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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C.
20549
 FORM 10 - Q þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
  or o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the transition period from  to Commission file number 0-28180 SPECTRALINK CORPORATION  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 reports required to be filed by
Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2)
has been subject to such filing requirements for the past
90 days. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). Yes þ No o Applicable only to corporate issuers:
As of April 30, 2005, there were 19,151,028 shares outstanding of SpectraLink Corporations Common
Stock  par value per share $0.01.




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SPECTRALINK CORPORATION AND SUBSIDIARY
INDEX Part I
    
    
    
    Financial Information
    
    PageItem 1
    
    Condensed Consolidated Financial StatementsCondensed Consolidated Balance Sheets at
March 31, 2005 and December 31, 2004 (Unaudited)
    
    
    3Condensed Consolidated Statements of Income for the
Three Months Ended March 31, 2005 and 2004 (Unaudited)
    
    
    4Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2005 and 2004 (Unaudited)
    
    
    5Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    
    6Item 2
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    11Item 3
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    22Item 4
    
    Controls and Procedures
    
    
    30Part II
    
    
    
    Other Information
    
    
    31Item 1
    
    Legal Proceedings
    
    
    31Item 6
    
    Exhibits
    
    
    32(a) Exhibits
    
    
    32Signature
    
    
    
    
    33Certifications
    
    
    
    
    35Certification Pursuant to Section 302 - John H. ElmsCertification Pursuant to Section 302 - David I. RosenthalCertification Pursuant to Section 906 - John H. ElmsCertification Pursuant to Section 906 - David I. Rosenthal
  2




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PART I   ITEM
1CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SPECTRALINK CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited) March 31,
    
    
    December 31,2005
    
    
    2004ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    14,813
    
    
    $
    14,625Investments in marketable securities  current
    
    
    12,527
    
    
    
    11,984Trade accounts receivable, net of allowance of $336 and $374, respectively
    
    
    13,693
    
    
    
    21,252Income taxes receivable
    
    
    189
    
    
    
    Inventory, net of allowance of $570 and $720, respectively
    
    
    9,905
    
    
    
    8,076Deferred income taxes
    
    
    1,458
    
    
    
    1,473Prepaids and other
    
    
    1,380
    
    
    
    1,088Total current assets
    
    
    53,965
    
    
    
    58,498INVESTMENTS IN MARKETABLE SECURITIES, net of current portion
    
    
    33,237
    
    
    
    27,781PROPERTY AND EQUIPMENT, at cost:Furniture and fixtures
    
    
    2,632
    
    
    
    2,481Equipment
    
    
    10,788
    
    
    
    10,503Leasehold improvements
    
    
    1,113
    
    
    
    1,03614,533
    
    
    
    14,020Less  accumulated depreciation
    
    
    (9,827
    )
    
    
    (9,436
    )Net Property and equipment
    
    
    4,706
    
    
    
    4,584DEFERRED INCOME TAXES
    
    
    151
    
    
    
    103OTHER
    
    
    497
    
    
    
    460TOTAL ASSETS
    
    $
    92,556
    
    
    $
    91,426LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    2,474
    
    
    $
    1,132Income taxes payable
    
    
    
    
    
    
    1,038Accrued payroll, commissions and employee benefits
    
    
    2,201
    
    
    
    3,727Accrued sales, use and property taxes
    
    
    713
    
    
    
    732Accrued warranty expenses
    
    
    908
    
    
    
    901Other accrued expenses and liabilities
    
    
    3,005
    
    
    
    3,315Deferred revenue
    
    
    7,588
    
    
    
    7,144Total current liabilities
    
    
    16,889
    
    
    
    17,989LONG-TERM LIABILITIES
    
    
    186
    
    
    
    214TOTAL LIABILITIES
    
    
    17,075
    
    
    
    18,203STOCKHOLDERS EQUITY:Preferred stock, 5,000 shares authorized, none issued and outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 50,000 shares authorized,
23,590 and 23,407 shares issued, respectively, and 19,320
and 19,138 shares outstanding, respectively
    
    
    236
    
    
    
    234Additional paid-in capital
    
    
    79,379
    
    
    
    77,356Retained earnings
    
    
    28,263
    
    
    
    28,030Treasury stock, 4,270 shares, respectively at cost
    
    
    (32,397
    )
    
    
    (32,397
    )TOTAL STOCKHOLDERS EQUITY
    
    
    75,481
    
    
    
    73,223TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    92,556
    
    
    $
    91,426
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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SPECTRALINK CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited) Three Months EndedMarch 31,2005
    
    
    2004SALES:Product Sales
    
    $
    15,456
    
    
    $
    15,206Service Sales
    
    
    5,132
    
    
    
    4,107Net Sales
    
    
    20,588
    
    
    
    19,313COST OF
SALES:Cost of Product Sales
    
    
    4,549
    
    
    
    4,407Cost of Service Sales
    
    
    2,754
    
    
    
    2,441Total Cost of Sales
    
    
    7,303
    
    
    
    6,848Gross Profit
    
    
    13,285
    
    
    
    12,465OPERATING EXPENSES:Research and Development
    
    
    2,457
    
    
    
    2,066Marketing and Selling
    
    
    6,055
    
    
    
    5,951General and Administrative
    
    
    1,582
    
    
    
    1,216Total Operating Expenses
    
    
    10,094
    
    
    
    9,233INCOME FROM OPERATIONS
    
    
    3,191
    
    
    
    3,232INVESTMENT
INCOME AND OTHER:Interest Income, net
    
    
    351
    
    
    
    116Other Income (Expense)
    
    
    (52
    )
    
    
    41Total Investment Income and Other
    
    
    299
    
    
    
    157INCOME BEFORE INCOME TAXES
    
    
    3,490
    
    
    
    3,389INCOME TAX EXPENSE
    
    
    1,326
    
    
    
    1,288NET INCOME
    
    $
    2,164
    
    
    $
    2,101BASIC EARNINGS PER SHARE
    
    $
    0.11
    
    
    $
    0.11BASIC WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    19,230
    
    
    
    18,940DILUTED EARNINGS PER SHARE
    
    $
    0.11
    
    
    $
    0.11DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    19,710
    
    
    
    19,770
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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SPECTRALINK CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) Three Months EndedMarch 31,2005
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    2,164
    
    
    $
    2,101Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    395
    
    
    
    386Amortization of premium on investments in marketable securities
    
    
    33
    
    
    
    Income tax benefit from the exercise of stock options
    
    
    438
    
    
    
    194Provision for (recovery of) bad debts
    
    
    (20
    )
    
    
    35Provision for excess and obsolete inventory
    
    
    133
    
    
    
    128Deferred income taxes
    
    
    15
    
    
    
    (89
    )Changes in
assets and liabilities Decrease in trade accounts receivable
    
    
    7,579
    
    
    
    64Increase in income taxes receivable
    
    
    (189
    )
    
    
    Increase in inventory
    
    
    (1,962
    )
    
    
    (1,742
    )(Increase) decrease in other assets
    
    
    (329
    )
    
    
    57Increase in accounts payable
    
    
    1,342
    
    
    
    538(Decrease) increase in income taxes payable
    
    
    (1,038
    )
    
    
    875Decrease in accrued liabilities
    
    
    (1,868
    )
    
    
    (864
    )Increase in deferred revenue
    
    
    444
    
    
    
    372Net cash provided by operating activities
    
    
    7,137
    
    
    
    2,055CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (517
    )
    
    
    (490
    )Purchases of investments in marketable securities
    
    
    (6,139
    )
    
    
    Net cash used in investing activities
    
    
    (6,656
    )
    
    
    (490
    )CASH FLOWS FROM FINANCING ACTIVITIES:Principal payments under long-term obligation
    
    
    (8
    )
    
    
    (6
    )Proceeds from exercises of common stock options
    
    
    1,646
    
    
    
    1,049Dividends paid
    
    
    (1,931
    )
    
    
    (1,900
    )Net cash used in financing activities
    
    
    (293
    )
    
    
    (857
    )INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    188
    
    
    
    708CASH AND CASH EQUIVALENTS, beginning of period
    
    
    14,625
    
    
    
    51,861CASH AND CASH EQUIVALENTS, end of period
    
    $
    14,813
    
    
    $
    52,569SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid for income taxes
    
    $
    2,130
    
    
    $
    106SUPPLEMENTAL DISCLOSURE OF NON CASH INVESTING AND FINANCING
ACTIVITIES:Assets acquired under long-term obligation
    
    $
    
    
    
    $
    21
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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SPECTRALINK CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Unaudited) 1. Basis of Presentation The accompanying condensed consolidated financial statements as of March 31, 2005 and December
31, 2004, have been prepared from the books and records of SpectraLink Corporation and its wholly
owned subsidiary, SpectraLink International Corporation (together SpectraLink or the Company)
and are unaudited. In managements opinion, these financial statements include all adjustments,
consisting only of normal recurring adjustments, necessary to fairly present SpectraLinks
financial position, results of operations and cash flows for the periods presented. The results of
operations for the period ended March 31, 2005, are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending December 31, 2005. The financial statements should be read in conjunction with the audited financial statements
and notes thereto as of, and for the year ended, December 31, 2004, which are included in
SpectraLinks Annual Report on Form 10-K. The accounting policies utilized in the preparation of
the financial statements herein presented are the same as set forth in SpectraLinks annual
financial statements. Since its inception, the Company has conducted its operations in one
operating segment. Certain reclassifications have been made to the prior year financial statements to conform to
the current year presentation. 2. Stock-Based Compensation Plans The Company accounts for its stock-based compensation plans under Accounting Principles Board
Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees. Statement of Financial
Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation defines a fair
value based method of accounting for stock options and similar equity instruments. As allowed by
SFAS 123, the Company has continued to apply APB No. 25 to account for its employee stock based
compensation plans, and has adopted the disclosure requirements of SFAS 123 and Statement of
Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure, an amendment of SFAS 123. Had the Company determined compensation expense for its
stock-based compensation plans based on fair value at the date of grant under SFAS 123, the
Companys consolidated net income, and basic and diluted earnings per share, would have been the
pro forma amounts as follows: Three months ended March 31,2005
    
    
    2004(In thousands, except per share amounts)Net Income, as reported
    
    $
    2,164
    
    
    $
    2,101Deduct stock based employee compensation
expense under the fair value based method,
net of related tax effect:Compensation expense for stock options
    
    
    (858
    )
    
    
    (455
    )Compensation expense for the stock
purchase plan
    
    
    (37
    )
    
    
    (45
    )Net Income, pro forma
    
    $
    1,269
    
    
    $
    1,601Earnings Per Share:Basic  as reported
    
    $
    0.11
    
    
    $
    0.11Basic  pro forma
    
    $
    0.07
    
    
    $
    0.08Diluted  as reported
    
    $
    0.11
    
    
    $
    0.11Diluted  pro forma
    
    $
    0.06
    
    
    $
    0.08
 For SFAS 123 purposes, the fair value of each option grant is estimated as of the date of
grant using the Black-Scholes option pricing model with the following weighted average assumptions
used for grants: risk-free interest rates of 3.80% and 1.56% for the three months ended March 31,
2005 and 2004, respectively; expected lives (net of forfeitures) of 3.35 years and 4.06 years for
the three months ended March 31, 2005 and 2004, respectively; 6




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a $0.10 per share quarterly dividend for the three months ended March 31, 2005 and 2004,
respectively; and expected volatility of 74% and 79%, for the three
months ended March 31, 2005 and
2004, respectively. The fair value of each purchase right under the employee stock purchase plan
is estimated, for disclosure purposes, on the date of grant using the Black-Scholes model with the
following assumptions: a $0.10 per share quarterly dividend for the three months ended March 31,
2005 and 2004, respectively, an expected life of six months; expected volatility of 47% and 77%
for the three months ended March 31, 2005 and 2004, respectively; and a risk-free interest rate of
3.80% and 1.56% for the three months ended March 31, 2005 and 2004, respectively. 3. Inventories Inventories include the cost of raw materials, direct labor and manufacturing overhead, and
are stated at the lower of cost (first-in, first-out) or market. Inventories, net, as of March 31,
2005 and December 31, 2004, consisted of the following: March 31,
    
    
    December 31,2005
    
    
    2004(In thousands)Raw materials
    
    $
    4,435
    
    
    $
    4,245Work in progress
    
    
    
    
    
    
    1Finished goods
    
    
    5,470
    
    
    
    3,830$
    9,905
    
    
    $
    8,076
 The reserve for potential excess and/or obsolete inventories was $570,000 and $720,000 as of
March 31, 2005 and December 31, 2004, respectively. 4. Earnings Per Share Basic earnings per share is computed by dividing the net income by the weighted average number
of shares of common stock outstanding for the period. Diluted earnings per share is determined by
dividing the net income by the sum of the weighted average number of common shares outstanding, and
if not anti-dilutive, the effect of outstanding stock options and/or other common stock equivalents
as determined utilizing the treasury stock method. Potentially dilutive common stock options are
excluded from the calculation of dilutive income per share because they were anti-dilutive totaled
1,048,270 and 151,161 for the three months ended March 31, 2005 and 2004, respectively. A
reconciliation of the numerators and denominators used in computing earnings per share is as
follows: Three months ended March 31,(In thousands, except per share amounts)2005
    
    
    2004Income
    
    
    Shares
    
    
    Per Share
    
    
    Income
    
    
    Shares
    
    
    Per ShareBasic EPS
    
    $
    2,164
    
    
    
    19,230
    
    
    $
    0.11
    
    
    $
    2,101
    
    
    
    18,940
    
    
    $
    0.11Effect of dilutive securities:Stock purchase plan
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock options outstanding
    
    
    
    
    
    
    471
    
    
    
    
    
    
    
    
    
    
    
    830
    
    
    
    Diluted EPS
    
    $
    2,164
    
    
    
    19,710
    
    
    $
    0.11
    
    
    $
    2,101
    
    
    
    19,770
    
    
    $
    0.11
 7




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5. Product Warranties and Service The Company provides warranties against defects in materials and workmanship for its products
generally ranging from 90 days to 15 months, and, in limited cases, up to 18 months. At the time
the product is shipped, the Company establishes a provision for estimated expenses of providing
service under these warranties based on historical warranty experience. A summary of activity for
accrued product warranty and service is as follows: Three months endedMarch 31,2005
    
    
    2004(In thousands)Beginning Balance, Accrued Product Warranty and
Service
    
    $
    901
    
    
    $
    493Additions to the accrual for product warranties
    
    
    254
    
    
    
    314Reductions for incurred warranty charges
    
    
    (247
    )
    
    
    (213
    )Ending Balance, Accrued Product Warranty and Service
    
    $
    908
    
    
    $
    594
 6. Advertising Costs The Company expenses all advertising costs as they are incurred. Advertising expense for the
three months ended March 31, 2005 and 2004, were approximately $70,000 and $168,000, respectively. 7. Stockholders Equity During the first fiscal quarters of 2005 and 2004, the Company paid a quarterly cash dividend
of $0.10 per share totaling $1,931,000 and $1,900,000, respectively, to holders of common stock.
The Company did not repurchase any shares of outstanding common stock during the first fiscal
quarters of 2005 or 2004. 8. Legal Proceedings On January 14, 2002, SpectraLink issued a press release announcing preliminary financial
results for the fourth quarter of 2001 and revising downward its estimates for year 2002 results of
operations. Shortly after the press release, the Companys stock price declined and the Company
and certain of its officers and directors were named as defendants in four lawsuits filed between
February 7, 2002 and March 6, 2002, three of which were filed in the United States District Court
for the District of Colorado and one of which was filed in the Colorado District Court for the City
and County of Denver. In each of the lawsuits, plaintiffs, who purport to be purchasers or holders
of SpectraLink common stock, initially sought to assert claims either on behalf of a class of
persons who purchased securities in SpectraLink between July 19, 2001 and January 11, 2002, or in
the case of two of the lawsuits (one filed in the United States District Court and one in the
Colorado District Court), derivatively on behalf of SpectraLink. Two of the lawsuits filed in the
United States District contained essentially identical claims alleging that SpectraLink and certain
of its officers and directors violated Sections 10(b) and 20(a) and Rule 10b-5 under the Securities
Exchange Act of 1934, as a result of alleged public misstatements and omissions, accompanied by
insider stock sales made in the months prior to the decline in the price of SpectraLinks stock
after the January 14, 2002 press release. In the cases brought as derivative actions, the
plaintiffs allege that the officers and directors of SpectraLink violated fiduciary duties owed to
SpectraLink and its stockholders under state laws by allowing and/or facilitating the issuance of
these same alleged public misstatements and omissions, misappropriating nonpublic information for
their own benefit, making insider stock sales, wasting corporate assets, abusing their positions of
control, and mismanaging the corporation. The plaintiffs in these derivative cases allege that
SpectraLink has and will continue to suffer injury as a result of these alleged violations of duty
for which the officers and directors should be liable. The cases were designated as follows: Wilmer Kerns, Individually And On Behalf of All Others
Similarly Situated, Plaintiff, vs. SpectraLink Corporation, Bruce Holland and Nancy K. Hamilton,
Defendants (United States District Court Civil Action Number 02-D-0263); Danilo Martin Molieri,
Individually and On Behalf of All Others Similarly Situated, Plaintiff, v. SpectraLink Corporation,
Bruce Holland and Nancy K. Hamilton, Defendants (United States District Court Civil Action Number
02-D-0315); Evie Elennis, derivatively on behalf of SpectraLink 8




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Corporation, Plaintiff(s), v. Bruce M. Holland, Anthony V. Carollo, Jr., Gary L. Bliss, Michael P.
Cronin, Nancy K. Hamilton and John H. Elms, Defendants), and SpectraLink Corporation, Nominal
Defendant (United States District Court Civil Action Number 02-D-0345); and Roger Humphreys,
Derivatively on Behalf of Nominal Defendant SpectraLink Corporation, Plaintiff, v. Carl D. Carman,
Anthony V. Carollo, Jr., Bruce M. Holland, Burton J. McMurtry, Gary L. Bliss, Michael P. Cronin,
John H. Elms, and Nancy K. Hamilton, Defendants (Colorado District Court Case. No. 02CV1687). The Kerns and Molieri purported class actions were consolidated, and the plaintiffs filed a
Consolidated Amended Complaint in these Consolidated Actions. In January of 2003, the Court denied
a motion to dismiss that amended pleading, and discovery commenced. The Court certified a class of
all purchasers of publicly traded common stock of SpectraLink from April 19, 2001 through January
11, 2002, inclusive. On November 26, 2003, the Lead Plaintiffs in these Consolidated Actions moved
the court for permission to file a second consolidated amended class action, which would have
deleted certain of the original claims, would have extended the class period so that it would
commence on February 1, 2001 instead of April 19, 2001, and would have added more detail on claims
relating to alleged improper revenue recognition. The Company filed an opposition to that motion.
On March 5, 2004, the Magistrate Judge entered his Order denying plaintiffs motions, and
plaintiffs appealed that decision to the district court. On April 16, 2004, the parties to these Consolidated Actions held a mediation in San
Francisco. The parties entered into a Memorandum of Understanding settling the case for $1.5
million, subject to certain terms and conditions, including approval by the Court. The Court
granted a final hearing for approval of the settlement on October 7, 2004, ending the litigation.
The $1.5 million negotiated settlement was funded by the Companys directors and officers insurance
carrier. The two derivative actions were stayed pending resolution of the motion to dismiss in the
consolidated class action securities litigation, and plaintiffs counsel in the Elennis derivative
action filed an unopposed motion for relief from the stay and filed an amended complaint and then a
corrected amended complaint. Prior to the entry of the stays in each of the derivative cases, the
defendants had filed motions to dismiss. In August of 2003, Defendants moved to dismiss the amended
and corrected Elennis complaint. The Court denied that motion on March 22, 2004. No discovery has
been conducted in either of the derivative actions. The defendants in the derivative actions
engaged in settlement discussions with the derivative plaintiffs in light of the settlement of the
Consolidated Actions and the parties reached an agreement in settling both derivative cases on
March 23, 2005. An Order and Final Judgment was entered on March 25, 2005, ending the litigation.
The settlement was paid by SpectraLinks directors and officers insurance carrier. The Company has incurred a loss related to the directors and officers insurance deductible of
which the majority of the expense was reflected in 2002. As noted, the settlement of the
Consolidated Actions has been funded by insurance proceeds. SpectraLink is not presently a party to any other material pending legal proceedings of which
it is aware. 9. Recently Issued or Proposed Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS
123R), which replaces SFAS No.123, Accounting for Stock-Based Compensation, (SFAS123) and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123R requires all
share-based payments to employees, including grants of employee stock options, to be recognized in
the financial statements based on their fair values beginning with the first interim or annual
period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously
permitted under SFAS123 no longer will be an alternative to financial statement recognition. In
April 2005, the Securities and Exchange Commission made an amendment to Rule 401(a) regarding the
compliance date for SFAS 123R. Under Rule 401(a) as amended, the Company is not required to adopt
SFAS 123R until January 1, 2006. Under SFAS 123R, the Company must determine the appropriate fair
value model and related assumptions to be used for valuing share-based payments, the amortization
method for compensation cost and the transition method to be used at date of adoption. The
transition methods include prospective and retroactive adoption options. Under the retroactive
option, prior periods may be restated either as of the beginning of the year of adoption or for all
periods presented. The prospective method requires that compensation expense be recognized over
their vesting period for all unvested stock options at January 1, 2006, while the retroactive
method would record compensation expense for all unvested stock options beginning with the first
period restated. The Company is evaluating the requirements of SFAS123R and expects that the
adoption of SFAS 123R will have a material impact on its consolidated results of operations and
earnings per share. The Company has not yet determined the method of adoption or the effect of
adopting SFAS123R, and the Company has 9




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not determined whether the adoption will result in amounts that are similar to the current pro
forma disclosures under SFAS 123. In November 2004, the FASB issued SFAS No. 151, Inventory CostsAn Amendment of ARB No. 43,
Chapter 4 (SFAS 151). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, Inventory
Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that
items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be
recognized as current-period charges regardless of whether they meet the criterion of so abnormal
as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the production facilities.
SFAS 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted
by us in the first quarter of fiscal 2006, beginning on January 1, 2006. The Company is currently
evaluating the effect, if any, that the adoption of SFAS 151 will have on its consolidated results
of operations. 10




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##### Table of Contents



PART I   ITEM
2MANAGEMENTS DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Form 10-Q contains forward-looking statements within the context of Section 21E of the
Securities Exchange Act of 1934, as amended. Each and every forward-looking statement involves a
number of risks and uncertainties, which are described in this report. The actual results that we
achieve may differ materially from those described in any forward-looking statement due to such
risks and uncertainties. Certain statements in this Form 10-Q, as well as statements made by us in
periodic press releases, oral statements made by our officials to analysts and stockholders in the
course of presentations about us, and conference calls following earnings releases, constitute
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of
1995 (the Reform Act). Words such as believes, anticipates, expects, intends, could, might, and
similar expressions are intended to identify forward-looking statements, but are not the exclusive
means of identifying such statements. These projections and forward-looking statements are based
on assumptions, which are believed reasonable but are, by their nature, inherently uncertain. In
all cases, results could differ materially from those projected. Accordingly, caution should be
taken not to place undue reliance on any such forward-looking statements since such statements
speak only as of the date of the making of such statements. Some of the important factors that
could cause actual results to differ from any of these projections or other forward-looking
statements are detailed below and in other reports filed by us under the Securities Exchange Act of
1934. Certain risks and uncertainties relating to forward-looking statements are set forth below
in Managements Discussion and Analysis of Financial Condition and in Item 3 under the caption
Risk Factors. We undertake no obligation to revise any forward-looking statements in order to
reflect events or circumstances that may arise after the date of this report, except as may be
required under law. You should not place undue reliance on these forward-looking statements, which
apply only as of the date of this quarterly report on Form 10-Q. Business Description and Overview We commenced operations in April 1990 to design, manufacture and sell unlicensed wireless
telephone communication systems for businesses. Our product portfolio consists of two types of
product categories differentiated by the wireless technologies implemented into the product: The
LinkÔ wireless telephone system (Link WTS) and NetLinkÔ wireless telephones. Link WTS
uses a proprietary radio infrastructure in the 902-928 MHz radio band targeted to organizations
that desire a dedicated wireless voice solution for their on-premises mobile workforce. The
NetLink wireless telephone products operate over IEEE 802.11-compliant wireless local area networks
(WLANs) in the 2400-2483 MHz frequency band using standards-based Internet Protocol (IP)
technology. NetLink products are targeted at organizations that want both a wireless voice and
wireless data solution on a single network. We also offer an Open Application Interface (OAI),
which enables third-party messaging applications to be integrated with our wireless telephones.
Because of the recent advances in wireless local area network (WLAN) technology, a significant
portion of our development efforts will focus on our existing NetLink products as well as new
products that operate on a WLAN. For the three months ended March 31, 2005, we generated $20.6 million in revenue, resulting in
net income of $2.2 million and $0.11 earnings per fully diluted share. This represents
year-over-year growth in revenue of 7% and net income of 3%. In comparison, for the first quarter
of 2004, net income was $2.1 million, or $0.11 earnings per fully diluted share, on revenue of
$19.3 million. Our traditional distribution channels were responsible for about 59% of first quarter product
sales, original equipment manufacturer (OEM) partners contributed approximately 16% of first
quarter product sales, and the balance of 25% was met through our direct sales team. International
product sales were approximately $1 million in the first quarter equaling 6.3% of total product
sales. Sales from our Link Wireless Telephone Systems exceeded sales from our NetLink Wireless
Telephone Systems in the first quarter. Link accounted for 56% of product sales, delivering $8.7 million in
revenue. NetLink sales accounted for 44% of total product sales, or $6.8 million, which is down on
a percentage basis from a record high of 53% in the fourth quarter of 2004. As OEM sales
fluctuate, we experience correlating fluctuations for the NetLink product line. Overall gross margin was 64.5% in the first quarter, which is at the high end of our guidance
range of 60-65% for the year. We attribute this to above average direct sales as a percentage of
revenue as well as the shift in product mix favoring the Link products. Our Link product line gross
margin is approximately 10% higher than the aggregate gross margin from the sale of the NetLink
products because of the added infrastructure associated with Link sales. 11




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##### Table of Contents



However, we expect that we will sell more NetLink products; as a percentage of our total revenue,
over time, so we expect that our overall gross margin will decrease in the future. Our operating margin of 15.5% in the first quarter is below our annual guidance of 18 to 20%,
and is a direct result of lower than expected revenue for the first quarter and an increase in
sales and marketing expenses from hiring additional direct sales personnel, which we had
anticipated. However, our net income for the twenty-seventh consecutive quarter led to another
quarter of positive cash from operations. The $2.2 million in net income for the first quarter,
along with strong cash collections, resulted in the achievement by us of our twenty-fifth
consecutive quarter of positive cash from operations, with cash from operations totaling over $7
million. The total of cash, cash equivalents and investments on our balance sheet at March 31, 2005,
rose by more than 10% to $60.6 million from $54.4 million at December 31, 2004. We continue to
invest in low-risk instruments including government securities and tax-free investments. During the first quarter, we paid a cash dividend of $1.9 million for the sixth straight
quarter. We did not repurchase company stock in the first quarter. We have repurchased
approximately 4.3 million shares through our repurchase program leaving a remaining balance of
about 1.7 million shares still authorized for repurchase. In the first quarter, we launched enhanced features and capabilities for our NetLink Wireless
Telephones. These enhancements include support for the latest security standards, improved
performance and management for SpectraLinks exclusive Wi-Fi push-to-talk feature and new
user-interface attributes to improve usability in a wide variety of enterprise applications and
environments. We also announced our new NetLink h340 Wireless Telephone in the first quarter.
Designed for the demanding needs of the healthcare industry, the Wi-Fi handsets provide immediate
communication for nurses, doctors and hospital staff with the privacy, security, voice quality and
other business quality call features they require. We continue to monitor several emerging competitive threats. One such threat comes from
overseas manufacturers attempting to bring products to the U.S. market that operate on the 1900 MHz
DECT standard. We note that products from manufacturers in the Far East are not yet competitive
with our products, since they remain entirely based on off-the-shelf silicon and standards based
audio technology that provide none of the standards-plus features and quality that our customers
have come to expect in a business quality wireless telephone. In addition, several manufacturers
have announced wireless telephony products targeted at the enterprise with availability planned for
later in 2005. Taking into account our first quarter results, and the near-term outlook for continuing
softness in the OEM channel, we now expect our 2005 revenue to be just above $100 million, plus or
minus 5%, with upside and downside potential roughly equal. 12




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##### Table of Contents



Results of Operations Net Sales Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    March 31, Ended2005
    
    
    2004 to 2005
    
    
    2004Net sales
    
    $
    20,588,000
    
    
    
    6.6
    %
    
    $
    19,313,000
 Product Sales, Net.We derive our product revenue principally from the sale of
wireless, on-premises telephone systems. Product sales for the three months ended March 31, 2005 remained relatively constant with an
increase of 1.7% to $15,456,000 from $15,206,000 for the same period last year. Service Sales. We derive our service revenue principally from the installation and service
of wireless, on-premises telephone systems. Service sales for the three months ended March 31, 2005 increased 25.0% to $5,132,000 from
$4,107,000 in the same period last year. The increase in service sales was primarily due to
increased revenue from maintenance contracts relating to products previously sold to a larger
installed base of customers, which continue to use our products and purchase maintenance
contracts. Service sales also increased due to additional installations and time and material
service repairs. The following table details the sales to different customer types as a percentage of total net
sales. Three Months EndedMarch 31,Customer Mix Table (As a Percentage of Net Sales)
    
    2005
    
    
    2004Customer Type:Indirect Product Sales (excluding OEM)
    
    
    44.4
    %
    
    
    49.4
    %OEM Product Sales
    
    
    12.1
    %
    
    
    5.7
    %Direct Product Sales
    
    
    18.6
    %
    
    
    23.6
    %Service Sales
    
    
    24.9
    %
    
    
    21.3
    %Total Net Sales
    
    
    100.0
    %
    
    
    100.0
    %
 The following table summarizes sales to major customers: Three Months EndedMarch 31,Sales to Major Customers (As a Percentage of Net Sales)
    
    2005
    
    
    2004Customer A:
    
    
    *
    
    
    
    10.8
    %
 (*) represents less than 10% of our revenue As of March 31, 2005, we had no customers that represented more than 10% of our net trade
accounts receivable. As of December 31, 2004, three customers represented more than 10% of our
trade accounts receivable. These customers represented 13.2%, 11.9% and 10.2% of net trade accounts
receivable. 13




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##### Table of Contents



Total Cost of Sales Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    Ended March 31,2005
    
    
    2004 to 2005
    
    
    2004Total cost of sales
    
    $
    7,303,000
    
    
    
    6.6
    %
    
    $
    6,848,000
 Cost of Product Sales.Our cost of product sales consists primarily of direct
material, direct labor, product packaging, third party royalties, and manufacturing overhead. In the three months ended March 31, 2005, cost of product sales increased by 3.2% to
$4,549,000 from $4,407,000 in the same period last year. Cost of product sales as a percentage of
product sales, net was 29.4% and 29.0% for the three months ended March 31, 2005 and 2004,
respectively. Gross profit from product sales, net increased 1.0% to $10,907,000 for the three months ended
March 31, 2005, from $10,799,000 in the same period last year. For the three months ended March 31,
2005 and 2004, gross profit percentage from product sales, net (gross profit from product sales,
net as a percentage of product sales, net) remained constant at 70.6% from 71.0%, respectively. Cost of Service Sales.Our cost of service sales consists primarily of employee-related costs
and the associated costs incurred to provide installation, maintenance, training, and product
repair and support. Cost of service sales for the three months ended March 31, 2005, increased by 12.8% to
$2,754,000 from $2,441,000 in the same period last year. Cost of service sales as a percentage of
service sales was 53.7% for the three months ended March 31, 2005, compared to 59.4% for the same
period last year. For the three months ended March 31, 2005, gross profit from service sales increased by 42.7%
to $2,378,000 from $1,666,000 in the same period last year. For the three months ended March 31,
2005 and 2004, respectively, gross profit from service sales, as a percentage of service sales,
increased to 46.3% from 40.6%. For the three months ended March 31, 2005, compared to the same
periods last year, gross profit from service sales increased primarily due to lower write-offs and
reserves for obsolete service inventory and to economies of scale resulting from increased service
sales. Gross Profit Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    Ended March 31,2005
    
    
    2004 to 2005
    
    
    2004Gross profit
    
    $
    13,285,000
    
    
    
    6.6
    %
    
    $
    12,465,000
 For the three months ended March 31, 2005, our gross profit margin (gross profit as a
percentage of net sales) remained constant at 64.5% when compared to the same period last year. Operating Expenses Research and Development Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    Ended March 31,2005
    
    
    2004 to 2005
    
    
    2004Expenses
    
    $
    2,457,000
    
    
    
    18.9
    %
    
    $
    2,066,000Percentage of net sales
    
    
    11.9
    %
    
    
    
    
    
    
    10.7
    %
 Research and development expenses consist primarily of employee costs, professional
services, and supplies necessary to develop new products, enhance existing products and reduce the
cost of our systems. We expect that research and development expenses will be approximately 10% of
net sales for fiscal 2005. 14




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##### Table of Contents



For the three months ended March 31, 2005, compared to the same period last year, the increase
was primarily due to increases in salaries and employee benefits related to increases in headcount
and merit raises as well as consulting and facility costs. Marketing and Selling Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    Ended March 31,2005
    
    
    2004 to 2005
    
    
    2004Expenses
    
    $
    6,055,000
    
    
    
    1.7
    %
    
    $
    5,951,000Percentage of total net sales
    
    
    29.4
    %
    
    
    
    
    
    
    30.8
    %
 Marketing and selling expenses consist primarily of salaries and other expenses for
personnel, commissions, travel, advertising, tradeshows, sales meetings and market research. The increase in dollars spent for the three months ended March 31, 2005, compared to the same
period last year for both domestic and international sales, was primarily related to commissions
due to higher sales in 2005 compared to the same period last year, as well as an increase in
training and tradeshows. In addition, the increase was offset by a decrease in legal fees, as we
negotiated and finalized several OEM agreements in the first quarter of 2004 and telephone
expenses. Marketing and selling expenses as a percentage of net sales decreased from the prior
year due to higher sales. General and Administrative Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    Ended March 31,2005
    
    
    2004 to 2005
    
    
    2004Expenses
    
    $
    1,582,000
    
    
    
    30.1
    %
    
    $
    1,216,000Percentage of total net sales
    
    
    7.7
    %
    
    
    
    
    
    
    6.3
    %
 General and administrative expenses consist primarily of salaries and other expenses for
management, finance, accounting, contract administration, order processing, investor relations, and
human resources, as well as legal and other professional services. The increase for the three months ended March 31, 2005, compared to the same period last year,
was primarily due to increasing our infrastructure to support future growth, which resulted in
increased headcount, salaries and employee benefits to hire and retain personnel, as well as
increases in insurance, travel and professional fees. This increase was offset by a decrease in
legal fees and bad debt expense. Income from Operations Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    Ended March 31,2005
    
    
    2004 to 2005
    
    
    2004Income from Operations
    
    $
    3,191,000
    
    
    
    (1.3
    )%
    
    $
    3,232,000Percentage of total net sales
    
    
    15.5
    %
    
    
    
    
    
    
    16.7
    %
 The income from operations for the three months ended March 31, 2005, remained relatively
consistent with the same period last year. 15




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##### Table of Contents



Other Non-Operating Income Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    Ended March 31,2005
    
    
    2004 to 2005
    
    

2004Investment income and other
    
    $
    299,000
    
    
    
    90.4
    %
    
    $
    157,000Percentage of total net sales
    
    
    1.5
    %
    
    
    
    
    
    
    0.8
    %
 Investment income is the result of our investment in money market, investment-grade debt
securities, government securities, and corporate bonds, while reduced by typical banking fees. Income Tax Three Months
    
    
    
    
    
    
    Three MonthsEnded March 31,
    
    
    % Change
    
    
    Ended March 31,2005
    
    
    2004 to 2005
    
    
    2004Income tax expense
    
    $
    1,326,000
    
    
    
    3.0
    %
    
    $
    1,288,000Percentage of total net sales
    
    
    6.4
    %
    
    
    
    
    
    
    6.7
    %Effective tax rate
    
    
    38.0
    %
    
    
    
    
    
    
    38.0
    %
 The
increase in income tax expense for the three months ended March 31, 2005, compared to the
same period last year was primarily related to higher taxable income. Liquidity and Capital Resources Three Months
    
    
    Three MonthsEnded March 31,
    
    
    Ended March 31,2005
    
    
    2004Cash from operating activities
    
    $
    7,137,000
    
    
    $
    2,055,000Cash used in investing activities
    
    
    (6,656,000
    )
    
    
    (490,000
    )Cash used in by financing activities
    
    
    (293,000
    )
    
    
    (857,000
    )
 We have funded our operations since inception with cash provided by operations,
supplemented by equity financing and leases on capital equipment. As of March 31, 2005, we had
$60,577,000 of cash, cash equivalents, short-term and long-term investments. During the three months ended March 31, 2005, we generated cash from operations of $7,137,000
consisting principally of net income of $2,164,000, a decrease in trade account receivable of
$7,579,000, adjustments for depreciation and amortization, income tax benefit from exercises of
stock options, and provision for excess and obsolete inventory that reconcile net income to cash,
as well as increases in accounts payable and deferred revenue. The cash generated from operations
was offset by increases in inventory, and other assets and decreases in income taxes payable and
accrued liabilities. The decrease in the trade accounts receivable balance relates to a decrease
in revenue in the first quarter of 2005 compared to the fourth quarter of 2004 and cash collections
of approximately $29,000,000 during the first quarter of 2005. As of March 31, 2005, our trade
accounts receivable days sales outstanding (DSO) was 45 days compared to 54 days as of December 31,
2004. This decrease in DSO was due to higher OEM sales in the fourth quarter 2004 which have
longer payment terms. As OEM sales increase, we expect our DSO to trend up. For the three months ended March 31, 2005, investing activities used cash of $6,656,000, of
which $6,139,000 was used for the purchase of marketable securities and $517,000 was used for
purchases of property and equipment primarily related to purchases of software, research equipment,
manufacturing equipment, manufacturing tooling and molds and leasehold improvements. Our
investments in marketable securities consist of available for sale and held to maturity securities
invested in government securities, tax-free short-term bond funds and an
enhanced income fund with investments primarily in corporate notes and bonds, asset backed
securities, U.S. government securities and municipal obligations. 16




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##### Table of Contents



We used $293,000 of cash in financing activities in the three months ended March 31, 2005,
which was primarily a result of the issuance and payment of a quarterly cash dividend for
$1,931,000. This cash outflow was offset by proceeds of $1,646,000 received from common stock
option exercises. As of March 31, 2005, we had no debt outstanding, and there were no off-balance sheet
arrangements, unconsolidated subsidiaries, commitments or guarantees, except as disclosed in the
notes to the consolidated financial statements included in the 2004 Form 10-K or as noted in the
Aggregate Contractual Obligations and Commercial Commitments section. Stockholders equity at
March 31, 2005, was $75,481,000, which represented 81.6% of total assets. As of March 31, 2005, we had working capital of $37,076,000 compared to $40,509,000 at
December 31, 2004. The decrease in working capital occurred primarily from the purchase of
investments in marketable securities classified as long-term. As of March 31, 2005, our current
ratio (ratio of current assets to current liabilities) was 3.20:1, compared with a current ratio of
3.25:1 as of December 31, 2004. We believe that our current cash, cash equivalents, marketable securities and cash generated
from operations will be sufficient, based on our presently anticipated needs, to fund necessary
capital expenditures, to provide adequate working capital, pay dividends if any are declared and to
finance our expansion for the foreseeable future (next 12 months). There can be no assurance,
however, that we will not require additional financing. There can be no assurance that any
additional financing will be available to us on acceptable terms, or at all, when required by us.
If additional funds were to be raised through the sale of equity securities, additional dilution to
the existing stockholders would be likely to result. Aggregate Contractual Obligations and Commercial Commitments We incur various contractual obligations and commercial commitments in our normal course of
business. Such obligations and commitments consist primarily of the following: Lease Commitments.We lease our facilities under non-cancelable operating lease arrangements
that expire at various dates through 2007. We have other obligations for office equipment that
expire at various dates through 2008. Purchase Commitments.We incur various purchase obligations with vendors and suppliers for
the purchase of inventory, as well as goods and services, in the normal course of business. These
obligations are generally evidenced by purchase orders with delivery dates from six to twelve
months from the purchase date, and in certain cases, purchase orders that contain
non-cancelable/non-returnable terms and conditions associated with these purchase arrangements. We
are committed to accept delivery of such materials pursuant to such purchase orders subject to
various contract provisions, which allow us to delay receipt of such orders. Such orders may or
may not include cancellation costs payable by us. In the past, we have been required to take
delivery of materials from our suppliers that were in excess of demand requirements, and we have
previously recognized charges and expenses related to such excess material, resulting primarily
from engineering changes. If we are not able to adequately manage our supply chain and adjust such
commitments for changes in demand, we may incur additional inventory expenses related to excess and
obsolete inventory. Such expenses could have a material adverse effect on our business, financial
condition and results of operations. Indemnifications. We provide indemnifications of varying scope and size to certain customers
against claims of intellectual property infringement made by third parties arising from the use of
our products. We evaluate estimated losses for such indemnifications under SFAS 5, Accounting for
Contingencies, as interpreted by FASB Interpretation 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others(FIN 45). We
consider such factors as the degree of probability of an unfavorable outcome and 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 have not accrued any liabilities related to such
indemnifications in our financial statements. 17




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##### Table of Contents



As of March 31, 2005, expected future cash payments related to contractual obligations and
commercial commitments were as follows: 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    Thereafter
    
    
    TotalOperating leases
    
    $
    902,000
    
    
    $
    912,000
    
    
    $
    344,000
    
    
    $
    
    
    
    $
    
    
    
    $
    2,158,000Purchase commitments
    
    
    1,350,000
    
    
    
    106,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,456,000Other obligations
    
    
    42,000
    
    
    
    50,000
    
    
    
    50,000
    
    
    
    18,000
    
    
    
    
    
    
    
    160,000Total contractual
obligations and
commercial
commitments
    
    $
    2,294,000
    
    
    $
    1,068,000
    
    
    $
    394,000
    
    
    $
    18,000
    
    
    $
    
    
    
    $
    3,774,000
 We believe our existing cash balances and funds expected to be generated from future
operations will be sufficient to satisfy these contractual obligations and commercial commitments,
and that the ultimate payments associated with these commitments will not have a material adverse
effect on our liquidity position. Critical Accounting Policies and Estimates We have identified the most critical accounting principles upon which our reported financial
position and results of operations depends. We determined the critical accounting principles by
considering accounting policies that involve the most complex or subjective decisions or
assessments. Below is a summary of our most critical accounting policies. This discussion and
analysis should be read in conjunction with our condensed consolidated financial statements and
related notes beginning on page 3 of this report and in conjunction with our consolidated financial
statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2004, which was filed with the U.S. Securities and Exchange Commission on March 4,
2005. Our discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
We evaluate our estimates, on an on-going basis, including those related to revenue recognition,
receivables, product warranty obligations, inventories and income taxes. We base our estimates on
historical experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. We consider an accounting estimate to be critical if:  
    It requires us to make assumptions about matters that were uncertain at the time of
making the estimate, and
    Changes in the estimate or assumptions in the estimate could have a material impact
on our financial condition or results of operations. The following table presents information about the nature and rationale for our critical
accounting policies and estimates used in the preparation of our consolidated financial statements. 18




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##### Table of Contents



Financial Statement
    
    Critical Estimate
    
    Nature of Estimates
    
    Assumptions/ApproachesCaption(s)
    
    Item
    
    Required
    
    Used
    
    Key FactorsSales 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
 19




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##### Table of Contents



Financial Statement
    
    Critical Estimate
    
    Nature of Estimates
    
    Assumptions/ApproachesCaption(s)
    
    Item
    
    Required
    
    Used
    
    Key FactorsAccounts 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
 Financial Statement
    
    Critical Estimate
    
    Nature of Estimates
    
    Assumptions/ApproachesCaption(s)
    
    Item
    
    Required
    
    Used
    
    Key FactorsCost 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
 20




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Financial Statement
    
    Critical Estimate
    
    Nature of Estimates
    
    Assumptions/ApproachesCaption(s)
    
    Item
    
    Required
    
    Used
    
    Key FactorsDeferred 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
carryforward
period, tax
planning
opportunities and
other relevant
considerations.
    
     Tax law changes
 Variances in future projected profitability, including by taxing entity
 Financial Statement
    
    Critical Estimate
    
    Nature of Estimates
    
    Assumptions/ApproachesCaption(s)
    
    Item
    
    Required
    
    Used
    
    Key FactorsWarranty
    
    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
 In addition, there are other items within our financial statements that require estimation,
but are not as critical as those discussed above. Revisions to any of the discussed estimates, or
other non-critical items, could have a significant effect on our consolidated financial statements. Recently Issued Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS
123R), which replaces SFAS No.123, Accounting for Stock-Based Compensation, (SFAS123) and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123R requires all
share-based payments to employees, including grants of employee stock options, to be recognized in
the financial statements based on their fair values beginning with the first interim or annual
period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously
permitted under SFAS123 no longer will be an alternative to financial statement recognition. In
April 2005, the Securities and Exchange Commission made an amendment to Rule 401(a) regarding the
compliance date for SFAS 123R. Under Rule 401(a) as amended, we are not required to adopt SFAS
123R until January 1, 2006. Under SFAS 123R, we must determine the appropriate fair value model
and related assumptions to be used for valuing share-based payments, the amortization method for
compensation cost and the transition method to be used at date of adoption. The transition methods
include prospective and retroactive adoption options. Under the retroactive option, prior periods
may be restated either as of the beginning of the year 21




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of adoption or for all periods presented. The prospective method requires that compensation expense
be recognized over their vesting period for all unvested stock options at January 1, 2006, while
the retroactive method would record compensation expense for all unvested stock options beginning
with the first period restated. We are evaluating the requirements of SFAS123R and expect that the
adoption of SFAS 123R will have a material impact on our consolidated results of operations and
earnings per share. We have not yet determined the method of adoption or the effect of adopting
SFAS123R, and we have not determined whether the adoption will result in amounts that are similar
to the current pro forma disclosures under SFAS 123. In November 2004, the FASB issued SFAS No. 151, Inventory CostsAn Amendment of ARB No. 43,
Chapter 4 (SFAS 151). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, Inventory
Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that
items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be
recognized as current-period charges regardless of whether they meet the criterion of so abnormal
as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the production facilities.
SFAS 151 is effective for fiscal years beginning after June 15, 2005, and is required to be adopted
by us in the first quarter of fiscal 2006, beginning on January 1, 2006. We are currently
evaluating the effect, if any, that the adoption of SFAS 151 will have on our consolidated results
of operations. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk. Market risk represents the risk of loss that may impact our financial position, results of
operations or cash flows due to adverse changes in financial and commodity market prices and rates.
We are exposed to market risk due to changes in United States interest rates. These exposures are
directly related to our normal operating and funding activities. As of March 31, 2005, we have not
used derivative instruments or engaged in hedging activities, and have not been currently impacted
significantly by fluctuations in foreign currency exchange rates. Interest Rate Risk As part of our cash management strategy, at March 31, 2005, we had cash, cash equivalents and
investments in marketable securities of approximately $60,577,000 mainly in the form of bank demand
deposits, money market government securities and bond funds. We have completed a market risk
sensitivity analysis of these cash and cash equivalents based on an assumed 1% point increase in
interest rates. If market rates had increased or decreased 1% during the three month period ended
March 31, 2005, interest income would have increased or decreased by approximately $143,000. RISK FACTORS The factors discussed below are cautionary statements that identify important factors that
could cause actual results to differ materially from those anticipated by the forward-looking
statements contained in this report. For more information regarding the forward-looking statements
contained in this report, see the introductory paragraph to Part I of this report. You should
carefully consider the risks and uncertainties described below together with all of the other
information included in this report, in considering our business and prospects. The risks and
uncertainties described below are not the only ones facing SpectraLink. Additional risks and
uncertainties not presently known to us also may impair our business operations. The occurrence of
any of the following risks could affect our business, financial condition or results of operations.  
    If we are unable to fulfill quarter end customer orders, then we could lose revenue
and customers.The volume of customer orders for our products typically increases
significantly at the end of each quarter. Generally, sales in a given quarter are
distributed approximately as follows: 15% in the first month, 25% in the second month,
and 60% in the third month. We face significant challenges in meeting this demand. It
is difficult to ensure that we have the resources available to meet any such increase in
order volume since it is very difficult to predict what the level of demand will be. We
may not have the personnel and/or systems necessary to fulfill the large order volume or
the ability to upgrade and develop our systems and infrastructure to meet an increased
order volume. If we are unable to meet demand from our customers for our products in a
cost effective manner, then we might lose revenue and customers, or incur increased
operating costs, either of which would harm our business.
    Many of the orders for our products are realized at the end of the quarter, which
makes it difficult 22




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to forecast or adjust our operating activities quickly in response to an unexpected
increase or decrease in customer demand.Due to the timing of orders from customers, we
have often recognized a substantial portion of our revenue in the last month of a quarter.
As a result, minor fluctuations in the timing of orders and the shipment of products may,
in the future, cause operating results to vary significantly from quarter to quarter. The
demand for our products depends upon many factors and is difficult to forecast.
Significant unanticipated fluctuations in demand could cause problems in our operations.
The lead-time required to assemble our systems is often longer than the lead-time our
customers provide to us for delivery of their product requirements. Therefore, we often
must place orders in advance of expected purchase orders from our customers. As a result,
we have only a limited ability to react to fluctuations in demand for our products, which
could cause us to have either too much or too little inventory of a particular product.
Further, the business relationship which we have with Offshore Group to use a Mexico
facility to assemble our products may not be able to provide product in a timely manner.
Additionally, once we receive an order, it requires sufficient time to complete the
configuration of our product to our customers individual phone systems.Our inability to satisfy customer demand in a timely manner would lead to lost sales and
impede our ability to increase our revenue. Conversely, a large portion of our expenses,
including rent and salaries, is fixed and difficult to reduce. Our expenses are based in
part on expectations for our revenue. If our revenue does not meet our expectations, the
adverse effect of the revenue shortfall upon our operating results may be acute in light
of the fixed nature of our expenses.
    Our reliance on sole or limited sources of supply for many components and equipment
used in our manufacturing process.We rely on sole or limited sources of supply for many
components and equipment used in our manufacturing process. The delay, inability, or
refusal of any of these suppliers to ship these components or equipment could interrupt
our manufacturing process and ability to manufacture products in a timely manner to meet
customer demand. The limited number of sources for many of these components may also
prevent us from decreasing our reliance on certain suppliers and finding other sources at
competitive prices. Unforeseen price increases by any of the sole or limited source
suppliers could negatively impact product margins and the financial performance of our
company.
    Because many of our current and planned products are or will be highly complex, they
may contain defects or errors that are detectable only after deployment in complex
networks and which, if detected, could have a negative effect 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
discover defects or errors or experience breakdowns in their networks after the products
have been deployed. If any of these products contain defects, or have reliability,
quality or compatibility problems, our reputation might be damaged significantly and
customers might be reluctant to buy our products. These defects could interrupt or delay
sales. We may have to invest significant capital and other resources to correct these
problems. If we fail to provide solutions to the problems, we will also incur product
recall, repair, warranty or replacement costs. These problems might also result in
claims against us by our customer or others. In addition, the occurrence of any defects
or errors in these products, could result in: failure to achieve market acceptance and
loss of market share; cancellation of orders; difficulty in collecting accounts
receivable; increased service and warranty costs in excess of our estimates; diversion of
resources, and; increased insurance costs and other losses to our business or to
end-users.
    If we experience product failure that indicates either manufacturing or design
deficiencies, we may be required to recall units in the field and/or stop producing and
shipping such products until the deficiency is identified and corrected.In the event of
such product failures, our business could be adversely affected resulting in reduced
revenue, increased costs and decreased customer satisfaction. End-users have discovered
errors in our products in the past and may discover errors in our products in the future.
In addition, if our costs of remediating problems experienced by our customers exceed
the expectations used in developing our warranty reserves, these costs may adversely
affect our operating results. Consequently, our warranty failure could have a material
adverse impact on our operations and financial results.
    Our ability to attract and retain personnel, including key technical and management
personnel.Much of the future success of our company depends on the continued service and
availability of skilled personnel, including technical, marketing and staff positions.
Experienced personnel in the wireless communications industry are in high demand and
competition for their talents is intense. There can be no assurance that we will be able
to successfully retain and attract the key personnel we need. Many of 23




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our key personnel receive a total compensation package that includes stock options. The
Financial Accounting Standards Board and other agencies have enacted changes to accounting
principles generally accepted in the United States that, starting in 2006, will require us
and other companies to record a charge to earnings for employee stock option grants,
employee stock purchase plans and other equity incentives. In addition, applicable stock
exchange listing standards relating to obtaining stockholder approval of equity
compensation plans could make it more difficult or expensive to grant options to employees
in the future. To the extent that new regulations make it more difficult or expensive to
grant options to employees, we may incur higher compensation costs, change our equity
compensation strategy or find it difficult to attract, retain and motivate employees, any
of which could have a material and adverse impact on our business.
    The risk of business interruption arising from our dependence on our manufacturing
facility located in Boulder, Colorado, and the business relationship we have with
Offshore Group to use a facility in Empalme, Sonora, Mexico which provides assembly
services.We are highly dependent on our Boulder, Colorado manufacturing facility, which
is home to the majority of our manufacturing and repair operations. We are also highly
dependent upon our business relationship with Offshore Group to provide management
services and an assembly facility located in Empalme, Sonora, Mexico. Our agreement with
Offshore Group expires in August 2005, and we are in the process of re-negotiating a new
agreement. We cannot assure you that we will be able to successfully re-negotiate a new
agreement on terms favorable to us, or at all. If we are unable to enter a new agreement
with Offshore Group, or should any other event occur that disrupts or indefinitely
discontinues either of the facilities capacity to manufacture, assemble and repair our
products, our ability to generate revenue, fulfill orders and attain financial goals
would be greatly impaired. For instance, we may experience delays in the receipt of
assembled product from the facility in Mexico should the border between the U.S. and
Mexico close.
    Our ability to respond to rapid technological changes within the on-premises wireless
telephone industry.The wireless communications industry is characterized by rapid
technological change, short product life cycles, and evolving industry standards. To
remain competitive, we must:  
    develop or gain access to new technologies in order to increase product
performance and function, reduce product size, and maintain cost-effectiveness;
    develop new products for existing and emerging wireless communications markets,
and introduce such products in a timely manner;
    implement an emerging wireless standards or multiple emerging wireless
standards, quickly enough to satisfy market demands and without significant
product redesign or the need to allocate additional resources to comply with
multiple standards;
    develop or obtain access to advanced wireless capabilities as they become available; and
    design, develop and introduce competitive new products on a timely basis.  We may not successfully execute on our vision of product requirements because of errors
in defining product marketing requirements, planning or timing, technical hurdles that
we fail to overcome in a timely fashion, or a lack of appropriate resources. Due to the
competitive nature of our business, any failure by us to meet any of these challenges
could render our products or technologies obsolete or noncompetitive and thereby
materially and adversely affect our business, reputation, and operating results.
    Potential fluctuations in our future revenues, gross margins and operating results.
We have experienced, and may in the future continue to experience, significant quarterly
fluctuations in revenue, gross margins and operating results due to numerous factors,
some of which are outside our control. Among other things, these factors include:  
    changes in customer, geographic or product mix, including mix of configurations
within each product group;
    fluctuating market demand for, and declines in the average selling prices of, our products;
    the timing of, and delay of, significant orders from customers;
    seasonality in demand within our various sectors;
    increases in material or labor costs;
    excess inventory;
    obsolescence charges;
    changes in shipment volume; 24




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
    loss of cost savings due to changes in component pricing or charges incurred due
to inventory holding periods if parts ordering does not correctly anticipate
product demand;
    increases in price competition;
    changes in the mix of our distribution channels including our OEM partners;
    government regulation of frequency spectrum;
    increases in warranty costs; and
    introduction of new products and costs of entering new markets.  For example, historically we have not operated with a significant order backlog, and a
substantial portion of our revenue in any quarter has been derived from orders booked and
shipped in that quarter. Accordingly, our revenue expectations are based almost entirely
on our internal estimates of future demand and not on firm customer orders. Planned
expense levels are relatively fixed in the short-term and are based in large part on these
estimates, and if orders and revenue do not meet expectations, our revenues, gross margins
and operating results could be materially adversely affected.
    The uncertainty about economic prospects in some sectors of our target customer
market, adversely impacts their information technology spending and our business.Our
business has from time to time been adversely impacted by the uncertainty about general
economic prospects in some sectors of our target customer market within the United States
and worldwide, because this uncertainty has resulted in a decline in, or a failure to
increase, their information technology spending. Consumers of information technology in
some of these sectors may defer, and in some cases cancel, their purchase decisions. Our
operating results may be adversely affected as a result. We expect the economic
uncertainty to continue to adversely impact our business and operating results for at
least the next few quarters and perhaps significantly longer. The adverse impacts from
economic uncertainty include longer sales cycles, lower average selling prices, fewer
large orders from a single customer and reduced revenue.
    Changes in rules and regulations of the FCC and other regulatory agencies.The
wireless communications industry, regulated by the Federal Communications Commission
(FCC) in the United States and similar government agencies in other countries, is subject
to changing political, economic, and regulatory influences. Regulatory changes,
including changes in the allocation of available frequency spectrum, or changing free
un-licensed to free based spectrum licensing could significantly impact our operations in
the United States and internationally.
    We are dependent on indirect sales channels for most of our revenue.A significant
portion of our revenues is derived from a variety of third-party business partners,
including OEMs, distributors and resellers. During the three months ended March 31,
2005, sales of our products through our indirect distributors accounted for 75.3% of our
product revenue, of which 16.1% of product revenue was contributed by our OEM partners.
Our contracts with third party business partners do not require those partners to
purchase minimum quantities of our products or services. In fact, some of our third party
business partners also offer the products of some of our competitors. In addition, our
OEM agreements do not restrict an OEM from acquiring products from a third party or
independently developing products and services that would directly compete with us. We
cannot guarantee that any of our third party business partners will continue to market
our products or devote significant resources to doing so. Furthermore, we will, from
time to time, terminate or adjust some of our relationships with third party business
partners in order to address changing market conditions, adapt such relationships to our
business strategy, resolve disputes, or for other reasons. Any such termination or
adjustment could have a negative impact on our relationships with third party business
partners and our business, and result in decreased sales through third party business
partners or threatened or actual litigation. If our third party business partners do not
successfully market and sell our products or services for these or any other reasons, our
sales could be adversely affected and our revenue could decline. In addition, our
third-party business partners have confidential information concerning our products and
services, product release schedules and sales, marketing and third party reseller
operations. Although we have nondisclosure agreements with our third party business
partners, we cannot guarantee that any third-party business partner would not use our
confidential information to compete with us. Furthermore, since we have experienced
lower gross margins related to sales to our OEM partners, we may experience lower gross
margins in the future if sales to our OEM partners become a larger percentage of product
sales. Our success depends in part upon our ability to maintain and expand these
relationships. The loss of any major partner, the failure to attract new partners or
inability to maintain the current level of revenue from our existing partners could have
an adverse effect on our business, operating results and financial condition. 25




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
    Our revenue and earnings are seasonal.Seasonality and other factors may cause
significant quarterly fluctuations in our revenue and net income.Our business is
seasonal based on budget cycles in various vertical markets such as healthcare and
retail. This causes significant quarterly fluctuations in our financial results.
Generally, revenue and operating results are sequentially down in the first quarter from
the fourth quarter, sequentially higher in the second quarter, sequentially flat or
slightly higher or lower in the third quarter, and strongest in the fourth quarter.
Actual results from operations may or may not follow these normal seasonal patterns in a
given year leading to performance that is not in alignment with expectations.
    A lower than anticipated rate of acceptance of domestic and international markets
using the 802.11b standard.Our NetLink wireless telephones are compatible with the IEEE
802.11b standard for use on 802.11b compliant WLAN. Consequently, demand for NetLink
wireless telephones depends upon the acceptance of markets utilizing 802.11b compliant
networks. This depends in part upon the initial adoption of the 802.11b standard in
international markets, as well as enhancements to that standard in the U.S. and foreign
markets where the standard has already been adopted. Additionally, the acceptance of
802.11b compliant networks may move more slowly, if at all, if competing wireless
networks are established and utilized. Additionally, the deployment of wireless voice
and data systems has been inhibited by security concerns including the potential of
unauthorized access to data and communications transmitted over or accessible through a
wireless system. Potential customers may choose not to purchase our products until
wireless systems are developed which provide for greater security. Further, our products
may not be compatible with secure wireless systems that may be developed in the future.
If markets utilizing 802.11b compliant networks do not grow as we anticipate, our growth
would be impeded and we would not be able to factor the related revenue into our growth
in the future. If the 802.11b standard does not emerge as the dominant wireless standard
in our markets, or multiple standards are adopted that require different technologies we
may need to spend time and resources to add functionality to meet the additional
standards and many of our strategic initiatives and investments may be of no or limited
value. Further, to the extent that additional standards are adopted, our product
differentiation could be minimized and our implementation may not be interoperable with
the standard, necessitating additional product development to meet the standard which may
cause product delays.
    The market for on-premises wireless telephone systems may fail to grow or to grow as
quickly as we anticipate.We derive our revenue principally from the sale of wireless,
on-premises telephone systems and related 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
operations would be significantly harmed. In particular, increased demand for our
NetLink product depends on the growth of the voice over Wi-Fi-related market. Although
NetLink sales have grown significantly in recent periods, the market for deployment of
converged voice and data wireless networks in the general enterprise continues to be
immature. We expect that this will remain the case unless that market moves through its
acceptance of IP wireless applications, standards adoption increases to reduce
complexity, and customers deploy wireless IP access points more fully throughout their
enterprise networks in densities required to support wireless voice traffic.
    Our reliance on a limited number of significant customers.A portion of our revenue in
the past has been derived from a limited number of customers. We also have experienced
quarter-to-quarter variability in sales to each of our major customers and expect this
pattern to continue in the future.
    We might not be able to execute on our business plan if we lose key management or
technical personnel, on whose knowledge, leadership and technical expertise we rely, or
if new members of our management team fail to work effectively together.Our success
depends heavily upon the contributions of our key management and technical personnel,
whose knowledge, leadership and technical expertise would be difficult to replace. Many
of these individuals have been with us for several years and have developed specialized
knowledge and skills relating to our technology and business. Others have been promoted
within, or have joined senior management roles recently. For example, three of the five
executive officers were either new to the Company or were promoted. Our success depends
in part upon the ability of new executives to work effectively together and with the rest
of our employees to continue to develop our technology and manage the operation and
growth of our business. All of our executive officers and key personnel are employees at
will. We have no employment contracts for our executive officers, and do not maintain key
person insurance on any of our executive officers. We might not be able to execute on our
business plan if we were to lose the services of any of our key personnel. If any of
these individuals were to leave us unexpectedly, we could face substantial difficulty in
hiring 26




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qualified successors, and could experience a loss in productivity while any such successor
develops the necessary training and experience.
    Our reliance on our 802.11b technology partners to continue to provide the wireless
local area network for our NetLink product, and to provide access points which support
SpectraLinks Voice Priority Technology.In the absence of a wireless voice
prioritization standard to ensure quality of service, we rely on 802.11b technology
partners, such as Proxim, Symbol Technologies, and Cisco Systems to continue to provide
wireless local area network support for our NetLink product, and to provide access points
that support SVP capability. If any of our technology partners fail to provide voice
prioritization support for our products, the market opportunity for NetLink products
would be reduced and our future results of operations would be materially harmed until we
find new 802.11b technology partners or voice prioritization standards are adopted.
    Our ability to generate continued market growth rates may require us to participate in
industry consolidation. As part of our business strategy to continue our market growth
for IP telephony, we may engage in acquisitions or mergers with other companies, or
individual product lines, technologies and/or personnel or become the target for a merger
or acquisition. Acquisitions or mergers involve numerous risks, including the following:  
    Difficulties in integrating the operations, technologies, products,
and personnel of the acquired companies;
    Diversion of managements attention from normal daily operations of
the business;
    Potential difficulties in completing projects associated with
in-process research and development;
    Difficulties in entering markets in which we have no or limited direct
prior experience and where competitors in such markets have stronger
market positions;
    Initial dependence on unfamiliar supply chains or relatively small supply partners;
    Insufficient revenues to offset increased expenses associated with acquisitions; and
    The potential loss of key employees of the acquired companies.  Acquisitions may also cause us to:  
    Issue common stock that would dilute our current stockholders
percentage ownership;
    Assume liabilities;
    Record goodwill and nonamortizable intangible assets that will be
subject to impairment testing on a regular basis and potential periodic
impairment charges;
    Experience possible delays in financial reporting and additional
resources required to integrate ERP systems;
    Incur additional financial costs and personnel resources which may be
required to timely comply on a consolidated basis with Section 404,
Managements Internal Controls and Procedures for Financial Reporting
of the Sarbanes-Oxley Act of 2002;
    Incur amortization expenses related to certain intangible assets;
    Incur large and immediate write-offs and restructuring and other
related expenses; and
    Become subject to intellectual property or other litigation.  Mergers and acquisitions of telecommunications companies are inherently risky, and no
assurance can be given that any future acquisitions would be successful and would not
materially adversely affect our business, operating results, or financial condition.
Failure to manage and successfully integrate acquisitions could also materially harm our
business and operating results.Risks related to new product development also apply to acquisitions. Please see the risk
factor below entitled If we are unable to develop and introduce new products and
transition existing products and respond to emerging technological trends and customers
changing needs, our operating results and market share may suffer for additional
information.
    If we are unable to develop and introduce new products and transition existing
products and respond to emerging technological trends and customers changing needs, our
operating results and market share may suffer.The process of developing new technology
is complex and uncertain, and if we fail to accurately predict customers changing needs
and emerging technological trends, our business could be harmed. We must commit
significant resources to developing new products before knowing whether our investments
will result in products the market will accept. We may encounter delays in deploying new
or improved products. For instance, our new products may not properly function with our
customers existing telephone systems, or our new products may contain defects or bugs.
These incompatibilities, defects or bugs may not be detected until our customers begin to
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the products or thereafter. We may need to modify the design of our new or improved
products if they have incompatibilities, defects or bugs, which could result in
significant expenditures as we seek to remedy the problems, delays in the purchase of the
products or cancelled orders. We may also encounter delays in the manufacturing and
production of the new products. Additionally, the new products may not be commercially
successful. Demand for existing products may decrease upon the announcement of new or
improved products. Further, since products under development are often announced before
introduction, these announcements may cause customers to delay purchases of any products,
even if newly introduced, until the new or improved versions of those products are
available. If customer orders decrease or are delayed during the product transition, we
may experience a decline in revenue and have excess inventory on hand which could decrease
gross profit margins. Our gross margins might decrease if customers, who may otherwise
choose to purchase existing products, instead choose to purchase lower priced models of
new products. Delays or deficiencies in the development, manufacturing, and delivery of,
or demand for, new or improved products could have a negative effect on our business,
operating results or financial condition.
    Our ability to manage potential expansion of operations in the U.S. and
internationally.We intend to expand our existing domestic and international operations,
and to enter new markets. This expansion will require significant management attention
and financial resources. We currently have limited experience in marketing and
distributing our products internationally and in developing versions of products that
comply with local standards. We may also not be able to maintain or increase
international market demand for our products. International operations are subject to
other inherent risks, including foreign government regulation of technology or unexpected
changes in regulatory and customs requirements, difficulty and delays in accounts
receivable collection, difficulties and costs of staffing and managing foreign
operations, reduced protection for intellectual property rights, foreign currency
exchange rate fluctuations, and taxation consequences.
    We face increasing competition in the on-premises wireless telephone system market.
The on-premises wireless telephone system industry is competitive and influenced by the
introduction of new products and new entrants into the industry. The competitive factors
affecting the market for our systems include 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, and the
effectiveness of marketing and sales efforts. Most of our competitors have significantly
greater financial, technical, research and development, and marketing resources than us.
As a result, our competitors may respond more quickly to new or emerging technologies and
changes in customer requirements, or may devote greater resources to the development,
promotion, sale and support of their products than us. Enterprise adoption of standards
for wireless LAN and VoIP may lead to the commoditization of wireless telephone
technology and the availability of low-cost alternative products. Other purchasers may
prefer to buy their 802.11b wireless telephone systems from a single source provider of
wireless local area networks, or LANs, such as Cisco Systems which provides 802.11b
wireless infrastructure and wireless telephones. Because we focus on wireless on-premises
telephone communications, we cannot serve as the sole source for a complete telephone or
data communications system. There is no assurance that we will be able to compete
successfully in the future. Further, if a potential customer is already using a
competing product or system, that potential customer may not be willing or able to make
the investment necessary to replace such a system with our wireless telephone system. In
addition, there may be potential customers who choose another technology because of cost
or their belief that their needs do not require the full function provided by our
wireless telephone systems.
    The certification and approval process for our NetLink product for use in countries
that support the 802.11b standard.Foreign countries, which support the 802.11b
standard, could provide future markets for our NetLink products. However, countries
certification and approval processes for 802.11b compatible products, such as ours, are
typically time consuming and costly. If we have difficulty obtaining certification and
approval by foreign countries for our NetLink wireless telephone product, then we and/or
our distributor channels may not be able to gain access to the markets in these countries
in a timely fashion, if at all, which would limit international growth of our business.
    Our ability to protect or enforce our intellectual property rights.Our future
success depends, in part, upon our proprietary technology. We rely on a combination of
patent, copyright, trade secret and trademark laws, confidentiality procedures, and
nondisclosure and other contractual provisions to protect our proprietary rights. These
legal protections provide only limited protection and may be time consuming and expensive
to obtain and enforce. There can be no assurance that our issued patents will not be
challenged or circumvented by competitors or provide meaningful protection against
competition. If 28




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challenged, our patents might not be upheld or their claims could be narrowed. If we fail
to protect our proprietary rights adequately, our competitors might gain access to our
technology. As a result, our competitors might offer similar products and we might not be
able 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 we regard as proprietary. Also, our competitors may independently
develop similar, but not infringing, technology, duplicate our products, or design around
our patents or our other intellectual property. In addition, other parties may breach
confidentiality agreements or other protective contracts with us, and we may not be able
to enforce our rights in 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 extent as the laws
of the United States. We may be required to spend significant resources to monitor and
protect our intellectual property rights. Any litigation surrounding our rights could
force us to divert important financial and other resources from our business operations.
    The assertion of intellectual property infringement claims against us.Our industry
is characterized by the existence of a large number of patents and frequent claims and
related litigation regarding patent and other intellectual property rights. We cannot be
certain that our products do not and will not infringe upon issued patents, patents to be
issued in the future, or other intellectual property rights of others. We may in the
future be notified that we are infringing upon certain patent and/or other intellectual
property rights of others. Although there are no such pending lawsuits against us that
we are infringing upon intellectual property rights of others, there can be no assurance
that infringement 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 and related methods that are important to us. Litigation may be
necessary in the future to defend against claims of infringement or invalidity, to
determine the validity and scope of the proprietary rights of others, to enforce our
intellectual property rights, or to protect our trade secrets. We may also be subject to
claims from customers for indemnification. Any resulting litigation, regardless of our
resolution, could result in substantial costs and diversion of resources. If it were
determined that our products infringe upon the intellectual property rights of others, we
would need to obtain licenses from these parties or reengineer our products in order to
avoid infringement. We might not be able to obtain the necessary licenses on acceptable
terms or at all, or to reengineer our products successfully. Moreover, if we are sued
for infringement and lose the suit, we could be required to pay substantial damages or be
enjoined from licensing or using the infringing products or technology. Any of the
foregoing could cause us to incur significant costs and prevent us from selling our
products.
    We rely on the availability of third-party licenses.Many of our products
are designed to include software or other intellectual property
licensed from third-parties, especially through our OEM agreements. If we terminate OEM or technology
partner relationships, it may be necessary in the future to seek or renew licenses
relating to various aspects of these products. There can be no assurance that the
necessary licenses would be available on acceptable terms, if at all. The inability to
obtain certain licenses 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 our
business, operating results, and financial condition.
    Changes in securities laws and regulations have increased our costs.The
Sarbanes-Oxley Act of 2002 that became law in July 2002, as well as new rules
subsequently implemented by the SEC, have required changes in some of our corporate
governance, public disclosure and compliance practices. The Act also required the SEC to
implement additional new rules on a variety of subjects. In addition to rules made by the
SEC, the Nasdaq National Market has adopted revisions to its requirements for companies,
such as us, that are Nasdaq-listed. These developments have increased our legal and
financial compliance costs, and make some activities, like SEC reporting obligations,
more expensive and difficult. For instance, in seeking to comply with Section 404
Managements Internal Controls and Procedures for Financial Reporting of the
Sarbanes-Oxley Act of 2002, we spent approximately $700,000 in outside services
associated with documenting, testing and auditor review of our internal controls during
2004. In addition, these developments may make it more difficult and more expensive for
us to obtain director and officer liability insurance, and we may be required to accept
reduced coverage or incur substantially higher costs to obtain coverage. These
developments could make it more difficult for us to attract and retain qualified members
of our board of directors, particularly to serve on our audit committee, and qualified
executive officers. We are presently evaluating and monitoring regulatory developments
and are continuing to estimate the timing and magnitude of additional costs we may incur
as a result.
    Our reported financial results may be adversely affected by changes in accounting
principles generally accepted in the United States.Generally accepted accounting
principles in the United States 29




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are subject to issuance and interpretation by the Financial Accounting Standards Board, or
FASB, the American Institute of Certified Public Accountants, the SEC, and various bodies
formed to promulgate and interpret appropriate accounting principles. A change in these
principles or interpretations could have a significant effect on our reported financial
results, and could affect the reporting of transactions completed before the announcement
of a change. For example, in December 2004, the FASB issued SFAS No. 123 (revised 2004),
Share-Based Payment (SFAS 123R), which replaces SFAS No.123, Accounting for
Stock-Based Compensation, (SFAS123) and supersedes APB Opinion No.25, Accounting for
Stock Issued to Employees. SFAS 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial statements
based on their fair values beginning with the first interim or annual period after June
15, 2005, with early adoption encouraged. In April 2005, the Securities and Exchange
Commissions made an amendment to Rule 401(a) regarding the compliance date for SFAS 123R.
Under Rule 401(a) as amended, we are not required to comply with SFAS 123R until January
1, 2006. Our reported earnings will be decreased when we change our accounting policy in
accordance with the fair-value based concepts soon to be required.
    The historic volatility of our stock price, which may make it more difficult to resell
shares at prices attractive to sellers.The market price of our common stock has been
volatile and is likely to remain subject to wide fluctuations in the future. For
example, during the 12-month period ended March 31, 2005, the closing price of our common
stock has ranged from a high of $18.00 per share to a low of $7.97 per share. Many
factors could cause the market price of our common stock to fluctuate, including:  
    variations in our actual or anticipated quarterly or annual results;
    market conditions in our industry, the industries of our customers and the economy as a whole;
    announcements of technological innovations by us or by our competitors;
    introduction of new products or product enhancements or new pricing policies by
us or by our competitors;
    government regulation;
    acquisitions or strategic alliances by us or by our competitors;
    recruitment or departure of key personnel;
    the gain or loss of significant orders;
    changes in the market valuations of other telecommunications companies;
    the amount of liquid financial resources available to us;
    the gain or loss of significant customers including OEMs; and
    changes in the estimates of our operating performance or changes in
recommendations by securities analysts.  In addition, the stock market in general, and the market for technology-related stocks
in particular, could decline, which could cause the market price of our common stock to
fall for reasons not necessarily related to our business, results of operations or
financial condition. The market price of our stock also might decline in reaction to
events that affect other companies in our industry even if these events do not directly
affect us. Accordingly, you may not be able to resell your shares of common stock at or
above the price you paid. Securities class action litigation is often brought against a
company following a period of volatility in the market price of its securities, and we
have previously been sued in several securities class action lawsuits which we
successfully settled. 
 Item 4. Controls and Procedures. Evaluation of Disclosure Controls and Procedures.Regulations under the Securities Exchange
Act of 1934 require public companies to maintain disclosure controls and procedures, which are
defined to mean a companys controls and other procedures that are designed to ensure that
information required to be disclosed by the Company in the reports that it files or submits under
the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the
time periods specified in the Commissions rules and forms. Our Chief Executive Officer and Chief
Financial Officer, based on their evaluation of our disclosure controls and procedures as of the
end of the period covered by this report (the Evaluation Date), concluded that our disclosure
controls and procedures were effective as of the Evaluation Date for this purpose. Changes in Internal Controls over Financial Reporting.Regulations under the Securities
Exchange Act of 1934 require public companies to evaluate any change in internal control over
financial reporting, which is defined as a process to provide reasonable assurance regarding the
reliability of financial reporting and preparation of financial statements for external purposes in
accordance with accounting principles generally accepted in the 30




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United States. In connection with their evaluation of our disclosure controls and procedures as of
the end of the period covered by this report, our Chief Executive Officer and Chief Financial
Officer did not identify any change in our internal control over financial reporting during the
three-month period ended March 31, 2005, that materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. 
 Part II            Other Information Item 1. Legal Proceedings Two derivative lawsuits were filed in February 2002, each of which related to the now-settled
consolidated class action securities lawsuits that are summarized in Note 8 in the accompanying
Notes to the Consolidated Financial Statements: Evie Elennis, derivatively on behalf of SpectraLink
Corporation, Plaintiff(s), v. Bruce M. Holland, Anthony V. Carollo, Jr., Gary L. Bliss, Michael P.
Cronin, Nancy K. Hamilton and John H. Elms, Defendants), and SpectraLink Corporation, Nominal
Defendant (United States District Court Civil Action Number 02-D-0345); and Roger Humphreys,
Derivatively on Behalf of Nominal Defendant SpectraLink Corporation, Plaintiff, v. Carl D. Carman,
Anthony V. Carollo, Jr., Bruce M. Holland, Burton J. McMurtry, Gary L. Bliss, Michael P. Cronin,
John H. Elms, and Nancy K. Hamilton, Defendants (Colorado District Court Case No. 02CV1687). In
these cases, the plaintiffs allege that the officers and directors of SpectraLink violated
fiduciary duties owed to SpectraLink and its stockholders under state laws by allowing and/or
facilitating the issuance of alleged public misstatements and omissions, misappropriating nonpublic
information for their own benefit, making insider stock sales, wasting corporate assets, abusing
their positions of control, and mismanaging the corporation. The plaintiffs in these derivative
cases allege that SpectraLink has and will continue to suffer injury as a result of these alleged
violations of duty for which the officers and directors should be liable. The two derivative actions were stayed pending resolution of the motion to dismiss in the
consolidated class action, and plaintiffs counsel in the Elennis derivative action filed an
unopposed motion for relief from the stay and filed an amended complaint and then a corrected
amended complaint. Prior to the entry of the stays in each of the derivative cases, the defendants
had filed motions to dismiss. In August of 2003, Defendants moved to dismiss the amended and
corrected Elennis complaint. The Court denied that motion on March 22, 2004. No discovery has been
conducted in either of the derivative actions. The defendants in the derivative actions engaged in
settlement discussions with the derivative plaintiffs in light of the settlement of the
Consolidated Actions and the parties reached an agreement in settling both derivative cases on
March 23, 2005. An Order and Final Judgment was entered on March 25, 2005, ending the litigation.
The settlement was paid by SpectraLinks directors and officers insurance carrier. The Company has incurred a loss related to the directors and officers insurance deductible of
which the majority of the expense was reflected in 2002. As noted, the settlement of the
Consolidated Actions has been funded by insurance proceeds. 31




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Item 6 Exhibits (a) Exhibits The following exhibits are filed or furnished herewith: Exhibit Number
    
    Exhibit Title31.1 
    
    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 David I. Rosenthal 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 David I. Rosenthal pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
  Filed or furnished herewith. * In accordance with SEC Release No. 33-8238, these exhibits are furnished with this quarterly
report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission, and
are not incorporated by reference in any filing of SpectraLink Corporation under the Securities
Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof
and irrespective of any general incorporation language in any filings. Exhibits filed with SpectraLinks 2004 Form 10-K constitute those exhibits currently
required to be on file. The reader should refer to the 2004 Form 10-K under Part III, Item 15,
for a list of those exhibits. 32




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SPECTRALINK CORPORATION
SIGNATURE In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the
Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized. SPECTRALINK CORPORATIONDate: May 6, 2005By: /s/ DAVID I. ROSENTHAL
David I. Rosenthal,
Chief Financial Officer, Executive Vice
President of Finance and Administration,
Secretary and Treasurer
(Principal Financial and Accounting
Officer and on behalf of the Registrant)
 33




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EXHIBIT INDEX Exhibit Number
    
    Exhibit Title31.1 
    
    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 David I. Rosenthal 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 David I. Rosenthal pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
  Filed herewith or furnished. * In accordance with SEC Release No. 33-8238, these exhibits are furnished with this quarterly
report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and are
not incorporated by reference in any filing of SpectraLink Corporation under the Securities Act of
1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and
irrespective of any general incorporation language in any filings. 34