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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10 - Q x
    
    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
 
 Commission file number 0-28180 SPECTRALINK CORPORATION  Delaware
    
    84-1141188(State or other jurisdiction of incorporation or organization)
    
    (IRS EmployerIdentification 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 x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o Applicable only to corporate issuers: As of October 31, 2004, there were 19,034,334 shares outstanding of SpectraLink
Corporations Common Stock - par value per share $0.01.




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SPECTRALINK CORPORATION AND SUBSIDIARY
INDEX  
 PagePart I
    
    Financial InformationItem 1
    
    Condensed
Consolidated Financial StatementsCondensed Consolidated Balance Sheets at September 30, 2004 and December 31, 2003 (Unaudited)
    
    
    3Condensed Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2004 and 2003 (Unaudited)
    
    
    4Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003 (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
    
    
    29Item 4
    
    Controls and Procedures
    
    
    29Part II
    
    Other InformationItem 1
    
    Legal Proceedings
    
    
    30Item 2
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    31Item 6
    
    Exhibits(a) Exhibits
    
    
    32Signature
    
    
    
    
    33Certification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906Certification Pursuant to Section 906
  2




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PART I-ITEM 1 
 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SPECTRALINK CORPORATION AND SUBSIDIARY
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)
 September 30,
    
    December 31,2004
    
    2003ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    53,118
    
    
    $
    51,861Trade accounts receivable, net of allowance of $346 and $341, respectively
    
    
    14,606
    
    
    
    14,470Income taxes receivable
    
    
    
    
    
    
    204Inventories, net
    
    
    10,809
    
    
    
    7,653Deferred income taxes  current portion
    
    
    1,393
    
    
    
    1,562Other
    
    
    1,022
    
    
    
    800Total current assets
    
    
    80,948
    
    
    
    76,550PROPERTY AND EQUIPMENT, at cost:Furniture and fixtures
    
    
    2,393
    
    
    
    2,312Equipment
    
    
    10,010
    
    
    
    9,245Leasehold improvements
    
    
    1,020
    
    
    
    98913,423
    
    
    
    12,546Less  accumulated depreciation
    
    
    (9,351
    )
    
    
    (8,463
    )Net property and equipment
    
    
    4,072
    
    
    
    4,083DEFERRED INCOME TAXES, net of current portion
    
    
    154
    
    
    
    151OTHER
    
    
    479
    
    
    
    387TOTAL ASSETS
    
    $
    85,653
    
    
    $
    81,171LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    1,076
    
    
    $
    1,453Income taxes payable
    
    
    956
    
    
    
    Accrued payroll, commissions and employee benefits
    
    
    2,615
    
    
    
    3,114Accrued sales, use and property taxes
    
    
    684
    
    
    
    724Accrued warranty expenses
    
    
    750
    
    
    
    493Other accrued expenses and liabilities
    
    
    2,712
    
    
    
    2,269Deferred revenue
    
    
    7,014
    
    
    
    6,319Total current liabilities
    
    
    15,807
    
    
    
    14,372LONG-TERM LIABILITIES
    
    
    217
    
    
    
    250TOTAL LIABILITIES
    
    
    16,024
    
    
    
    14,622STOCKHOLDERS EQUITY:Preferred stock, 5,000 shares authorized, none issued and outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 50,000 shares authorized, 23,269 and 22,800 shares
issued, respectively, and 19,000 and 18,871 shares outstanding, respectively
    
    
    233
    
    
    
    227Additional paid-in capital
    
    
    75,761
    
    
    
    71,010Retained earnings
    
    
    26,032
    
    
    
    24,706Treasury stock, 4,269 and 3,929 shares, respectively at cost
    
    
    (32,397
    )
    
    
    (29,394
    )TOTAL STOCKHOLDERS EQUITY
    
    
    69,629
    
    
    
    66,549TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    85,653
    
    
    $
    81,171
 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 Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003SALES:Product sales, net
    
    $
    18,093
    
    
    $
    14,500
    
    
    $
    48,963
    
    
    $
    40,672Service sales
    
    
    4,875
    
    
    
    3,843
    
    
    
    13,443
    
    
    
    10,875Net sales
    
    
    22,968
    
    
    
    18,343
    
    
    
    62,406
    
    
    
    51,547COST OF SALES:Cost of product sales
    
    
    5,501
    
    
    
    4,042
    
    
    
    14,757
    
    
    
    11,380Cost of service sales
    
    
    2,654
    
    
    
    2,071
    
    
    
    7,613
    
    
    
    5,640Total cost of sales
    
    
    8,155
    
    
    
    6,113
    
    
    
    22,370
    
    
    
    17,020Gross profit
    
    
    14,813
    
    
    
    12,230
    
    
    
    40,036
    
    
    
    34,527OPERATING EXPENSES:Research and development
    
    
    2,268
    
    
    
    1,908
    
    
    
    6,636
    
    
    
    5,912Marketing and selling
    
    
    6,193
    
    
    
    5,709
    
    
    
    17,853
    
    
    
    16,696General and administrative
    
    
    1,660
    
    
    
    1,009
    
    
    
    4,470
    
    
    
    3,066Total operating expenses
    
    
    10,121
    
    
    
    8,626
    
    
    
    28,959
    
    
    
    25,674INCOME FROM OPERATIONS
    
    
    4,692
    
    
    
    3,604
    
    
    
    11,077
    
    
    
    8,853INVESTMENT INCOME AND OTHER:Interest income, net
    
    
    161
    
    
    
    96
    
    
    
    394
    
    
    
    334Other income (expense), net
    
    
    (40
    )
    
    
    (29
    )
    
    
    (10
    )
    
    
    (102
    )Total investment income and other
    
    
    121
    
    
    
    67
    
    
    
    384
    
    
    
    232INCOME BEFORE INCOME TAXES
    
    
    4,813
    
    
    
    3,671
    
    
    
    11,461
    
    
    
    9,085INCOME TAX EXPENSE
    
    
    1,886
    
    
    
    1,395
    
    
    
    4,412
    
    
    
    3,452NET INCOME
    
    $
    2,927
    
    
    $
    2,276
    
    
    $
    7,049
    
    
    $
    5,633BASIC EARNINGS PER SHARE (Note 4)
    
    $
    0.15
    
    
    $
    0.12
    
    
    $
    0.37
    
    
    $
    0.30BASIC WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    19,110
    
    
    
    18,530
    
    
    
    19,050
    
    
    
    18,490DILUTED EARNINGS PER SHARE (Note 4)
    
    $
    0.15
    
    
    $
    0.12
    
    
    $
    0.36
    
    
    $
    0.30DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING
    
    
    19,260
    
    
    
    19,500
    
    
    
    19,590
    
    
    
    19,020
 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)
 Nine Months EndedSeptember 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    7,049
    
    
    $
    5,633Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation and amortization
    
    
    1,262
    
    
    
    862Provision for bad debts
    
    
    83
    
    
    
    34Provision for excess and obsolete inventories
    
    
    472
    
    
    
    474Deferred income taxes
    
    
    166
    
    
    
    Income tax benefit from the exercise of stock options
    
    
    656
    
    
    
    1,374Changes in operating assets and liabilities-Increase in trade accounts receivable
    
    
    (219
    )
    
    
    (2,125
    )Increase in inventories
    
    
    (3,628
    )
    
    
    (498
    )Increase in other assets and income taxes receivable
    
    
    (110
    )
    
    
    (1,360
    )(Decrease) increase in accounts payable
    
    
    (377
    )
    
    
    464Increase in accrued liabilities, income taxes payable and
deferred revenue
    
    
    1,776
    
    
    
    2,462Net cash provided by operating activities
    
    
    7,130
    
    
    
    7,320CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (1,223
    )
    
    
    (2,262
    )Net cash used in investing activities
    
    
    (1,223
    )
    
    
    (2,262
    )CASH FLOWS FROM FINANCING ACTIVITIES:Principal payments under long-term obligation
    
    
    (25
    )
    
    
    (11
    )Proceeds from exercises of common stock options
    
    
    3,780
    
    
    
    4,135Proceeds from issuances of common stock
    
    
    321
    
    
    
    297Dividends paid
    
    
    (5,723
    )
    
    
    Purchases of treasury stock
    
    
    (3,003
    )
    
    
    (3,688
    )Net cash (used in) provided by financing activities
    
    
    (4,650
    )
    
    
    733INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    1,257
    
    
    
    5,791CASH AND CASH EQUIVALENTS, beginning of period
    
    
    51,861
    
    
    
    44,211CASH AND CASH EQUIVALENTS, end of period
    
    $
    53,118
    
    
    $
    50,002SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid for income taxes
    
    $
    2,625
    
    
    $
    3,171SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:Assets acquired under long-term obligation
    
    $
    28
    
    
    $
    128
 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
SEPTEMBER 30, 2004
(Unaudited)
 1. Basis of Presentation The accompanying condensed consolidated financial statements as of
September 30, 2004 and December 31, 2003, and for the three and nine months
ended September 30, 2004 and 2003, 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 September 30, 2004, are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending
December 31, 2004. 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, 2003, 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
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except per
    
    (In thousands, except pershare amounts)
    
    share amounts)Net Income, as reported
    
    $
    2,927
    
    
    $
    2,276
    
    
    $
    7,049
    
    
    $
    5,633Deduct stock based employee compensation
expense under the fair value based method,
net of related tax effect:Compensation expense for stock options
    
    
    (699
    )
    
    
    (579
    )
    
    
    (2,106
    )
    
    
    (1,748
    )Compensation
expense for the stock purchase plan
    
    
    (41
    )
    
    
    (41
    )
    
    
    (124
    )
    
    
    (122
    )Net Income, pro forma
    
    $
    2,187
    
    
    $
    1,656
    
    
    $
    4,819
    
    
    $
    3,763Earnings Per Share:Basic  as reported
    
    $
    0.15
    
    
    $
    0.12
    
    
    $
    0.37
    
    
    $
    0.30Basic  pro forma
    
    $
    0.11
    
    
    $
    0.09
    
    
    $
    0.25
    
    
    $
    0.20Diluted  as reported
    
    $
    0.15
    
    
    $
    0.12
    
    
    $
    0.36
    
    
    $
    0.30Diluted  pro forma
    
    $
    0.11
    
    
    $
    0.09
    
    
    $
    0.25
    
    
    $
    0.20
 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 6




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interest rates of 2.60% and 2.23% for the three months and nine months
ended September 30, 2004, respectively, and 1.45% and 1.40% for the three
months and nine months ended September 30, 2003, respectively; expected lives
(net of forfeitures) of 1.75 years and 1.69 years for the three and nine months
ended September 30, 2004, respectively, and 1.70 years and 1.75 years for the
three months and nine months ended September 30, 2003, respectively; a $0.10
per share quarterly dividend for the three months and nine months ended
September 30, 2004, respectively, and no dividends for the three months and
nine months ended September 30, 2003; and expected volatility of 69% and 74%
for the three months and nine months ended September 30, 2004, respectively,
and 83% and 82% for the three months and nine months ended September 30, 2003,
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-Sholes model with the following assumptions: a $0.10 per share
quarterly dividend for the three months and nine months ended September 30,
2004, respectively, and no dividends for the three months and nine months ended
September 30, 2003, respectively; an expected life of six months; expected
volatility of 74% and 76% for the three months and nine months ended September
30, 2004, respectively, and 83% for the three months and nine months ended
September 30, 2003, respectively; and a risk-free interest rate of 2.60% and
2.23% for the three months and nine months ended September 30, 2004,
respectively and 1.45% and 1.40% for the three months and nine months ended
September 30, 2003, 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 September 30, 2004 and December
31, 2003, consisted of the following: September 30,
    
    December 31,2004
    
    2003(In thousands)Raw materials
    
    $
    4,825
    
    
    $
    3,276Work in progress
    
    
    6
    
    
    
    25Finished goods
    
    
    5,978
    
    
    
    4,352$
    10,809
    
    
    $
    7,653
 The reserve for potential excess and/or obsolete inventories was $894,000
and $591,000 as of September 30, 2004 and December 31, 2003, 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 excluded from the calculation of
dilutive income per share because they were anti-dilutive totaled 1,710,768 and
67,265 for the three months ended September 30, 2004 and 2003, respectively,
and 840,806 and 277,542 for the nine months ended September 30, 2004 and 2003,
respectively. A reconciliation of the numerators and denominators used in
computing earnings per share is as follows: Three months ended September 30,(In thousands, except per share amounts)2004
    
    2003Income
    
    Shares
    
    Per Share
    
    Income
    
    Shares
    
    Per ShareBasic EPS
    
    $
    2,927
    
    
    
    19,110
    
    
    $
    0.15
    
    
    $
    2,276
    
    
    
    18,530
    
    
    $
    0.12Effect of dilutive securities:Stock purchase plan
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    13
    
    
    
    Stock options outstanding
    
    
    
    
    
    
    139
    
    
    
    
    
    
    
    
    
    
    
    957
    
    
    
    Diluted EPS
    
    $
    2,927
    
    
    
    19,260
    
    
    $
    0.15
    
    
    $
    2,276
    
    
    
    19,500
    
    
    $
    0.12
 7




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Nine months ended September 30,(In thousands, except per share amounts)2004
    
    2003Income
    
    Shares
    
    Per Share
    
    Income
    
    Shares
    
    Per ShareBasic EPS
    
    $
    7,049
    
    
    
    19,050
    
    
    $
    0.37
    
    
    $
    5,633
    
    
    
    18,490
    
    
    $
    0.30Effect of dilutive securities:Stock purchase plan
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    Stock options outstanding
    
    
    
    
    
    
    528
    
    
    
    (0.01
    )
    
    
    
    
    
    
    514
    
    
    
    Diluted EPS
    
    $
    7,049
    
    
    
    19,590
    
    
    $
    0.36
    
    
    $
    5,633
    
    
    
    19,020
    
    
    $
    0.30
 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 24 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 ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In thousands)
    
    (In thousands)Beginning Balance, Accrued Product Warranty and
Service
    
    $
    711
    
    
    $
    404
    
    
    $
    493
    
    
    $
    274Additions to the accrual for product warranties
    
    
    298
    
    
    
    143
    
    
    
    970
    
    
    
    526Reductions for incurred warranty charges
    
    
    (259
    )
    
    
    (136
    )
    
    
    (713
    )
    
    
    (389
    )Ending Balance, Accrued Product Warranty and Service
    
    $
    750
    
    
    $
    411
    
    
    $
    750
    
    
    $
    411
 6. Advertising Costs The Company expenses all advertising costs as they are incurred.
Advertising expense for the three months ended September 30, 2004 and 2003,
were approximately $179,000 and $187,000, respectively, and $489,000 and
$505,000 for the nine months ended September 30, 2004 and 2003, respectively. 7. Stockholders Equity During the three and nine months ended September 30, 2004, the Company
repurchased 340,455 shares of outstanding common stock (now classified as
treasury stock) at a cost of $3,003,000. The Company did not repurchase any
shares of outstanding common stock during the third quarter of 2003. For the
nine months ended September 30, 2003, the Company repurchased 447,100 shares of
outstanding common stock (now classified as treasury stock) at a cost of
$3,688,000. During the third quarter of 2004, the Company paid a quarterly cash
dividend of $0.10 per share for a total of $1,898,000 to holders of common
stock. For the nine months ended September 30, 2004, the Company paid three
cash dividends of $0.10 per share for a total of $5,723,000. The Company did
not pay any dividends during the nine months ended September 30, 2003. 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 8




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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 are 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 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 preliminary
approval to the settlement, and a final hearing for approval of the settlement
was scheduled for October 7, 2004. An Order and Final Judgment was entered on
October 7, 2004, ending the litigation. The settlement was paid by
SpectraLinks directors and officers insurance carrier. 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 have reached an agreement in principle settling both
derivative cases. The settlement is conditioned upon reaching agreement on
written settlement documents and on court approval. The defendants in the remaining lawsuits believe these cases are without
merit and intend to vigorously defend themselves if the settlement of the two
derivative cases is not effectuated. SpectraLink does not believe that its
interests and that of the named officers and directors are adverse to each
other as of this time. However, if the settlement is not consummated, no
assurance can be given that SpectraLink will be successful in defending the
claims being asserted in these suits, or that the interests of the various
parties will remain aligned. In addition, the derivative litigation could
result in substantial costs, divert managements attention and resources, or
ultimately 9




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result in the interests of SpectraLink becoming adverse to those of certain of
its officers and directors. In either case, SpectraLinks business could be
adversely affected, even if the plaintiffs are not successful in their claims. 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. Based on current facts and circumstances, the Company is
unable to estimate future losses, if any, it may incur if the remaining cases
are not settled, after considering the amounts that will be covered by
insurance. 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 On March 31, 2004, the FASB issued a proposed Statement, Share-Based
Payment, which addresses the accounting for share-based payment transactions.
The proposed Statement would eliminate the ability to account for share-based
compensation transactions using APB Opinion No. 25, Accounting for Stock
Issued to Employees, and generally would require instead that such
transactions be accounted and recognized in the statement of income based on
their fair value. The FASB recently announced that the final standard will be
effective for public companies for fiscal periods beginning after June 15,
2005. The proposed final standard offers the Company alternative methods of
adopting this final rule. At the present time, the Company has not yet
determined which alternative method it will use or the expected impact on its
financial statements. 10




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##### Table of Contents



PART I   ITEM 2
MANAGEMENTS DISCUSSION AND ANALYSIS
OF 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
Forward-Looking Statement 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 product categories differentiated by the
wireless technology implemented: Link Wireless Telephone Systems (Link WTS)
and NetLink Wireless Telephones. Link WTS targets organizations that require a
dedicated wireless voice solution for their on-premises mobile workforce.
NetLink Wireless Telephones target organizations that want both a wireless
voice and wireless data solution on a single network. Because of the recent
advances in wireless local area network (LAN) technology, a significant portion
of our development efforts will focus on our existing NetLink products as well
as new products that operate on a wireless LAN. For the three months ended September 30, 2004, our revenue was $23.0
million, which was the most revenue that we have ever recorded in a fiscal
quarter, and earnings per fully diluted share were $0.15 on net income of $2.9
million. This represents a 25% growth in both quarterly year-over-year revenue
and earnings per fully diluted share, and a 29% increase in quarterly
year-over-year net income. Earnings per fully diluted share for the nine months
ended September 30, 2004, was $0.36 on net income of $7.0 million and revenue
of $62.4 million. This represents year-over-year growth in net income of 25%
year-to-date, year-over-year growth in revenue of over 21% year-to-date and a
20% year-over-year growth in earnings per fully diluted share. Revenue growth for the three months ended September 30, 2004, was
primarily due to a year-over-year increase of approximately $2.5 million or
58.9% for our NetLink product sales. For the three months ended September 30,
2004, Link WTS represented 62.5% of total product revenue or approximately
$11.3 million. The future growth of NetLink product sales as a percentage of
our total product sales is dependent 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. Although we expect Link revenue to fluctuate from quarter to quarter, we
believe that revenue from this legacy product may increase from, or remain
consistent with, the amount recognized in the three months ended September 30,
2004. We intend to continue to invest in the Link product line because of the
ongoing demand from our customer base, which is interested in a purpose built
voice-only wireless telephone system. We are continuing our transition from a North American-oriented niche
market provider to a mainstream supplier of wireless telephony in partnership
with large telecommunications manufacturers worldwide. We have 11




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Original Equipment Manufacturer (OEM) relationships with the top six global
telephony providers (Avaya, Nortel, Alcatel, Siemens, NEC and Inter-Tel). Our
OEM management office, established in 2003, will continue to seek relationships
that will not only distribute our products but also co-brand and private label
these products. The goal of this strategy is to provide greater exposure to our
products through the reach these partners have with their customers. Our OEM
partners are primarily focused on selling NetLink Wireless Telephones, and in
the third quarter 2004, we began to see replenishment orders come from recently
signed OEM partners as they fulfill customer orders from their initial stocking
supplies. If OEM sales increase, we expect that NetLink revenue will also
increase and we expect sales through our OEM partners to become a larger
percentage of product sales. These relationships also help to establish an
international presence for our products. For the three months ended September
30, 2004, international sales remained strong at $895,000 following record
levels for the second quarter 2004, and international sales accounted for
approximately 5% of product sales. For the three months ended September 30, 2004, revenue through our
traditional distribution channels accounted for 58% of product revenue, OEM
partners contributed 20% of product revenue and 22% was from direct sales. Our
target vertical markets currently focus on home improvement, grocery, and other
retail store chains, hospitals, nursing homes, distribution centers,
manufacturing and service centers, corporate offices, government and education. For the three months ended September 30, 2004, our overall gross margin
was 64.5%. The primary reason for higher gross margin as compared to the
second quarter of 2004 (63.4%) was strong Link sales that generate higher
margins because of infrastructure products sold with Link systems. We realize
relatively lower margins on products sold through OEM relationships because of
the pricing arrangements inherent in these relationships. We expect OEM sales
to increase as a percentage of our total sales, and if this occurs, we will
experience downward pressure on gross margins from historical percentages
ranging from the mid-to-high 60% range. Another factor that will directly
affect gross margins is product mix. The NetLink e340 handset carries a much
lower margin than any other of our products as it has a lower average selling
price. As a result, if we succeed in penetrating new enterprise markets, and
sales of the NetLink e340 handset increase as a result, gross margins will
decline. These two factors may potentially push gross margins below the
targeted range of 60 to 65%. For the nine months ended September 30, 2004, we used $5,723,000 of our
cash to pay cash dividends to our stockholders. In connection with the
re-initiation of our stock repurchase program in the third quarter 2004 we
repurchased 340,455 shares of outstanding common stock for $3,003,000. As of
September 30, 2004, under our stock repurchase plan, we may repurchase up to an
additional 1.73 million shares of our common stock. On a continual basis, we
will evaluate options for utilizing our cash in an effort to maximize returns
to our shareholders, including paying quarterly dividends and making purchases
under our stock repurchase program. Results of Operations Net Sales September
    
    % Change
    
    September30, 2004
    
    2003 to 2004
    
    30, 2003Net sales
    
    For the three months ended
    
    $
    22,968,000
    
    
    
    25.2
    %
    
    $
    18,343,000For the nine months ended
    
    $
    62,406,000
    
    
    
    21.1
    %
    
    $
    51,547,000
 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 September 30, 2004, increased
24.8% to $18,093,000 from $14,500,000 for the same period last year. Product
sales for the nine months ended September 30, 2004, increased 20.4% to
$48,963,000 from $40,672,000 for the same period last year. The increase in
product sales for the three months and nine months ended September 30, 2004,
was primarily due to an increase in NetLink sales, including sales of this
product to our OEMs. For the three months and nine months ended September 30,
2004, NetLink product revenue was approximately $6.8 million and $18.5
million, respectively, compared to $4.3 million and $10.0 million,
respectively, for the same periods last year. For the three months and nine
months ended September 12




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30, 2004, Link product revenue was approximately $11.3 million and $30.5
million, respectively, compared to $10.2 million and $30.7 million,
respectively, for the same periods last year. Service Sales. We derive our service revenue principally from the
installation and service of wireless on-premises telephone systems. Service
sales represented 21.2% of total net sales in the quarter ended September 30,
2004, compared to 21.0% in the quarter ended September 30, 2003. For the nine
months ended September 30, 2004 and 2003, service sales were 21.5% and 21.1%
of total net sales, respectively. Service sales for the three months ended September 30, 2004, increased
26.9% to $4,875,000 from $3,843,000 in the same period last year. Service
sales for the nine months ended September 30, 2004, increased 23.6% to
$13,443,000 from $10,875,000 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 our maintenance
contracts. Service sales also increased due to additional time and material
service repairs and training. The following table summarizes sales to a major customer (a customer that
represented more than 10% of our revenue): Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,Sales to Major Customer (As a Percentage of Net Sales)
    
    2004
    
    2003
    
    2004
    
    2003Customer A:
    
    
    *
    
    
    
    10.0
    %
    
    
    *
    
    
    
    *Customer B:
    
    
    *
    
    
    
    *
    
    
    
    10.5
    %
    
    
    *
 (*) represents less than 10% of our revenue As of September 30, 2004, we had no customers that represented more than
10% of our trade accounts receivable. As of December 31, 2003, one customer
represented more than 10% of our trade accounts receivable. This customer
represented 16.7% of trade accounts receivable as of December 31, 2003. Total Cost of Sales September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003Total cost of sales
    
    For the three months ended
    
    $
    8,155,000
    
    
    
    33.4
    %
    
    $
    6,113,000For the nine months ended
    
    $
    22,370,000
    
    
    
    31.4
    %
    
    $
    17,020,000
 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 September 30, 2004, cost of product sales
increased by 36.1% to $5,501,000 from $4,042,000 in the same period last year.
Cost of product sales as a percentage of product sales, net was 30.4% and 27.9%
for the three months ended September 30, 2004 and 2003, respectively. Gross
profit from product sales, net increased 20.4% to $12,592,000 for the three
months ended September 30, 2004 from $10,458,000 in the same period last year.
In the nine months ended September 30, 2004, cost of product sales increased
29.7% to $14,757,000 from $11,380,000 in the same period last year. Cost of
product sales as a percentage of product sales, net was 30.1% and 28.0% for the
nine months ended September 30, 2004 and 2003, respectively. Gross profit from
product sales, net increased 16.8% to $34,206,000 for the nine months ended
September 30, 2004 from $29,292,000 in the same period last year. For the three months ended September 30, 2004 and 2003, gross profit from
product sales, net as a percentage of product sales, net, was 69.6% and 72.1%,
respectively. For the nine months ended September 30, 2004 and 2003, gross
profit from product sales, net, as a percentage of product sales, net, was
69.9% and 72.0%, respectively. For the three months and nine months ended September 30, 2004, compared to
the same periods last year, gross margin from product sales, net decreased
because OEM sales, which typically have larger discounts, grew to 20% of total
product revenue in the third quarter of 2004, a significant increase over the
previous year. In addition, our NetLink 13




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sales increased which carry lower margins. 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 September 30, 2004,
increased by 28.2% to $2,654,000 from $2,071,000 in the same period last year.
Cost of service sales as a percentage of service sales was 54.4% for the three
months ended September 30, 2004, compared to 53.9% for the same period last
year. For the three months ended September 30, 2004, gross profit from service
sales increased by 25.3% to $2,221,000 from $1,772,000 in the same period last
year. For the three months ended September 30, 2004 and 2003, respectively,
gross profit from service sales, as a percentage of service sales, decreased to
45.6% from 46.1%. Cost of service sales for the nine months ended September 30, 2004,
increased by 35.0% to $7,613,000 from $5,640,000 in the same period last year.
Cost of service sales as a percentage of service sales was 56.6% for the nine
months ended September 30, 2004, compared to 51.9% for the same period last
year. Gross profit from service sales increased by 11.4% to $5,830,000 for the
nine months ended September 30, 2004 from $5,235,000 for the same period last
year. For the nine months ended September 30, 2004 and 2003, respectively,
gross profit from service sales, as a percentage of service sales, decreased to
43.4% from 48.1%. For the three months and nine months ended September 30, 2004, compared to
the same periods last year, gross profit from service sales decreased primarily
because we increased headcount to support future growth, we had higher
inventory write-offs as a result of us removing additional older products from
the field at the time they are returned for repair, and we experienced an
increase in costs for materials primarily related to an increase in product
volume and freight charges. In addition, for the nine months ended September
30, 2004, our travel costs were higher to install, train and support our larger
customer base compared to the same period last year. Gross Profit September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003Gross Profit
    
    For the three months ended
    
    $
    14,813,000
    
    
    
    21.1
    %
    
    $
    12,230,000For the nine months ended
    
    $
    40,036,000
    
    
    
    16.0
    %
    
    $
    34,527,000
 For the three months ended September 30, 2004, our gross profit margin
(gross profit as a percentage of net sales) decreased to 64.5% from 66.7% in
the same period last year. For the nine months ended September 30, 2004, our
gross profit margin decreased to 64.2% from 67.0% in the same period last year.
The decrease in gross profit margin was primarily due to increased OEM sales,
which typically have larger discounts, an increase in NetLink sales which have
lower margins, and an increase in our service infrastructure to support future
growth. Operating Expenses Research and Development September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003Expenses
    
    For the three months ended
    
    $
    2,268,000
    
    
    
    18.9
    %
    
    $
    1,908,000Percentage of total net sales for
the three months ended
    
    
    9.9
    %
    
    
    
    
    
    
    10.4
    %For the nine months ended
    
    $
    6,636,000
    
    
    
    12.2
    %
    
    $
    5,912,000Percentage of total net sales for
the nine months ended
    
    
    10.6
    %
    
    
    
    
    
    
    11.5
    %
 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% to 12% of net sales for
fiscal 2004. 14




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##### Table of Contents



For the three months ended September 30, 2004, compared to the same period
last year, the increase in dollars spent was primarily due to increases in
salaries and employee benefits related to increases in headcount and merit
raises as well as tooling costs. The percentage of net sales decreased from
the prior year due to an increase in sales. For the nine months ended September 30, 2004, compared to the same period
last year, the increase in dollars spent was primarily due to increases in
salaries and employee benefits related to increases in headcount and merit
raises as well as tooling costs. In addition, depreciation expense increased
as we purchased research and development test equipment. The percentage of net
sales decreased from the prior year due to an increase in sales. Marketing and Selling September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003Expenses
    
    For the three months ended
    
    $
    6,193,000
    
    
    
    8.5
    %
    
    $
    5,709,000Percentage of total net sales for
the three months ended
    
    
    27.0
    %
    
    
    
    
    
    
    31.1
    %For the nine months ended
    
    $
    17,853,000
    
    
    
    6.9
    %
    
    $
    16,696,000Percentage of total net sales for
the nine months ended
    
    
    28.6
    %
    
    
    
    
    
    
    32.4
    %
 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 September 30,
2004, compared to the same period last year for both domestic and international
sales, was primarily related to an increase in commissions due to higher sales
in 2004 compared to the same period last year. In addition, the increase
related to an increase in salaries and benefits to hire new personnel and
retain existing personnel as well as an increase in consulting fees. The
increase in expenses was offset by a decrease in travel and telephone expenses.
Marketing and selling expenses as a percentage of net sales decreased from the
prior year due to an increase in sales. The increase in dollars spent for the nine months ended September 30,
2004, compared to the same period last year for both domestic and international
sales, was primarily due to an increase in salaries and employee benefits to
hire new personnel and to retain existing personnel and executive recruiting
costs to hire a new Vice President of Sales and Marketing. The increase also
related to an increase in commissions related to an increase in sales,
increases related to travel and legal fees as we negotiated and finalized
several OEM agreements in the first quarter of 2004, as well as consulting
fees. The increase in expenses was offset by a decrease in marketing and
promotional costs, including tradeshow expenses (as we launched our new NetLink
products in April 2003). Marketing and selling expenses as a percentage of net
sales decreased from the prior year due to an increase in sales. General and Administrative September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003Expenses
    
    For the three months ended
    
    $
    1,660,000
    
    
    
    64.5
    %
    
    $
    1,009,000Percentage of total net sales for
the three months ended
    
    
    7.2
    %
    
    
    
    
    
    
    5.5
    %For the nine months ended
    
    $
    4,470,000
    
    
    
    45.8
    %
    
    $
    3,066,000Percentage of total net sales for
the nine months ended
    
    
    7.2
    %
    
    
    
    
    
    
    6.0
    %
 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 in dollars spent for the three months ended September 30,
2004, compared to the same period last year, was primarily due to costs
(including legal) incurred for compliance with Section 404, Managements
Internal Controls and Procedures for Financial Reporting, of the
Sarbanes-Oxley Act of 2002. For the three months ended September 30, 2004, we
spent approximately $200,000 in documenting, testing and auditor review of our
internal controls. Other increases in costs were related to increasing our
infrastructure to support future growth, which 15




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resulted in increased headcount, salaries and employee benefits to hire and
retain personnel, as well as increases in insurance, consulting and
professional fees related to international accounting, and board member fees. The increase in dollars spent for the nine months ended September 30,
2004, compared to the same period last year, was primarily due to costs
(including legal) incurred for compliance with the Section 404, Managements
Internal Controls and Procedures for Financial Reporting of the Sarbanes-Oxley
Act of 2002, and recruiting and hiring costs for our new Chief Financial
Officer. We spent approximately $400,000 associated with documenting, testing
and auditor review of our internal controls for the nine months ended September
30, 2004. Other increases in costs were related 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, consulting and professional fees related to
international accounting, and board member fees, as well as an increase in our
bad debt provision related to an increase in sales. Income from Operations September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003For the three months ended
    
    $
    4,692,000
    
    
    
    30.2
    %
    
    $
    3,604,000Percentage of total net
sales for the three
months ended
    
    
    20.4
    %
    
    
    
    
    
    
    19.6
    %For the nine months ended
    
    $
    11,077,000
    
    
    
    25.1
    %
    
    $
    8,853,000Percentage of total net
sales for the nine months
ended
    
    
    17.7
    %
    
    
    
    
    
    
    17.2
    %
 The increases in the income from operations for the three and nine months
ended September 30, 2004, compared to the same periods last year primarily
relates to an increase in net sales offset by increases in cost of sales and
operating expenses. Other Non-Operating Income and Expenses September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003For the three months ended
    
    $
    121,000
    
    
    
    80.6
    %
    
    $
    67,000Percentage of total net
sales for the three
months ended
    
    
    0.5
    %
    
    
    
    
    
    
    0.4
    %For the nine months ended
    
    $
    384,000
    
    
    
    65.5
    %
    
    $
    232,000Percentage of total net
sales for the nine months
ended
    
    
    0.6
    %
    
    
    
    
    
    
    0.5
    %
 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. The increase in other income was primarily due to an increase in interest
rates, and the nine months ended September 30, 2004, also increased due to a
refund for certain banking fees. Income Tax September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003Income tax expenseFor the three months ended
    
    $
    1,886,000
    
    
    
    35.2
    %
    
    $
    1,395,000Percentage of total net sales for
the three months ended
    
    
    8.2
    %
    
    
    
    
    
    
    7.6
    %Effective tax rate for the three months ended
    
    
    39.2
    %
    
    
    
    
    
    
    38.0
    %For the nine months ended
    
    $
    4,412,000
    
    
    
    27.8
    %
    
    $
    3,452,000
 16




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##### Table of Contents



September 30,
    
    % Change
    
    September 30,2004
    
    2003 to 2004
    
    2003Percentage of total net sales for the nine
    
    
    7.1
    %
    
    
    
    
    
    
    6.7
    %months endedEffective tax rate for the nine months ended
    
    
    38.5
    %
    
    
    
    
    
    
    38.0
    %
 The increase in income tax expense for the three months and nine months
ended September 30, 2004, compared to the same periods last year was primarily
related to an increase in our tax rate because of higher taxable income
expected for calendar year 2004 that will move us into a higher federal tax
bracket. We now estimate that the full-year 2004 tax rate will be 38.5%. We
recorded a 39% tax rate in the third quarter to reach a year-to-date effective
tax rate of 38.5%. Liquidity and Capital Resources Nine Months
    
    Nine MonthsEnded September
    
    Ended September30, 2004
    
    30, 2003Cash from operating activities
    
    $
    7,130,000
    
    
    $
    7,320,000Cash used in investing activities
    
    
    (1,223,000
    )
    
    
    (2,262,000
    )Cash (used in) provided by financing activities
    
    
    (4,650,000
    )
    
    
    733
 We have funded our operations since inception with cash provided by
operations, supplemented by equity financing and leases on capital equipment.
As of September 30, 2004, we had $53,118,000 of cash and cash equivalents. For
the nine months ended September 30, 2004, we paid three quarterly cash
dividends of $0.10 per share for a total of $5,723,000 to holders of common
stock, and we may use some of our cash provided by operations to pay future
quarterly dividends as determined by the board of directors. In addition, in
July 2004, we announced that our board of directors approved the re-initiation
of our stock repurchase program. During the three months ended September 30,
2004, we repurchased 340,455 of outstanding shares under our stock repurchase
plan for $3,003,000. As of September 30, 2004, under our stock repurchase
plan, we may repurchase up to an additional 1.73 million shares of our common
stock. On a continual basis, we will evaluate options for utilizing our cash
in an effort to maximize returns to our shareholders, including paying
quarterly dividends and making repurchases under our stock repurchase program. During the nine month period ending September 30, 2004, the cash we
generated from operations of $7,130,000, consisted principally of net income of
$7,049,000, and was reduced principally by an increase in inventories of
$3,628,000 that related to OEMs with order-to-ship commitments being shorter
than the manufacturing build pipeline, and to accommodate our expanded product
mix and other orders shipped subsequent to September 30, 2004. The cash we
generated from operations also included adjustments for depreciation and
amortization, income tax benefit from exercises of stock options, deferred
income taxes, provisions for bad debts, and excess and obsolete inventories
that reconcile net income to cash generated by operating activities, as well as
increases in accrued liabilities and deferred revenue. This was partially
offset by increases in trade accounts receivable, other assets and income tax
receivable, and a decrease in accounts payable. Investing activities used cash of $1,223,000 for purchases of property and
equipment primarily related to purchases of research and development test
equipment, manufacturing tooling, and molds designed for our NetLink product,
and office equipment. We used $4,650,000 of cash in financing activities during the nine month
period ended September 30, 2004, which was a direct result of the issuance and
payment of cash dividends of $5,723,000, repurchases of treasury stock of
$3,003,000, and payments on obligations of $25,000. These cash outflows were
offset by proceeds of $4,101,000 received from common stock option exercises
and purchases of common stock under our employee stock purchase plan. As of September 30, 2004, 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 2003 Form 10-K or as noted in the Aggregate
Contractual Obligations and Commercial Commitments section. Stockholders
equity at September 30, 2004, was $69,629,000, which represented 81.3% of total
assets. As of September 30, 2004, we had working capital of $65,141,000 compared
to $62,178,000 at December 31, 2003. The increase in working capital of
$2,963,000 occurred primarily from cash flows from operations and proceeds from
common stock option exercises, offset by the purchases of capital assets,
repurchases of treasury stock and cash dividends paid. As of September 30,
2004, our current ratio (ratio of current assets to current liabilities) was
5.12:1, compared with a current ratio of 5.33:1 as of December 31, 2003. 17




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##### Table of Contents



We believe that our current cash, cash equivalents 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, repurchase shares of our common stock and to finance our expansion
for the foreseeable future (the 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 likely 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 and equipment, 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. As of September 30, 2004, expected future cash payments related to
contractual obligations and commercial commitments were as follows: 2004
    
    2005
    
    2006
    
    2007
    
    Thereafter
    
    TotalOperating leases
    
    $
    376,000
    
    
    $
    1,179,000
    
    
    $
    977,000
    
    
    $
    344,000
    
    
    $
    
    
    
    $
    2,876,000Purchase commitments
    
    
    1,251,000
    
    
    
    482,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,733,000Other obligations
    
    
    10,000
    
    
    
    34,000
    
    
    
    34,000
    
    
    
    34,000
    
    
    
    14,000
    
    
    
    126,000Total contractual
obligations and
commercial
commitments
    
    $
    1,637,000
    
    
    $
    1,695,000
    
    
    $
    1,011,000
    
    
    $
    378,000
    
    
    $
    14,000
    
    
    $
    4,735,000
 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 18




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##### Table of Contents



Below is a summary of our most critical accounting policies and estimates.
We determined the critical accounting principles by considering accounting
policies that involve the most complex or subjective decisions or assessments.
This discussion and analysis should be read in conjunction with our unaudited
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, 2003, which was filed with the U.S. Securities and
Exchange Commission on March 11, 2004 (2003 Form 10-K). 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: 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 possible
credit deterioration,
the customers
ability to sell
through the products
purchased and the
relationship we have
with our customer.
    
     Customer ability to pay 

Customer ability to sell to end-userOur 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
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.
 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 all
applicable
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.
    
    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
 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
 20




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##### Table of Contents



Financial Statement
    
    Critical Estimate
    
    Nature of Estimates
    
    Assumptions/ApproachesCaption(s)
    
    Item
    
    Required
    
    Used
    
    Key FactorsWarranty
    
    Warranty obligations
    
    Estimating warranty
liability requires
us to forecast and
use historical data
as a basis for
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 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 or Proposed Accounting Pronouncements On March 31, 2004, the FASB issued a proposed Statement, Share-Based
Payment, which addresses the accounting for share-based payment transactions.
The proposed Statement would eliminate the ability to account for share-based
compensation transactions using APB Opinion No. 25, Accounting for Stock
Issued to Employees, and generally would require instead that such
transactions be accounted and recognized in the statement of income based on
their fair value. The FASB recently announced that the final standard will be
effective for public companies for fiscal periods beginning after June 15,
2005. The proposed final standard offers us alternative methods of adopting
this final rule. At the present time, we have not yet determined which
alternative method we will use or the expected impact on our financial
statements. FORWARD-LOOKING STATEMENT FACTORS 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 our presentations, 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. 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. 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. 21




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##### Table of Contents




    
    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 to estimate 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. It is possible that due to fluctuations in revenue, our
operating results could be below the expectations of securities analysts
and investors. For instance, our stock price declined substantially
after our preliminary announcement of second quarter 2004 results
reported in July 2004. In such an event, or in the event that adverse
market conditions prevail or are perceived to prevail either generally
or with respect to our business, the price of our common stock would
likely decline further.
    
    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 commercial networks. As a result, end-users
may 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 22




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##### Table of Contents



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 warranty 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
warranty 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 our key personnel receive
a total compensation package that includes stock options. The
Financial Accounting Standards Board and other agencies have proposed
changes to accounting principles generally accepted in the United
States that would 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 operations. We are
also highly dependent upon our business relationship with Offshore
Group to provide management services and a facility located in
Empalme, Sonora, Mexico that assembles our products. Any event that
may disrupt or indefinitely discontinue either of the facilities
capacity to manufacture, assemble and repair our products could
greatly impair our ability to generate revenues, fulfill orders and
attain financial goals. 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 emerging wireless standards quickly enough to
satisfy market demands and without significant product redesign;
    
    develop or obtain access to advanced wireless
networking capabilities as they become available; and
    
    design, develop and introduce competitive new products
on a timely basis.  Due to the competitive nature of our business, any failure by us to
meet any of these challenges could materially and adversely affect our
business, reputation, and operating results. 23




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
    
    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;
    
    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;
    
    increases in warranty costs; and
    
    introducing 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 continuing uncertainty about economic prospects in some
sectors of our target customer market, adversely impacts their
information technology spending and our business.Our business has
been adversely impacted by the continuing 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 continue to defer, and in some cases cancel, their
purchase decisions. Our operating results have been 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 revenues.
    
    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,
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 OEMs,
distributors and resellers. During the three months ended September
30, 2004, sales of our products through our indirect distributors
accounted for 78% of our product revenue, of which 20% 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 24




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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. For instance, we experienced a decrease in sales by
distributors during the second quarter of 2002 when those distributors
downsized their businesses in reaction to the economic slowdown and, as
a result, had fewer sales representatives marketing our products. 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.
    
    Our revenue and earnings are highly seasonal. Seasonality and
other factors cause significant quarterly fluctuations in our revenue
and net income.Our business is highly seasonal. 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.
    
    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 wireless LANs. 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 revenues into our growth in the future.
    
    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 25




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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, in September
2003, John Elms, our Vice President of Operations, was promoted to
President and Chief Executive Officer, while Bruce Holland, the former
President and Chief Executive Officer, continued with us as Chairman of
the Board until he resigned from the Board in March 2004. Additionally,
in October 2003, we hired John Kelley as Vice President of Operations.
In February 2004, Michael Cronin, our Vice President of Sales and
Marketing resigned his positions of Vice President of Sales and
Marketing and Corporate Officer effective April 1, 2004, although he
agreed to remain an employee to assist us with the transition through
June 30, 2004. In April 2004, Nancy Hamilton, our Vice President of
Finance and Administration and Chief Financial Officer, resigned her
positions as Vice President of Finance and Administration and Chief
Financial Officer and Corporate Officer effective April 20, 2004,
although she remained an employee to assist us with the transition
through July 20, 2004. Additionally, in April 2004, we hired David
Rosenthal as Executive Vice President of Finance and Administration,
Chief Financial Officer, and Corporate Secretary, and we hired Jill
Kenney as Executive Vice President of Sales and Marketing effective May
17, 2004. 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 Chief
Executive Officer, Executive Vice President of Finance and
Administration and Chief Financial Officer, Executive Vice President of
Sales and Marketing, Executive Vice President of Engineering and
Executive Vice President of Operations, and do not maintain key person
insurance on any of our executives. 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 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 our Voice Priority.In the
absence of a wireless voice prioritization standard, 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 our Voice Priority functionality. 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 develop and introduce new products and transition
existing products.Our development efforts may not lead to the
successful introduction of new or improved products. 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 install 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 26




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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
voice-over-IP may lead to the commoditization of wireless telephone
technology and the availability of low-cost alternative products. In
addition, some purchasers may prefer to buy their wireless telephone
systems from a single source provider of telephone systems, such as
Alcatel or Cisco Systems, both of which manufacture and sell
enterprise telephone systems. 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 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 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
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. 27




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
    
    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.
    
    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
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
$400,000 associated with documenting, testing and auditor review of
our internal controls during the nine months ended September 30, 2004.
In addition, we expect these developments to 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
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, we currently are not required to record stock-based
compensation charges if the employees stock option exercise price is
equal to or exceeds the deemed fair value of our common stock at the
date of grant. However, several companies have recently elected to
change their accounting policies and begun to record the fair value of
stock options as an expense. The FASB published in March 2004, an
exposure draft that would require us to record expense for the fair
value of stock options granted. Recently, the FASB announced that the
final standard will become effective for public companies for fiscal
periods beginning after June 15, 2005. 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 September 30, 2004, the closing price of our
common stock has ranged from a high of $24.80 per share to a low of
$7.97 per share. Many factors could cause the market price of our
common stock to fluctuate, including: 28




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
    
    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;
    
    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 purported securities class action lawsuits. Further,
certain of our management and directors were also sued in purported
shareholder derivative actions. While the consolidated class action suit
has been settled, we have not finally resolved the shareholder derivative
actions. Although we believe that the shareholder derivative actions lack
merit, due to inherent uncertainties in litigation, we cannot accurately
predict the outcome of this litigation. An adverse determination could
have a significant effect upon our business and materially affect the price
of our stock. Moreover, regardless of the ultimate result, it is likely
that the lawsuit will require us to incur expenses and divert managements
attention and resources from other matters, which could also adversely
affect our business and the price of our stock. 
 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 September 30,
2004, 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 September 30, 2004, we had
cash and cash equivalents of approximately $53,118,000 mainly in the form of
bank demand deposits and money markets. 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 nine month period ended September 30, 2004, interest income would
have increased or decreased by approximately $394,000. 
 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 29




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financial statements for external purposes in accordance with accounting
principles generally accepted in the 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 September 30, 2004, that
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting. 
 Part II Other Information 
 Item 1. 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 are 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 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 preliminary
approval to the settlement, and a final hearing for approval of the settlement
was scheduled for October 7, 2004. An Order and Final Judgment was entered on
October 7, 2004, ending the litigation. The settlement was paid by our
directors and officers insurance carrier. 30




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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 have reached an agreement in principle settling both
derivative cases. The settlement is conditioned upon reaching agreement on
written settlement documents and on court approval. The defendants in the remaining lawsuits believe these cases are without
merit and intend to vigorously defend themselves if the settlement of the two
derivative cases is not effectuated. SpectraLink does not believe that its
interests and that of the named officers and directors are adverse to each
other as of this time. However, if the settlement is not consummated, no
assurance can be given that SpectraLink will be successful in defending the
claims being asserted in these suits, or that the interests of the various
parties will remain aligned. In addition, the derivative litigation could
result in substantial costs, divert managements attention and resources, or
ultimately result in the interests of SpectraLink becoming adverse to those of
certain of its officers and directors. In either case, our business could be
adversely affected, even if the plaintiffs are not successful in their claims. 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. Based on current facts and circumstances, the Company is
unable to estimate future losses, if any, it may incur if the remaining cases
are not settled, after considering the amounts that will be covered by
insurance. SpectraLink is not presently a party to any other material pending legal
proceedings of which it is aware. 
 Item 2 Unregistered Sales of Equity Securities and Use of Proceeds ApproximateTotal Number of
    
    Dollar Value ofShares Purchased
    
    Shares that Mayas Part of Publicly
    
    Yet Be PurchasedTotal Number of
    
    Average Price Paid
    
    Announced Plans
    
    under the Plans orPeriod
    
    Shares Purchased
    
    Per Share
    
    or Programs
    
    ProgramsMonth #1
(July 2004)
    
    
    100,000
    
    
    $
    9.04
    
    
    
    100,000
    
    
    $
    17,816,737Month #2
(August 2004)
    
    
    240,455
    
    
    $
    8.73
    
    
    
    240,455
    
    
    $
    15,106,593Month #3
(September 2004)
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    15,106,593Total
    
    
    340,455
    
    
    $
    8.82
    
    
    
    340,455
    
    
    
    
 31




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##### Table of Contents



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 2003 Form 10-K constitute those
exhibits currently required to be on file. The reader should refer to the
2003 Form 10-K under Part III, Item 15, for a list of those exhibits. 32




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##### Table of Contents



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: November 8, 2004By: /s/ DAVID I. ROSENTHALDavid I. Rosenthal,Executive Vice President of
Finance and Administration and
Chief Financial Officer(Principal Financial and Accounting
Officer and on behalf of the Registrant)
 33




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##### Table of Contents



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