiods in the prior year. For the three months and six months ended June 30,2006, we incurred interest expense related to our Credit Facility ofapproximately $0.3 million and $0.6 million and amortization of debtissuance costs. There was nominal-interest expense for the same period lastyear. Interest expense was offset by interest income on investments.

Consolidatedincome tax expense was $0.1 million for the three months ended June 30, 2006,compared to income tax expense of $1.6 million for the same period last year.For the six months ended June 30, 2006, consolidated income tax expense was abenefit of $0.2 million and an income tax expense of  $3.0 million for the same period last year.We have estimated a GAAP effective tax rate for the year of approximately 41%.

**Segment Results of Operations**

*SpectraLinkSegment*

The SpectraLink segment primarily consists of our Americasoperations and corporate activities, including global corporate supportfunctions, such as executive offices, legal, finance and treasury. TheSpectraLink segment also includes branch sales and support personnel locatedinternationally.  The following includesinsignificant intersegment sales to KIRK for the three and six months endedJune 30, 2006.
|                                      | ** ** | **Three months ended June 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**                                            | ** ** | **% change** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(actual)**                                        | ** ** | ** ** | ** ** | **(actual)** | ** ** |
| Net product and  service sales       |       | $                                                   | 27,111     |   | 22.6 | % | $ | 22,111 |   |
| Cost of product  and service sales   |       | 10,567                                              |       | 38.5 | % | 7,628 |   |
| Gross profit                         |       | 16,544                                              |       | 14.2 | % | 14,483 |   |
| Research and  development            |       | 4,402                                               |       | 76.9 | % | 2,489 |   |
| Marketing and  selling               |       | 8,046                                               |       | 23.6 | % | 6,508 |   |
| General and  administrative          |       | 2,580                                               |       | 70.0 | % | 1,518 |   |
| Amortization of  intangible assets   |       | 32                                                  |       | 10.3 | % | 29 |   |
| Income from operations               |       | $                                                   | 1,484      |   | (62.3 | )% | $ | 3,939 |   |

 
|                                      | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2006**                                          | ** ** | **% change** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **(actual)**                                      | ** ** | ** ** | ** ** | **(actual)** | ** ** |
| Net product and  service sales       |       | $                                                 | 53,430     |   | 25.1 | % | $ | 42,699 |   |
| Cost of product  and service sales   |       | 20,473                                            |       | 37.1 | % | 14,931 |   |
| Gross profit                         |       | 32,957                                            |       | 18.7 | % | 27,768 |   |
| Research and  development            |       | 8,850                                             |       | 79.0 | % | 4,946 |   |
| Marketing and selling                |       | 15,638                                            |       | 24.7 | % | 12,541 |   |
| General and  administrative          |       | 5,470                                             |       | 76.5 | % | 3,100 |   |
| Amortization of  intangible assets   |       | 59                                                |       | 15.7 | % | 51 |   |
| Income from operations               |       | $                                                 | 2,940      |   | (58.8 | )% | $ | 7,130 |   |

 

*NetProduct Sales and Service Revenue.*SpectraLink derives itsproduct revenue principally from the sale of wireless, on-premises telephonesystems. SpectraLink derives its service revenue principally from theinstallation and maintenance service of wireless, on-premises telephonesystems. Net product and service sales increased 22.6% and 25.1%, respectively,for the three months and six months ended June 30, 2006, compared to the sameperiods last year. Product sales increased 19.1% and 23.0% to $19.8 million and$39.4 million, respectively,  for the threemonths and six months ended June 30, 2006, from $16.6 million and $32.1 for the same periods last year. Theincrease in product sales was primarily related to an increase in our NetLinkproduct sales, which was largely attributable to an increase in OEM sales andsales to our retail market segment. Service sales increased 33.3% and 31.6% to$7.3 million and $14.0 million, respectively, for the three months and sixmonths ended June 30, 2006, from $5.5 million and $10.6 million for the sameperiods last year. The increase in service sales was primarily related to anincrease in maintenance contracts relating to all products previously sold to alarger installed base of our customers. The increase also related to anincrease in installation and time and materials services.

*Cost ofProduct Sales and Service Revenue.*Our cost of product salesconsists primarily of direct material, direct labor*,*product packaging, third-party royalties, and manufacturing overhead. Our costof service sales consists

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primarily of employee-related costs and the associated costs incurredto provide installation, maintenance, training, and product repair and support.

 

*Cost ofProduct*. For the three months and six months ended June 30,2006, cost of product sales increased by 42.8% and  42.0%, respectively, to $6.7 million and$13.1 million, respectively, from $4.7 million and $9.2 million, respectively,for the same periods last year. Cost of product sales as a percentage ofproduct sales, net was 33.7% and 33.2%, respectively, for the three months  and six months ended June 30, 2006 comparedto 28.1%  and  28.8% for the same periods last year. Grossprofit from product sales, net increased by 9.8% and 15.3%, respectively, to$13.1million and $26.3 million, respectively, for the three months and sixmonths ended June 30, 2006, from $11.9 million and $22.8 million, respectively,for the same periods last year. Gross profit percentage from product sales, net(gross profit from product sales, net as a percentage of net product sales) forthe three months ended June 30, 2006, decreased to 66.3% from 71.9% for thesame period last year primarily due an increase in material costs andadditional manufacturing variances. Gross profit percentage from product sales,net for the six months ended June 30, 2006, decreased to 66.8% from 71.2% forthe same period last year primarily due an increase in material costs,additional warranty costs SpectraLink incurred in the first quarter 2006 ofapproximately $0.3 million for field replacements related to an issue with aspecific product, and additional material costs related to a change in productmix including the launch of a new product in the second quarter 2006.

*Cost ofService Sales.*For the three months and six months ended June30, 2006, cost of service sales increased by 31.7% and 29.2%, respectively, to$3.9 million and $7.4 million from $3.0 million and $5.7 million for the sameperiods last year. Cost of service sales as a percentage of service sales was53.1% and 52.7%, respectively, for the three months and six months ended June30, 2006, compared to 53.7% and 53.7%, respectively, for the same periods lastyear. Gross profit from service sales increased by 35.1% and 34.5% to $3.4million and $6.6 million, respectively, for the three months and six monthsended June 30, 2006, from $2.5 million and $4.9 million, respectively,  for the same periods last year. Gross profitpercentage from service sales (gross profit from service sales as a percentageof service sales) for the three months and six months ended June 30, 2006,increased to 46.9% and 47.3%, respectively, from 46.3%  and 46.3%,respectively, for the same periods last year. The increase in gross profit fromservice sales was due to increased service sales, while costs remain relativelyflat.

*GrossProfit.*For the three months and six months ended June 30,2006, the SpectraLink segment’s gross profit percentage (gross profit as apercentage of net sales) decreased to 61.0% and 61.7%, respectively, from 65.5%and 65.0%  for the same periods last year.The decrease in gross profit was due to stronger NetLink product sales, whichcarry lower margins, and increased sales through the SpectraLink segment’s OEMpartners which typically carry higher discounts as well as an increase inwarranty costs in the first quarter 2006.

*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 were16.2% and 16.6%, respectively, for the three months and six months ended June30, 2006, compared to 11.3% and 11.6%, respectively, for the three months andsix months ended June 30, 2005. The increase in research and developmentdollars spent and the increase as a percentage of net sales, were each due toincreases in salaries, and employee benefits primarily related to increases inheadcount to support SpectraLink’s accelerated new product rollout schedule andcompensation expense associated with the fair value of share-based payments toemployees related to the adoption of SFAS 123R in the first quarter of 2006.Other factors contributing to this increase included consulting fees andmiscellaneous parts and supplies for the development of new products andenhancements to existing products.

*Marketing andSelling.*Marketing and selling expenses consistprimarily of salaries and other expenses for personnel, commissions, travel,advertising, tradeshows, sales meetings and market research. Marketing andselling expenses as a percentage of net sales were 29.7% and 29.3% for thethree months and six months ended June 30, 2006, compared to 29.4% and 29.4%,respectively, for the three months and six months ended June 30, 2005. Salesand marketing dollars spent increased due to increases in salaries and employeebenefits primarily related to increases in headcount and compensation expenseassociated with the fair value of share-based payments to employees related tothe adoption of SFAS 123R in the first quarter of 2006. Other factorscontributing to the increase included commissions and bonuses related to anincrease in sales.

*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 9.6% and 10.3%for the three months and six months ended June 30, 2006, compared to 7.0% and7.4%, respectively, for the three months and six months ended June 30,2005.  The increase in general andadministrative dollars spent and the increase as a percentage of net sales,were each due to increases in salaries and employee benefits primarily relatedto increases in headcount and merit raises as well as compensation expenseassociated with the fair value of share-based payments to employees related tothe adoption of SFAS 123R in

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the first quarter of 2006. For the six months ended June30, 2006, general and administrative expenses also increased due to increasedcosts in the first quarter 2006 for audit, 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.

For the three months and sixmonths ended June 30, 2006, SpectraLink also incurred interest expense relatedto its Credit Facility of approximately $0.3 million and $0.9 million,respectively, and amortization of debt issuance costs of approximately $0.03million and $0.3 million, respectively, related to the repayment of the termloan on the Credit Facility. There was nominal interest expense for the sameperiods last year. For the three months ended June 30, 2006, interest incomewas offset by a loss on sale of investments of $0.06 million.  Also, for the six months ended June 30, 2006,interest expense was offset by interest income on investments and a realizedgain on forward currency contracts.

*KIRKSegment*

The KIRK segment is comprised of the operations of KIRKtelecom A/S acquired on January 3, 2006 (“KIRK”) and the corporate activitiesof our wholly-owned subsidiary SpectraLink Denmark ApS, which exists to holdthe investment in KIRK. KIRK designs, manufactures and sells wireless on siteadjunct communication solutions. Based on the long-established DECT technologystandard, KIRK offers wireless handsets as well as the underlying radioinfrastructure for professional use. KIRK products are targeted at specificvertical markets and are offered in most major markets around the world.Products are sold under the KIRK brand as well as incorporated into OEMsolutions. The KIRK segment also includes KIRK telecom, Inc., which in 2005 wasa distribution sales subsidiary in the United States and KIRK scantel A/S,which designs, contract manufactures and sells wired and wireless telephonesunder the KIRK brand name to the residential market, primarily in theScandinavian countries.

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 telecom’s functional currency, therefore,results are impacted by fluctuations in the currency exchange between theDanish Krone and the U.S. Dollar.  Theyear to date June 30, 2006 results were impacted by an approximate 5%strengthening of the U.S. Dollar against the Danish Krone when compared to theyear to date June 30, 2005 pro forma results.
| ** **                                             | ** ** | **Three months ended June 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                            | ** ** | **% change** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(actual)**                                        | ** ** | ** ** | ** ** | **(pro-forma)** | ** ** |
| Net product  sales and service sales                   |       | $                                                   | 8,228      |   | (15.6 | )% | $ | 9,753 |   |
| Cost of sales                                          |       | 4,635                                               |       | (5.4 | )% | 4,898 |   |
| Gross profit                                           |       | 3,593                                               |       | (26.0 | )% | 4,855 |   |
| Research and  development                              |       | 1,433                                               |       | 17.6 | % | 1,219 |   |
| Marketing and  selling                                 |       | 914                                                 |       | (7.8 | )% | 991 |   |
| General and  administrative                            |       | 1,208                                               |       | (6.4 | )% | 1,291 |   |
| Acquired in  process research and development expenses |       | —                                              |       | — | % | — |   |
| Amortization of  intangible assets                     |       | 1,098                                               |       | — | % | 1,098 |   |
| (Loss) income from  operations                         |       | $                                                   | (1,060     | ) | (514.1 | )% | $ | 256 |   |

 

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|                                                        | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                          | ** ** | **% change** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(actual)**                                      | ** ** | ** ** | ** ** | **(pro-forma)** | ** ** |
| Net product  sales and service sales                   |       | $                                                 | 15,878     |   | (16.1 | )% | $ | 18,929 |   |
| Cost of sales                                          |       | 9,277                                             |       | (7.1 | )% | 9,988 |   |
| Gross profit                                           |       | 6,601                                             |       | (26.2 | )% | 8,941 |   |
| Research and  development                              |       | 2,791                                             |       | 15.0 | % | 2,426 |   |
| Marketing and  selling                                 |       | 1,965                                             |       | (11.7 | )% | 2,225 |   |
| General and  administrative                            |       | 2,326                                             |       | 1.3 | % | 2,297 |   |
| Acquired in  process research and development expenses |       | 2,021                                             |       | — | % | 2,021 |   |
| Amortization of  intangible assets                     |       | 2,196                                             |       | — | % | 2,196 |   |
| Loss from operations                                   |       | $                                                 | (4,698     | ) | 111.1 | % | $ | (2,224 | ) |

 

*NetProduct Sales and Service Revenue.*KIRK derives its productrevenue principally from the sale of wireless, on-premises telephone systems.KIRK derives its service revenue principally from the time and material repairsof wireless, on-premises telephone systems. Net product and service salesdecreased 15.6% and 16.1%, respectively, for the three months and six monthsended June 30, 2006, compared to the same periods last year. Product salesdecreased 18.5 % and 17.8% to $7.9 million and $15.4 million, respectively, forthe three months and six months ended June 30, 2006, from $9.8 million and$18.7 million for the same periods last year. The decrease in productsales was primarily related to a decrease in its OEM product sales, primarilyfrom one customer.  Service salesremained relatively constant between periods.

*Cost ofProduct Sales and Service Revenue.*KIRK’s cost of productsales consists primarily of direct material, direct labor*,*product packaging, third-party royalties, and manufacturing overhead. KIRK’scost of service sales consists primarily of costs incurred to provide productrepair.

*Cost ofProduct Sales*. For the three months and six months ended June30, 2006, cost of product sales decreased by 6.1% and  7.6%, respectively, to $4.6 million and $9.2million, respectively, from $4.9 million and $10.0 million, respectively, forthe same periods last year. Gross profit percentage from product sales, net forthe three months ended June 30, 2006, decreased to 42.1% from 49.8% for thesame period last year primarily due a decrease in material costs as there wasless OEM sales and it was offset by fixed costs over a lower volume.  Gross profit percentage from product sales,net for the six months ended June 30, 2006, decreased to 40.1% from 46.7% forthe same period last year primarily due a decrease in material costs as therewas less OEM revenue in the second quarter 2006 compared to the same periodlast year and was offset by fixed costs over a lower volume.

*Cost ofService Sales.*For the three months and six months ended June30, 2006, cost of service sales remained relatively constant between periods.

*GrossProfit.*For the three months and six months ended June 30,2006, the KIRK segment’s gross profit percentage (gross profit as a percentageof net sales) decreased to 43.7% and 41.6%, respectively, from 49.8% and 47.2%for the same periods last year. The decrease in gross profit was due to lowersales primarily in its OEM channel.

*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 17.4% and 17.6%,respectively, for the three months and six months ended June 30, 2006, comparedto 12.5% and 12.8%, respectively, for the three months and six months endedJune 30, 2005. The increase in research and development dollars spent and theincrease as a percentage of net sales, were each due to increases in salaries,and employee benefits primarily related to increases in headcount to supportdevelopment 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 andpromotion costs. Marketing and selling expenses as a percentage of net saleswere 11.1% and 12.4% for the three months and six months ended June 30, 2006,compared to 10.2% and 11.8%, respectively, for the three months and six monthsended June 30, 2005. The increase marketing and selling as a percentage ofrevenue is primarily due to a decrease in sales.

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*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 14.7% and 14.7% for the three months and six months endedJune 30, 2006, compared to 13.2% and 12.1%, respectively, for the three monthsand six months ended June 30, 2005. The increase in general and administrativedollars spent and the increase as a percentage of net sales, were each due toaudit, legal and outside consulting fees incurred due to the integration ofKIRK with SpectraLink for the first half of 2006.

**Liquidityand Capital Resources**

The followingsummarizes our key liquidity and capital resources metrics for the periodspresented:
|                                       | ** ** | **Six months ended  (In thousands)** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** ** | **June 30, 2006**                         | ** ** | **June 30, 2005** | ** ** |
| **Cash  Flows**                       |       |                                                |       |   |   |
| Cash provided by operating activities |       | $                                                   | 4,974      |   | $ | 8,731 |   |
| Cash used in investing activities     |       | (2,283                                              | )          | (7,820 | ) |
| Cash used in  financing activities    |       | (13,637                                             | )          | (6,672 | ) |
|                                       |            |                                                     |            |  |  |  |  |

 
|                                                | ** ** | **As of  June 30, 2006** | ** ** | **As of  December 31, 2005** | ** ** |
|------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------|------------|
| **Capital  Resources**                         |       |                                    |       |                                        |       |
| Cash and cash equivalents                      |       | $                                       | 5,855      |                                        | $          | 16,703 |   |
| Investments                                    |       | 10,564                                  |       | 14,088                                      |       |
| Cash held in escrow                            |       | —                                  |       | 55,148                                      |       |
| Working capital, excluding cash held in escrow |       | 29,426                                  |       | 30,271                                      |       |
| Short-term debt                                |       | 6,000                                   |       | 15,000                                      |       |
| Long-term debt                                 |       | 11,050                                  |       | 18,050                                      |       |
| Available credit                               |       | 9,000                                   |       | 1,950                                       |       |
|                                                |            |                                         |            |                                             |            |  |  |

 

Cashflows provided by operations decreased $3.8 million in the first half of 2006,compared to the first half of 2005.   Thedecrease is primarily due to increased spending related to the development andproduction 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 $5.5 million in the first half of2006, compared to the first half of 2005.  This is primarily the result of selling investments to fund part of theKIRK acquisition in 2006, as opposed to purchasing investments in 2005 with ourexcess cash flow.

Cash used in financingactivities increased by $7.0 million in the first half of 2006, compared to thefirst half of 2005.  The paydown ofacquisition-related debt in 2006 totaled $16.0 million, which is offset by  the $3.9 million of dividends paid and the$5.0 million of treasury stock purchases made in the first half of 2005.

Our available credit under ourrevolver at the end of June 2006 represents additional borrowings available tous based upon receivables and inventory at June 30, 2006, which is greater thanthe $7.0 million outstanding under the revolver at the end of June 2006.We calculate our available credit at the end of each month, beginning in June2006 under our Credit Facility (see Note 9 on page 13). The available credit isgenerally higher at the end of a quarterly period, due to the normallyoccurring fluctuations in our receivable and inventory balances.  Our intent is to reduce our outstanding debtunder the revolver by $1 million over the next 12 months.   Through August 9, 2006, we have made no additionalborrowings under the revolver.

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 be likely to result.

**Aggregate Contractual Obligationsand Commercial Commitments**

As of June 30, 2006, expected future cash paymentsrelated to contractual obligations and commercial commitments weresignificantly impacted by the addition of KIRK:
| Contractual Obligations    | ** ** | **Less Than  1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **More than  5 Years** | ** ** | **Total** | ** ** |
|---------------------------------|------------|---------------------------------|------------|--------------------|------------|--------------------|------------|----------------------------------|------------|-----------|------------|
| Debt (1)                        |       | $                               | 6,000      |               | $          | 11,050             |       | $                                | —     |      | $          | — |   | $ | 17,050 |   |
| Interest (1)                    |       | 1,024                           |       | 761                |       | —             |       | —                           |       | 1,785     |       |
| Operating Leases  (2)           |       | 1,119                           |       | 2,739              |       | 2,502              |       | 1,115                            |       | 7,475     |       |
| Other Purchase  Commitments (3) |       | 1,344                           |       | —             |       | —             |       | —                           |       | 1,344     |       |
| Total                           |       | $                               | 9,487      |               | $          | 14,550             |       | $                                | 2,502      |      | $          | 1,115 |   | $ | 27,654 |   |

 

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(1)          Referto Note 9 to our Condensed Consolidated Financial Statements on page 13.

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

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(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 amaterial adverse effect on our business, financial condition and results ofoperations.

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, chief financialofficer, secretary and treasurer effective May 15, 2006, and members ofthe Company’s executive team consisting of John Elms (president, chiefexecutive officer and a director), Masood Garahi (executive vice president ofengineering and chief technology officer), John Kelley (executive vicepresident of operations), Jill Kenney (executive vice president of Americassales, and marketing), Leah Maher (executive vice president and generalcounsel) and Gary Mead (vice president of market development) effectiveApril 17, 2006, all in the same form. The Company previously agreed to achange of control provision with Ole Lysgaard Madsen (executive vice presidentof international, and president and managing director of KIRK telecom A/S) uponthe Company’s acquisition of KIRK telecom A/S on January 3, 2006, underdifferent terms. According to the terms of the Agreement, in the event a changeof control of the Company occurs and an executive’s employment is terminated orconstructively terminated within twelve months following the change of control,the affected executive’s outstanding options will fully vest and the affectedexecutive will be entitled to twelve months of the affected executive’s annualsalary plus the affected executive’s target bonus plan (which assumes 100% ofthe target bonus plan is met for the year). Additionally, in the precedingcircumstance, that executive will receive benefits until the earlier of oneyear following termination or the date that executive receives comparablebenefits from another employer. On April 10, 2006, David Rosenthalresigned his position as executive vice president, chief financial officer,secretary and treasurer of the Company, and remains as special assistance tothe chief executive officer until September 10, 2006, at his currentsalary. Jill Kenney’s change of control contract severance agreement willterminate effective with her resignation as an executive officer of the Companyon August 31, 2006.

**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 consideringaccounting policies that involve the most complex or subjective decisions orassessments. Below is a summary of our most critical accounting policies. Thisdiscussion and analysis should be read in conjunction with our condensedconsolidated financial statements and related notes beginning on page 3 ofthis report and in conjunction with our consolidated financial statements andrelated notes included in our Annual Report on Form 10-K for the fiscal yearended December 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:

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•                    Itrequires us to make assumptions about matters that were uncertain at the timeof making the estimate, and

•                    Changesin the estimate or assumptions in the estimate could have a material impact onour financial condition or results of operations.

The followingtable presents information about the nature and rationale for our criticalaccounting policies and estimates used in the preparation of our consolidatedfinancial statements.
| **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 |

 

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| 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 |
|----------------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                   |   |                                       |   |                                                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   |                                                                                                                                                                                                                                                                                                 |
| 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                                                                                                                                                                                                             |

 

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| 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                                                                                                                                                                                                  |

 

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| 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 first half of 2006 did not have amaterial impact on our results of operations, financial condition, or cashflows:

·                  Statement of Financial AccountingStandards (“SFAS”) No. 151, “Inventory Costs – An Amendment of ARB No. 43,Chapter 4”;

·                  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”;

·                  EmergingIssues Task Force (“EITF”) Issue 05-06, “Determining the Amortization Periodfor Leasehold Improvements”; and

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·                  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,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 valueestimated in accordance with the provisions of SFAS 123R.  In accordancewith the modified 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 June 30, 2006.  This analysis will be re-evaluated quarterlyand the forfeiture rate will be adjusted as necessary.  Ultimately, theactual expense recognized over the vesting period will only be for those sharesthat vest. Forfeited or otherwise cancelled options are returned to the pool ofoptions authorized for issuance under our stock-based compensation plans. It isour policy to issue new shares, as opposed to treasury shares upon exercise orpurchase under our stock-based compensation plans.

See Note12 to the accompanying condensed consolidated financial statements onpage 15.

**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 presecribes a recognitionthreshold and measurement attribute for the financial statement recognition andmeasurement of a tax position 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 be after our year ending December 31, 2006.

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***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 servicing assetsand liabilities and clarifies when to separately recognize servicingobligations. We do not believe that the adoption of SFAS 156 will have animpact on our financial statements.

**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 wasdetermined by obtaining quoted market prices, and recognized as either assetsor liabilities. Changes in fair value of forward contracts are recognized inother income (loss), net at the end of each period. In the first half of 2006,we recognized a net realized gain of $0.2 million that was included in otherincome (expense) in the consolidated statements of operations, which was offsetby the related unrealized losses recorded as of December 31, 2005, fromthe changes in the 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 purchases. For the six months ended June 30, 2006, gainsfrom KIRK’s foreign currency contracts were insignificant.

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. We can borrow at the JP Morgan prime rateplus 1% or at the LIBO rate plus 2%. We borrowed $33.0 million under the CreditFacility as of December 31, 2005. As of June 30, 2006, we had $17.0million outstanding under the Credit Facility. On June 30, 2006, weelected to base the variable interest rate of our Credit Facility on theEurodollar rate, which is LIBO plus 2% (7.38%). Based upon borrowingsoutstanding at the end of June 2006, an increase in variable interestrates of 100 basis points would have an effect on the our annual results ofoperations and cash flows 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

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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 June 30, 2006, and based on theirevaluation, have concluded that our disclosure controls and procedures wereeffective 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 June 30, 2006, ourChief Executive Officer and Chief Financial Officer identified no changes inour internal control over financial reporting during the three-month periodended June 30, 2006, that affected, or are reasonably likely to affect, ourinternal control 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 our businessand prospects. The risks and uncertainties described below are not the onlyones that we face. Additional risks and uncertainties not presently known to usalso may impair our business operations. The occurrence of any of thefollowing risks could affect our business, financial condition or results ofoperations.*

·                                          **We are subject to numerous risks associated with our recent acquisitionof KIRK.**On January 3, 2006, we acquired KIRK, a provider of onsite,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 begiven that 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

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other acquired company could lead to the following:

·                  Diversion of management’s attentionfrom normal daily operations of the business;

·                  Potential difficulties in completingprojects associated with research and development due to uncertainty ofcombined product roadmap plans;

·                  Insufficient revenue to offsetincreased acquisition expenses;

·                  Recording goodwill andnon-amortizable intangible assets that will be subject to impairment testing ona regular basis and potential  impairmentcharges;

·                  Experience an increase in thecomplexity of accounting issues and reporting requirements related topreviously inapplicable accounting pronouncements, such as accounting policesrelated to foreign currency transactions;

·                  Difficulties in managing andintegrating internal financial control systems;

·                  Risks associated with a foreigncompany privately held becoming part of a U.S. public company;

·                  Complexities associated with managinginternal control systems in foreign subsidiaries;

·                  Incurring additional financial costsand personnel resources which may be required to timely comply on a consolidatedbasis with Section 404, “Management’s Internal Controls and Procedures forFinancial Reporting” of the Sarbanes-Oxley Act of 2002;

·                  Be subject to the impacts of currencyfluctuations;

·                  Incurring amortization expensesrelated to certain intangible assets;

·                  Incurlarge and immediate 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 a specific country’s orregion’s political or economic conditions;

·                  laws and regulations that restrictrepatriation of earnings or other funds; and

·                  difficultyin recruiting 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 risks associatedtherein. 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.

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·                  **Substantial leverage anddebt service obligations may adversely affect us.**Inanticipation of the KIRK acquisition, we took on a substantial amount ofindebtedness. As of June 30, 2006, we had approximately $17 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 obtainadditional long-term debt and working capital lines of credit to meet futurefinancing needs. 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; and

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

·                  **Restrictive covenants in theCredit Facility could adversely affect our business by limiting flexibility.**TheCredit Facility contains restrictive covenants and requirements that we complywith certain leverage and other financial tests. These limit our ability totake various 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-partyproduct development, 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 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

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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 these componentsmay also prevent us from decreasing our reliance on certain suppliers andfinding other sources at competitive prices. Unforeseen price increases by anyof the sole or limited source suppliers could negatively impact product marginsand 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 market share; cancellation of orders; difficulty in collecting accountsreceivable; increased service and warranty costs in excess of our estimates;diversion of resources, and; increased insurance costs and other losses to ourbusiness 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

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adversely affected resulting in reduced revenue,increased costs and decreased customer satisfaction. End-users have discoverederrors in our products in the past and may discover errors in our productsin the future. In addition, if our costs of remediation problems experienced byour customers 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 gainaccess to new technologies in order to increase product performance andfunction, reduce product size, and maintain cost-effectiveness;

·                  develop newproducts for existing and emerging wireless communications markets, andintroduce such products in a timely manner;

·                  implementemerging wireless standards or multiple emerging wireless standards quicklyenough to satisfy market demands and without significant product redesign orthe need to allocate additional resources to comply with multiple standards;

·                  develop orobtain access to advanced wireless capabilities as they become available; and

·                  design, developand 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:

·                  changes incustomer, geographic or product mix, including mix of configurations withineach product group;

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·                  fluctuatingmarket demand for, and declines in the average selling prices of, our products;

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

·                  seasonality indemand within our various sectors;

·                  increases inmaterial or labor costs;

·                  excessinventory;

·                  obsolescencecharges;

·                  changes inshipment volume;

·                  foreign currencyfluctuations;

·                  loss of costsavings due to changes in component pricing or charges incurred due toinventory holding periods if parts ordering does not correctly anticipateproduct demand;

·                  increases inprice competition;

·                  changes in themix of our distribution channels including our OEM partners;

·                  governmentregulation of frequency spectrum;

·                  increases inwarranty costs; and

·                  introduction ofnew 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 our targetcustomer 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 June 30, 2006, sales of our products through our indirectdistributors accounted for 44% of our product revenue and 34% 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

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have nondisclosure agreements with our third-partybusiness partners, we cannot guarantee that any third-party business partnerwould not use our confidential information to compete with us. Furthermore,since we have experienced lower gross margins related to sales to our OEMpartners, we may experience lower gross margins in the future if sales toour OEM partners become a larger percentage of product sales. Our successdepends in part upon our ability to maintain and expand theserelationships. The loss of any major partner, the failure to attract newpartners or inability to maintain the current level of revenue from ourexisting partners could have an adverse effect on our business, operatingresults and financial condition.

·                  **A lower than anticipated rate of acceptance of domestic andinternational markets using the 802.11 standard may impede our growth.**OurNetLink wireless telephones are compatible with the IEEE 802.11 standard foruse on 802.11 compliant WLAN networks. Consequently, demand for NetLinkwireless telephones depends upon the acceptance of markets utilizing 802.11compliant networks. This depends in part upon the initial adoption of the802.11 standard in international markets, as well as enhancements to thatstandard in the U.S. and foreign markets where the standard has already beenadopted. 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 wireless telephonesystems. Sales of our Link product have generally been flat in recent years. KIRKDECT solutions could face the same competition and cause a downward trend inour sales growth and 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 VicePresident of Engineering and Chief Technology Officer. Also, effective

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April 10, 2006, David Rosenthal, our ExecutiveVice President of Finance and Administration, Chief Financial Officer,Corporate Secretary and Treasurer resigned from his position. On May 15,2006, Ernest J. Sampias was hired as our Executive Vice President of Financeand Administration, Chief Financial Officer, Corporate Secretary and Treasurer.In addition, during the last two years, four of the six executive officers wereeither new to the Company or were promoted. Our success depends inpart upon the ability of new executives to work effectively together andwith the rest of our employees to continue to develop our technology and managethe operation and growth of our business. Excepting Ole Lysgaard Madsen,President and Managing Director of KIRK in Denmark, we have no employmentcontracts for our executive officers, and do not maintain key person insuranceon any of our executive officers. We might not be able to execute on ourbusiness plan if we were to lose the services of any of our key personnel. Ifany of these individuals were to leave us unexpectedly, we could facesubstantial difficulty in hiring qualified successors, and could experience aloss in productivity while any such successor develops the necessary trainingand experience.

·                  **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 Technology.**In theabsence 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 have incompatibilities,defects or bugs, which could result in significant expenditures as we seek toremedy the problems, delays in the purchase of the products or cancelledorders. We may also encounter delays in the manufacturing and productionof the new products. Additionally, the new products may not becommercially successful. Demand for existing products may decrease uponthe announcement of new or improved products. Further, since products underdevelopment are often announced before introduction, these announcementsmay cause customers to delay purchases of any products, even if newlyintroduced, until the new or improved versions of those products are available.If customer orders decrease or are delayed during the product transition, wemay experience a decline in revenue and have excess inventory on handwhich could decrease gross profit margins. Our gross margins might decrease ifcustomers, who may otherwise choose to purchase existing products, insteadchoose to purchase lower priced models of new products. Delays or deficienciesin the development, manufacturing, and delivery of, or demand for, new orimproved products could have a negative effect on our business, operatingresults 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

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accounts receivable collection, difficulties and costsof staffing and managing foreign operations, reduced protection forintellectual property rights, foreign currency exchange rate fluctuations, andtaxation consequences.

·                  **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 of low-costalternative products. Other purchasers may prefer to buy their 802.11wireless telephone systems from a single source provider of wireless local areanetworks, or LANs, such as Cisco Systems, who provides 802.11 wirelessinfrastructure 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

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rights of others, there can be no assurance thatinfringement claims will not occur in the future. From time to time, third parties may assert exclusive patent,copyright, trademark and other intellectual property rights to technologies andrelated methods that are important to us. Litigation may be necessary in the future to defend against claimsof infringement or invalidity, to determine the validity and scope of theproprietary 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.

·                  **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 certainlicenses or other rights or to obtain such licenses or rights on favorable terms,or the need to engage in litigation regarding these matters, could harm ourbusiness, 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 National 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 ofadditional costs we may incur as a result. In addition, we will need todocument, test and audit KIRK’s operations prior to year-end in 2006, whichmay be difficult 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 3-month period ended June 30, 2006, the closingprice of our common stock has ranged from a high of $12.52 per share to a lowof $7.56 per share. Many factors could cause the market price of our commonstock to fluctuate, including:

·                  variations in our actual or anticipated quarterlyor annual results;

·                  market conditions in our industry, the industriesof our customers and the economy as a whole;

·                  announcements of technological innovations by usor by our competitors;

·                  introduction of new products or productenhancements or new pricing policies by us or by our competitors;

·                  government regulation;

·                  acquisitions or strategic alliances by us or byour competitors;

·                  recruitment or departure of key personnel;

·                  the gain or loss of significant orders;

·                  changes in the market valuations of othertelecommunications companies;

·                  the amount of liquid financial resourcesavailable to us;

·                  the gain or loss of significant customersincluding 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,

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which could cause the market price of our common stockto fall for reasons not necessarily related to our business, results ofoperations or financial condition. The market price of our stock also mightdecline in reaction to events that affect other companies in our industry evenif these events do not directly affect us. Accordingly, you may not beable to resell your shares of common stock at or above the price you paid.Securities class action litigation is often brought against a company followinga period of volatility in the market price of its securities, and we havepreviously been sued in several purported securities class actionlawsuits. Further, certain of our management and directors were also sued inpurported stockholder derivative actions. The consolidated class actionsuit and derivative actions have all been settled.

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**Item 4.    Submission of Matters to a Vote of Security Holders**

At our Annual Meeting ofStockholders held on May 23, 2006, the following proposals were adopted by themargins indicated.

1.               To elect a Board of Directors to serve until thenext Annual Meeting of Stockholders and until their successors are elected andqualified.
|                                  | ** ** | **Number of Shares** | ** ** |
|----------------------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | **Voted For**             | ** ** | **Withheld** | ** ** |
| Carl D. Carman                   |       | 17,485,674                     |       | 1,136,307 |   |
| Anthony V.  Carollo, Jr.         |       | 17,527,229                     |       | 1,094,752 |   |
| John H. Elms                     |       | 17,711,113                     |       | 910,868 |   |
| Gerald J. “Bud”  Laber |       | 17,378,091                     |       | 1,243,890 |   |
| Werner P. Schmucking             |       | 17,753,438                     |       | 868,543 |   |

 

2.               To approve SpectraLink’s 2006 Equity IncentivePlan.  Number of shares voted: For10,849,076; Against 2,759,957; Abstain 246,861; Non-vote 4,766,087.

3.               To approve SpectraLink’s 2006 Employee StockPurchase Plan and 2006 International Employee Stock Purchase Plan.  Number of shares voted: For 12,071,423;Against 1,539,175; Abstain 245,296; Non-vote 4,766,087.

4.               Toratify the selection of KPMG LLP, independent registered public accountantingfirm, as our auditors for SpectraLink for the fiscal year ending December 31,2006. Number of shares voted: For18,392,447; Against 208,674; Abstain 20,860; Non-vote 0.

**Item 6.    Exhibits**

**(a) Exhibits**

Thefollowing exhibits are filed or furnished herewith:

 
| Exhibit Number | ** ** | **Exhibit Title** |
|---------------------|------------|------------------------|
| 10.1†          |       |                   | Third Amendment to Credit  Agreement, dated May 17, 2006. |
| 10.2†          |       |                   | Fourth Amendment to Credit  Agreement and Third Amendment to Security Agreement, dated as of June 30,  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. |

 

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† 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.

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**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.

SPECTRALINK CORPORATION

 

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

 

**Exhibit Index**
| Exhibit Number | ** ** | **Exhibit Title** |
|---------------------|------------|------------------------|
| 10.1†          |       |                   | Third Amendment to Credit  Agreement, and dated May 17, 2006. |
| 10.2†          |       |                   | Fourth Amendment to Credit  Agreement Third Amendment to Security Agreement, dated as of June 30, 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. |

 

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† 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.

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.

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