**UNITEDSTATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K**

 

**(MarkOne)**

 
| **x**      |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                          |
|------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** |   | ** **                                                                                                                                                                                                                                   |
| ** ** |   | **FOR THE FISCAL YEAR ENDED  DECEMBER 31, 2007.**                                                                                                                                                                                            |
| ** ** |   | ** **                                                                                                                                                                                                                                   |
| **o**      |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                      |
| ** ** |   | ** **                                                                                                                                                                                                                                   |
| ** ** |   | **FOR THE TRANSITION PERIOD  FROM                TO                 .** |

 

**Commission file number: 000-30575**

 

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**AVOCENTCORPORATION**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                   | ** ** | **91-2032368**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer Identification No.) |
|                                                           |       |                                 |
| **4991 Corporate Drive**                                       | ** ** | ** **                           |
| **Huntsville, Alabama**                                        | ** ** | **35805**                            |
| (Address of Principal Executive Offices)                       |       | (Zip Code)                           |

 

**256-430-4000**

(Registrant’stelephone number, including area code)

 

Securitiesregistered under Section 12(b) of the Exchange Act

**Common Stock, $0.001 par value per share**

 

Securitiesregistered under Section 12(g) of the Exchange Act: **None**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes  x    No  o

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. Yes  o    No  x

 

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

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and disclosure will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K.  x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 
| Large  accelerated filer x | Accelerated  filer o | Non-accelerated  filer o | Smaller  reporting company o |
|----------------------------|----------------------|--------------------------|------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes  o    No  x

 

Theaggregate market value of the voting and non-voting common stock held bynon-affiliates of the registrant as of the last business day of the registrant’smost recently completed second fiscal quarter was approximately $1,451,497,393.

 

Thenumber of shares outstanding of the registrant’s common stock as of February 15,2008 was 45,696,212.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Informationwith respect to items 10 to 14 of Part III of this Form 10-K may befound in the definitive proxy statement to be delivered to stockholders inconnection with the 2007 Annual Meeting of Stockholders. Such information isincorporated herein by reference.

 

 

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**Item 1.  Business.**

 

*THIS ANNUAL REPORT CONTAINSFORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. ALL STATEMENTSCONTAINED IN THIS ANNUAL REPORT THAT ARE NOT PURELY HISTORICAL FACTS AREFORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THESECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIESEXCHANGE ACT OF 1934, AS AMENDED.  THESEFORWARD-LOOKING STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS RELATING TOFUTURE EVENTS, FUTURE RESULTS, AND FUTURE ECONOMIC CONDITIONS IN GENERAL ANDSTATEMENTS ABOUT:*

 

·                                          *OUR FUTURE STRATEGY,STRUCTURE, AND BUSINESS PROSPECTS;*

 

·                                          *PLANNED ENGINEERING ANDDESIGN ACTIVITIES, DEVELOPMENT AND ENHANCEMENT OF CURRENT PRODUCTS, ANDINTRODUCTION OR ACQUISITION OF NEW PRODUCTS AND TECHNOLOGIES;*

 

·                                          *THE SIZE, GROWTH, AND LEADERSHIP OF THE POTENTIALMARKETS FOR OUR PRODUCTS AND TECHNOLOGIES;*

 

·                                          *THE ADEQUACY OF CURRENT, AND THE DEVELOPMENT OF NEW, OEM, DISTRIBUTOR, RESELLER, AND SUPPLIERRELATIONSHIPS;*

 

·                                          *OUR FUTURE SALES,EARNINGS, INCOME, EXPENSES, OPERATING RESULTS, TAX RATES, OPERATING AND GROSSPROFIT AND MARGINS, INVENTORY LEVELS AND VALUATIONS, RECEIVABLES, RESERVES ANDINVESTMENT INCOME;*

 

·                                          *OUR FUTURE LIQUIDITY, THE IMPACT OF CURRENCY RATES,AND OUR PLANS REGARDING EQUITY-BASED COMPENSATION, CAPITAL RESOURCE NEEDS,SHARE REPURCHASES, BORROWINGS AND REPAYMENTS;*

 

·                                          *OUR CUSTOMERS, SEASONALITY AND COMPETITIVEENVIRONMENT;*

 

·                                          *OUR EFFORTS TO EXPAND RELATIONSHIPS WITH DISTRIBUTORS AND RESELLERS;*

 

·                                             *OUR ABILITY TO OBTAIN AND PROTECT OUR INTELLECTUALPROPERTY AND PROPRIETARY RIGHTS;*

 

·                                             *ANTICIPATED EXPANSION OF INTERNATIONAL SALES ANDOPERATIONS; AND*

 

·                                          *POTENTIAL ACQUISITIONS,CONTINGENT PURCHASE CONSIDERATION RELATED TO OUR ACQUISITION OF LANDESK,INTEGRATION COSTS, AND TRANSACTION COSTS AND ADJUSTMENTS.*

 

*ALL OF THESE FORWARD-LOOKINGSTATEMENTS ARE BASED ON INFORMATION, EXPECTATIONS, ESTIMATES, FORECASTS, ANDPROJECTIONS AVAILABLE TO US ON THE DATE OF THIS ANNUAL REPORT AND THE BELIEFSAND ASSUMPTIONS OF OUR MANAGEMENT.  WORDSSUCH AS “EXPECTS,” “ANTICIPATES,” “TARGETS,” “GOALS,” “PROJECTS,” “INTENDS,” “PLANS,”“BELIEVES,” “SEEKS,” “ESTIMATES,” “CONTINUES,” “MAY,” AND VARIATIONS OF THESEWORDS, AS WELL AS SIMILAR EXPRESSIONS, ARE INTENDED TO IDENTIFY SUCHFORWARD-LOOKING STATEMENTS.  IN ADDITION,ANY STATEMENTS THAT REFER TO PROJECTIONS OF OUR FUTURE FINANCIAL PERFORMANCE,OUR ANTICIPATED GROWTH, TRENDS IN OUR BUSINESSES, AND OTHER CHARACTERIZATIONSOF FUTURE EVENTS OR CIRCUMSTANCES ARE FORWARD-LOOKING STATEMENTS. OUR ACTUALRESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED IN THIS ANNUALREPORT.  THE FORWARD-LOOKING STATEMENTSCONTAINED IN THIS ANNUAL REPORT, AND OTHER WRITTEN AND ORAL FORWARD-LOOKINGSTATEMENTS MADE BY US FROM TIME TO TIME, ARE SUBJECT TO CERTAIN RISKS,UNCERTAINTIES, AND ASSUMPTIONS THAT COULD CAUSE ACTUAL RESULTS TO DIFFERMATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS.  FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCEINCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED*

 

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*IN ITEM 1A “RISK FACTORS.”  WE UNDERTAKE NO OBLIGATION TO REVISE ORUPDATE ANY FORWARD-LOOKING STATEMENTS FOR ANY REASON.*

 

**Overview**

 

AvocentCorporation designs, manufactures, licenses, and sells software and hardwareproducts and technologies that provide connectivity and centralized managementof information technology (IT) infrastructure. We (meaning Avocent and its wholly-owned subsidiaries) provide connectivityand systems management, endpoint security, and service management products andtechnologies that centralize control of servers, desktop computers, serialdevices, wireless devices, mobile devices, network appliances, and processmanagement, designed to increase the efficiency of IT personnel.  Server manufacturers resell private-labeledAvocent KVM (keyboard, video, and mouse) switches and embedded software andhardware technology in their systems, and companies large and small depend onour software and hardware products and technologies for managing their growingIT infrastructure.

 

Our technologicalinnovations include Internet protocol (IP) based switching, centralizedmanagement, and intuitive software interfaces. With more than two decades of experience, we have grown through productinnovations, global expansion, and strategic acquisitions.  Formed as a result of the merger in 2000between Apex Inc. and Cybex Computer Products Corporation, we subsequentlyacquired Equinox Systems Inc. in 2001, 2C Computing, Inc. in 2002, Soronti, Inc.in 2003, Crystal Link Technologies, OSA Technologies, Inc., and SonicMobility, Inc. in 2004, and Cyclades Corporation and LANDesk Group Limitedin 2006.

 

We market our productsaround the world to a diversified group of original equipment manufacturers(OEMs), dealers, distributors, resellers, and end users, primarily through oursales and customer support staff, advertisements in trade publications, on-linesponsorships, and participation in major industry trade shows.  A substantial portion of our sales is to majorserver OEMs that purchase our switching systems on a private-label orbranded basis.

 

Our corporate Internetaddress is *www.avocent.com*.  At this website, we make available free ofcharge our annual report on Form 10-K, our annual proxy statement, ourquarterly reports on Form 10-Q, any current reports on Form 8-K, andany amendments to these reports, as soon as reasonably practicable after weelectronically file them with, or furnish them to, the Securities and ExchangeCommission (“SEC”).  Also available atthis website are our Code of Business Conduct and Ethics, our CorporateGovernance Guidelines, our Whistleblower Policy, the Nominating and GovernanceCommittee’s Policies and Procedures for Director Candidates, and the Chartersfor our Acquisition and Strategy Committee, Audit Committee, CompensationCommittee, and Nominating and Governance Committee.  If any amendment to our Code of BusinessConduct and Ethics or any waiver granted under it is applicable to ourprincipal executive officer, our principal financial officer, our principal accountingofficer or controller (or any persons performing similar functions) and relatesto the code of ethics definition enumerated in the SEC’s regulations, we willdisclose such amendment or waiver at this website within five business daysafter the date of such amendment or waiver. The information found on our website is not part of this Form 10-K.  In addition to our website, the SEC maintainsan Internet site at *www.sec.gov*that contains reports, proxy and information statements, and other informationregarding us and other issuers that file electronically with the SEC.

 

ACS, Apex, AMX, AMWorks,Avocent, the Avocent logo, AutoView, Cybex, Cyclades, DSR, DSView, Emerge,Equinox, KVM over IP, LANDesk, the LANDesk logo, LongView, PM, The Power ofBeing There, and SwitchView are trademarks or registered trademarks owned byus. ** **Thisannual report also includes trademarks of other companies.

 

**Industry Background**

 

Information technology iscritical to most business operations as computers perform multiple and diversefunctions throughout many different types of organizations.  Many corporations have decentralizedcomputing power while sharing technology resources and providing broad accessto enterprise data.  This has resulted inthe widespread adoption of distributed network computing environments using anetwork-based architecture of interconnected computers that span from the datacenter to the corporate office. Businesses are increasingly faced with a growing number ofchallenges.  These challenges include:

 

*DataCenter Growth. *Thetypical data center installation consists of a local area network (LAN), with alarge number of computers operating as servers dedicated to performing specificfunctions for the many client computers connected to the LAN and, in manycases, a wide-area network (WAN).  Withthe shift of software applications to a web services model, the demand forservers and storage is growing.  Usersare accessing more data and resources using intranets and the Internet.  This growth causes a proliferation of serversand increases the administration, environmental, power, and space challenges ofmanaging data centers containing growing networks of servers, consoles,peripherals, and cables, and other network devices.

 

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*CorporateOffice Growth. *Thecorporate office environment is made up of both central office and distributedor branch locations.  These environmentstypically consist of a large number of connected devices that include servers, desktopcomputers, laptops, handheld devices, printers, and other networkeddevices.  The increase in the number ofthese devices in the office environment and the distributed nature of them posemany significant challenges in system, security, service, and processmanagement.

 

*IncreasinglyMobile Workforce. *Asthe workforce continues to become more mobile, handheld devices and laptopcomputers are increasingly used outside of the corporate LAN.  This proliferation of networked devices andthe difficulty in controlling these devices outside of the corporate LAN posemany significant management and security challenges.

 

*HeterogeneousEnvironment. *CorporateIT departments may manage hundreds or thousands of servers, clients, and othernetworked devices, must identify and access relevant devices, add or deleteusers, add, change, or upgrade applications, tune systems for betterperformance, and diagnose and correct network failures.  These network devices are generally purchasedfrom multiple vendors and are designed to operate as stand-alone systems, eachwith its own console.  IT professionalsmust therefore deal with a large number of consoles and workflow processes,whether centrally located or dispersed throughout the organization, whenperforming administration and management tasks.

 

*Always-OnInfrastructure. *Informationtechnology resources are critical to organizations.  Accordingly, constant availability is crucialto the operation of many businesses.  Thetime that an Internet service provider (ISP), an application service provider(ASP), a data center, a server farm, a corporate network, or a desktopcomputer, a laptop, or a mobile device is down or degraded can causesignificant inconvenience, loss of productivity, and financial loss.  Quick and efficient diagnosis and thecorrection of problems can be difficult, and the ability of a facilitiesmanager or network administrator to quickly and efficiently diagnose andcorrect the problem may be hampered by the inability to access the software.

 

*Virtualization*.Virtualization is the separation of the computer operating system andapplications from the hardware - often supporting multiple operating systemsand applications on a single hardware platform.  As a relatively new technology, virtualizationoffers significant economic benefits to IT organizations in the form ofincreased scalability and asset utilization, but this emerging mix of virtualand physical servers and desktops adds a new layer of complexity to ITmanagement.  IT administrators need to manageand control these virtual machines in the same manner as physical machines, andour management software products address many of these needs. Our solutionsoffer combined access and control of both virtual and physical servers anddesktops in a secure platform and reduce the cost and complexity of managingthe IT infrastructure.  We havevirtualization product roadmaps for both our Management Systems Division andour LANDesk Division, with product announcements expected later in the year. 

 

**Products and Technologies**

 

As of January 1,2008, we have three divisions that provide the following software and hardwareproducts and technologies.  The productsand technologies we provide solve many of the network administration, systems,security, device management, and storage problems faced by facilities managers,network administrators, and IT managers.

 

·                                          **The Management SystemsDivision consists of our branded and OEM IT infrastructure management products,which include KVM, serial console, power control, digital extension, managementappliances, management software, and our embedded manageability technologies,such as intelligent platform management infrastructure (IPMI) and embedded KVMsystems.**

 

This division focuses onIT infrastructure management solutions and technologies for (i) datacenters, (ii) remote access and distributed branch office environments, (iii) mid-sizeserver rooms for the small and medium business (SMB) market, and (iv) desktopswitching and universal serial bus (USB) hubs for simplified control ofdesktops, small offices, and home-based businesses. This division also providesthe technology that links our embedded technologies and our DSView managementsoftware.

 

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The products and technologiesoffered by our Management Systems Division include:

 

·                                          Our*DS Series*TM products, which allow usersto control both physical and virtual servers from remote locations using anInternet or network connection without the necessity of remote access hardwareor software on the computers or servers being accessed.  The *DS Series *KVMproducts digitize keyboard, video, and mouse information and compress andtransport that information in packets over traditional network connectionsoptimizing performance for busy data centers. Our *DSR*®switching systems feature a digital console connection that allows facilitiesmanagers and network administrators access to servers utilizing standardnetworking infrastructure and our *KVM over IP*TMtechnology.  Our *DS Series *appliances are managed with *DSView*® centralized management software,**providing access and control of servers andserial devices in the network operations center or from almost any location inthe world using TCP/IP connectivity. IT administrators can securely manage all connected data center devicesand gain “point-and-click” access and control over these devices using abrowser interface.

 

·                                          Our *AutoView*®**switch family, which offers users a variety of analog anddigital KVM switches.  Our AutoViewswitches provide small to medium size businesses with a 1U-high design savingvaluable rack space in the server room. Our *AutoView 1415, 1515, and 2015* switchesprovide KVM support for USB, PS/2, Sun, and serial target devices.  Our *AutoView 2020 and 2030*switches have a virtual media feature that allows sharing of adirectly-connected USB storage device to all servers connected to theswitch.  Our *AutoView3100 and 3200* switches are 16-port switches that provide serveraccess for up to two remote digital users and one local analog user.  All our *AutoView switches*offer an on-screen display and a web-based interface, which means that noadditional software is required for remote server access.

 

·                                          Our*SwitchView*® switchingproducts includes our*SwitchView**SC* family of secure switches, built for the secureenvironment and designed to restrict the transfer of data between connectedcomputers.  Our *SwitchView**1000*rack mounted KVM switches areavailable in 4, 8 and 16 port models with an on-screen display that supports2048 x 1536 video resolutions and can be cascaded to support up to 256 targetdevices.  Our compact, space-saving*SwitchView* desktop KVM switches support multiple computersand allow users to control multiple PCs and share access to a digital camera,CD-ROM, PDA, scanner, printer, speakers, and a microphone.

 

·                                          Our*AMX*TM analog matrix switchingsystems, which provide simpler access and easier manageability of servers inmulti-rack, multi-platform environments. Our *AMX*switches increasethe number of users with simultaneous access and offer efficient scalabilitywith an architecture that makes it easy to add and support additionalservers.  Our advanced*AMWorks*®software is also included with our *AMX*switches for central administration.

 

·                                          OurKVM extension product lines, including our CAT 5 extension products, fiberoptic and copper extension products, and wireless extension products.  The *LongView*®extender allows users to extend a keyboard, monitor, mouse, speakers,microphone, and serial port up to 500 feet away from the computer or KVM switchwith one CAT 5 UTP cable.

 

·                                          OurACS appliances, which deliver secure, serial over IP access to console ports ofcommand line driven operating systems such as LINUX or UNIX servers and otherserially-managed devices such as power management systems, storage elements,firewalls, and network switches and routers. These serial appliances and attached devices can be centrally managedusing our *DSView 3*management software.

 

·                                          Our*PM* series of intelligent power controland distribution devices, which provide control over any connected device’s ACpower source.  These devices are criticalin certain situations when the connected devices require a full hardware levelreset to restore operational service.  Our *PM* devices areconnected to DSR or ACS appliances and can be managed by the user interface ofthese appliances or centrally managed using our DSView 3 management software.

 

·                                          Ourembedded products, which are provided as hardware, software, firmware, orlicensed technology.  These productsinclude IPMI firmware, SMASH and WS-Man interfaces, DASH firmware, serviceprocess drivers, and development utilities. Our remote presence products include KVM switching and video compressiontechnologies, virtual media firmware, and software for graphical userinterfaces (GUIs).  Our embeddedtechnologies are licensed to our OEM customers for inclusion in their servers,desktops, notebooks, and other devices. Our hardware products consist of remote access, system management, andchassis management cards that are also sold to our OEMs for integration withtheir systems.

 

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·                  OurManagement Systems Division also offers the products and technologies formerlyoffered by our Desktop Solutions Division (which was discontinued on January 1,2008), including our digital extension product lines, which feature technologythat extends keyboard, video, mouse, audio, and USB over any TCP/IP network andallows administrators to centralize all computers for ease of maintenance whileproviding users with full “Rich-Media” PC functionality at the desktop.  This extension technology enables adistributed computing environment with access to centralized computer assetsfrom anywhere within the corporate network.

 

·                                          **The LANDesk Divisionconsists of our systems, security, and service management software fordesktops, servers, and mobile devices across an enterprise.**

 

This division delivers systems, security, and servicemanagement software solutions that simplify how corporate enterprisesmanage desktops, servers, mobile devices, and IT services and processes.  These LANDesk solutions allow an IT staff toincrease productivity and protect corporate assets from a single, easy-to-useconsole while leveraging prior investments in database, application, anddirectory service technologies and across heterogeneous IT environments(Windows, Mac OS, UNIX, LINUX, handheld, and embedded device operatingsystems).  LANDesk revenue and bookings are comprised of license-based revenue,primarily from the LANDesk Management Suite product, andsubscription-based revenue, primarily from the LANDesk Security Suite andLANDesk Patch Manager products and from maintenance and support agreementsrelated to LANDesk Management Suite.

 

The products andtechnologies offered by our LANDesk Division include:

 

*SystemsManagement Software*

 

·                                          Our*LANDesk® Management Suite *(LDMS) software, whichallows enterprise IT departments to easily and efficiently automate systemsmanagement tasks and see, manage, and update desktops, servers and mobiledevices from a single console. LDMS provides intelligent and efficientdistribution capabilities, such as functional load balancing, fault tolerance,bandwidth minimizing technologies, and local access to packages previouslydelivered to a subnet, to minimize the impact to corporate systems.  With just an Internet connection, corporateIT teams can identify and securely manage computer assets (including assetsoutside the firewall and at geographically distributed sites), scan, define,track, and audit applications, and provide compliance and usage reports.

 

·                                          Our*LANDesk Server Manager* software, whichprovides enterprises with the tools to improve server performance, reliability,and availability through operating system (OS) and application provisioning,real-time hardware health monitoring, automated patching, imaging, andupdating, historical data collection, predictive failure analysis andprevention, and remote problem resolution, all through a single console.

 

·                                          Our*LANDesk Application Virtualization*software, which provides enterprises with the capability to virtualize anapplication isolated from other applications running on the operatingsystem.  This allows IT managers to runolder applications on new operating system platforms.  The virtualized application can be run on thelocal device or streamed from a remote server, and does not require localadministration rights and does not require a local agent to be present.

 

·                                          Our*LANDesk Handheld and Embedded Device Manager*software, which is designed and optimized for managing across the low-speed,intermittent connections characteristic of handheld, embedded, and wirelessdevices, and allows an IT staff the ability to secure moving resources and theinformation on them, including the option to clear a device’s memory card,delete contacts, address book data, and e-mail, and perform a reset of themobile device.

 

·                                          Our*LANDesk Asset Manager* software, whichallows enterprises to track computer and non-computer resources (and associatedusers, contracts, maintenance agreements and more) through a single console toensure full system availability, security, and configuration management.

 

·                                          Our*LANDesk Inventory Manager* software, whichenables IT staff to discover networked computing devices, automaticallymaintain detailed hardware and software inventories, and gather and trackdetailed hardware, software, and OS configuration data for license compliance,plan upgrades, identification of security issues, and determination of purchaseneeds.

 

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*SecurityManagement Software*

 

·                                          Our*LANDesk Security Suite,*which includessoftware and subscription content that allows enterprises to easily perform andautomate patch, anti-spyware, and security threat management from a singleconsole with quarantine, antivirus enforcement, vulnerability detection, threatremediation, computer access restriction tools, and a variety of reportingcapabilities (including trend graphs, spyware reports, and an executivedashboard with a graphical view of critical enterprise concerns).

 

·                                          Our*LANDesk Patch Manager* software, whichallows corporate IT departments to actively scan managed computers acrossheterogeneous IT environments to identify application and operating systemvulnerabilities and quickly download patches with e-mail or pager alerts when avulnerability or a specific severity level is detected.

 

·                                          Our*LANDesk Antivirus* software, whichprovides enterprises with affordable, real-time virus protection and root kitdetection to user endpoints with little or no new infrastructure.  *LANDesk Antivirus*can automatically encrypt and quarantine suspicious files and known infections,and allows IT staffs to customize and control alerts, queries, and reports forfull security.

 

·                                          Our*LANDesk Host-based Intrusion Prevention (HIPs)*software, which provides enterprises the ability to protect endpoint devicesfrom zero-day attacks and other similar threats. The LANDesk HIPs solution alsomonitors the behavior of applications and isolates machines on the network thatare behaving erratically.

 

*ServiceManagement Software*

 

·                                          Our*LANDesk Process Manager,*which integrates,optimizes, and automates IT and business processes, workflow, changemanagement, and configuration management, with a graphical process builder,full-featured auditing, customizable reporting capabilities, and support forthird-party electronic forms.

 

·                                          Our*LANDesk Service Desk* software, whichprovides help desk and IT staff with an Internet-based consolidated servicedesk solution with process-driven incident management, role-based privilegesets, knowledge base, call logging, assignment, form design, and service levelescalation for delivering support services. *LANDesk Service Desk* includes anInternet-based interface that allows service providers and end users orcustomers to easily and proactively report problems, log incidents, communicateand track service status, and research the intelligent knowledge base forsolutions to facilitate faster resolution.

 

*ProfessionalServices*

 

·                  LANDeskoffers a wide range of professional services, training, maintenance, upgradeprotection, and customer support offerings to help customers realize the mostvalue from their LANDesk software investment.  The LANDeskProfessional Services team can draw from the experience, talents, andabilities of the people who develop award-winning LANDesk solutions, helpingcustomers experience the best implementation possible.  In addition,customers can attend LANDesk training courses or complete the Certified LANDeskEngineer or Administrator programs.

 

*HardwareProducts*

 

·                  Our*LANDesk Management Gateway Appliance, which*helps customers manage systems with an easy-to-use hardware product that comeswith LANDesk software pre-installed and allows the management of local andremote users without creating a hole in their firewall through any existingInternet connection via certificate-based authentication and SSL encryption.

 

·                                          **The Connectivity andControl Division consists of our professional audio-visual, broadcast, andserial connectivity products.**

 

This division offers managedaudio visual (“AV”) infrastructure solutions for professional audio-visual andbroadcast markets.  The division alsooffers serial connectivity solutions. Extension products simplify connectivity and control of displays,projectors, and AV source equipment. Matrix switches help broadcast engineersto back-rack and control studio production equipment.  LAN-based serial hubs provide cost-effectivedevice connectivity at the point of need.

 

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The products andtechnologies offered by our Connectivity and Control Division include:

 

·                                          Our*Emerge*TM family of products,which provide both wired and wireless switching and extension of video,audio, and control data for use in a range of markets.  Our *Emerge* family ofmultipoint high-definition wired/wireless extenders (MPX) allows AV consultantsto design managed audio-video extension networks for commercial signage andpresentation markets.  Our *Emerge Wireless*extender is ideal for use in boardrooms,classrooms, and commercial digital signage applications, and our *Emerge Media Streamer (EMS)* extenders offer CAT 5 wiredvideo extension for use in similar markets. Our digital *ECMS* productsprovide extension and switching of digital workstations across IP networks in marketswhere user responsiveness and high visual acuity are a must, such aspost-production and broadcast.  OurEmerge family also incorporates a range video processing products such asscalers and presentation switchers, which allow integrators to prove fullaudiovisual solutions when combined with our distribution and extensionproducts.

 

·                                          Our*SST* and *ESP*serial products, which offer high-performance, reliable, and managed deviceconnectivity for serial and dial access applications.  These product lines include network-basedappliances and bus-based adapters for use within security, commercialpoint-of-sale, process control, industrial automation, data collection, remoteaccess, fax servers, and custom applications.

 

**Sales and Marketing**

 

We market, sell, andlicense our hardware and software products and services through our own salesforce and various distribution channels, including OEMs, system integrators,distributors, and reseller arrangements. We market our products primarily through advertisements in tradepublications, online sponsorships, participation in major industry trade shows,promotions with distributors and resellers, direct marketing, telemarketing,publicity programs, and through our website. We also devote a substantial portion of our marketing efforts todeveloping, monitoring, and enhancing our relationships with our network ofOEMs, independent dealers, distributors, resellers, and end users.  Our sales personnel are supported by ourengineers and our customer service representatives who provide technicalsupport and advice to customers.  As of December 31,2007, we employed 727 people in sales, marketing, and customer support.  As of December 31, 2007, we were alsoworking with approximately 35 independent contractors on various sales andmarketing projects.

 

We currently sell orlicense various hardware and software products and technologies to Dell,Hewlett-Packard, IBM, Intel, Lenovo, Fujitsu Siemens, Symantec, and other OEMspursuant to private-label, branded, and other licensing arrangements.  These OEM customers integrate and sell ourproducts and technologies with or within their own products, includingnetworked servers and clients.  We devotesignificant sales, engineering, operations, and customer service resources toour OEM accounts.  We have significantexperience in working with our OEMs and other system manufacturers, and weintend to use that experience to enter into new relationships with othercomputer manufacturers in the United States, Europe, and Asia.  We believe that the architecture, quality,and reliability of our products and technologies, together with our commitmentto customer service, are attractive to computer manufacturers and softwaredevelopers worldwide.

 

We have relationshipswith a variety of distributors and resellers, and systems integrators, for thedistribution and sale of Avocent, Cybex, Cyclades, Equinox, and LANDesk brandedsoftware and hardware products in the United States, Canada, Europe, SouthAmerica, Asia, and elsewhere.  We devoteresources to educating our distributors and resellers about the benefits of ourproducts and training them in the proper sales, marketing, installation andsupport of our products.  We willcontinue to devote additional resources to increase these branded sales, and wewill pursue additional relationships with distributors and resellers, both domesticallyand internationally, who have the technical capability and market presence toassist end-user customers in developing network space management, access,control, systems management, and security products and technologies to meetcustomers’ particular needs.  Our futuresuccess will depend in part on our ability to attract, train, and motivateadditional distributors and resellers.

 

We provide discounts,other special pricing arrangements, and certain return privileges to ourOEMs and our distributors and resellers. Our agreements with our distributors and resellers are generallynonexclusive and may be terminated on short notice by either party withoutcause.  Our distributors and resellersare not within our control, are not obligated to purchase products from us, andfrequently offer products from several different manufacturers, includingproducts that compete with our products.

 

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International salesaccounted for approximately 44% of net sales in 2007, 43% of net sales in 2006,and 43% of net sales in 2005.  No foreigncountry accounted for more than 10% of 2007, 2006, or 2005 sales.  We are expanding our international salesefforts within Europe, Latin America, Asia, and the Pacific Rim through theutilization of our sales offices in Sydney, Australia; São Paulo, Brazil;Beijing, Guangzhou, and Shanghai, China; London, England; Paris, France;Munich, Germany; Rotterdam, Holland; Hong Kong; Shannon, Ireland; Tokyo, Japan;Mexico City, Mexico; Taipei, Taiwan; and Singapore.

 

**Customers**

 

Our principal customersinclude a diversified group of dealers, major distributors, resellers, anddirect end users who purchase our branded products (including our LANDeskproducts).  These customers represented65% of net sales in 2007, 60% of net sales in 2006, and 52% of net sales in2005.  We believe that our broad range ofproducts sold at different price points offers us the opportunity to market ourproducts to customers of all sizes, in different industries, and with varyingdegrees of technical sophistication.

 

A substantial portion ofour net sales has also been generated from sales of our switching products,software and technologies to OEMs for integration with their productofferings.  Sales to OEM customersrepresented 35% of net sales in 2007, 40% of net sales in 2006, and 48% of netsales in 2005, with this decline in percentage of sales due in part to thechange in the mix of our business as a result of our acquisitions.  While we have contracts with some of our OEMcustomers, none of them is obligated to purchase products from us exceptpursuant to binding purchase orders and licensing agreements.  Consequently, any OEM customer could ceasedoing business with us at any time.  Theloss of, or material decline in orders from, certain of our current OEMcustomers would have a material adverse effect on our business, financialcondition, results of operations, and cash flow.

 

The following table identifies our customers thatexceeded 10% of our net sales for the years 2007, 2006, and 2005:

 
| ** **      | ** ** | **Percentage of Net Sales for the Year Ended** | ** ** |
|-----------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **      | ** ** | **December 31,  2007**                                                       | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
| Dell            |       | 13                                                                                | %          | 14 | % | 15 | % |
| Hewlett-Packard |       | 12                                                                                | %          | 14 | % | 20 | % |
| Tech Data       |       | 11                                                                                | %          | 12 | % | 10 | % |
| Ingram Micro    |       | NA                                                                                |       | NA |   | 11 | % |

 

Sales to these customersare reported primarily through Management Systems Division, but also throughour LANDesk Division.    No othercustomer accounted for more than 10% of our net sales in 2007, 2006, or 2005.

 

**Seasonality**

 

Our operating results areaffected by seasonal trends and by general conditions in the servermarket.  We have experienced, and expectto continue to experience, some degree of seasonality due to customer buyingcycles.  We believe that the third andfourth quarters will generally have higher net sales levels due to customerbudgeting and procurement cycles, which may depress net sales in otherquarters.  In addition, we typically see a sequential decline in revenue from thefourth quarter of a year to the first quarter of the following year.  While it is difficult to predict revenue inany quarter, we expect that this pattern will continue in the future.

 

**Customer Service**

 

We emphasize customerservice by developing high quality products, encouraging customer feedbackthrough contact with our key customers, providing technical support andinformation on our website, and providing a customer hotline that offerstechnical support for the life of our hardware products.  We also offer annual software upgradeprotection and maintenance agreements for licensees of our softwareproducts.  We strive to respond quicklyto our customers’ requests for technical support and service, and ourengineering department often works with individual customers to troubleshootproblems and develop solutions.  We offerwarranties for parts and service on all of our hardware products, ranging fromone to three years (and, in the case of some of our Equinox branded products,five years).  We also offer a 30-daymoney-back guarantee for all of our appliance products sold in NorthAmerica.  To date, we have notexperienced any significant hardware product returns.  For our software products, we generallyprovide a 90-day limited warranty on the media used to deliver the software,which is not applicable to electronic downloads, and a 90-day limited warrantythat our software products will function in accordance with the userdocumentation provided with the software product.  We may, as a result of competitive pressuresor requirements in certain geographies, change our warranty policies in thefuture to provide coverage that is greater in scope and duration than thecoverage we currently offer.  If we wereto increase our warranty coverage, our risk of warranty claims, and thereforeour warranty expense and reserves, would likely increase.

 

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**Development of New Products andTechnologies**

 

We believe that thetimely development of enhancements to our existing hardware and softwareproducts and technologies and of new products and technologies is essential tomaintaining and building on our competitive position.  The market for our products has experiencedrapid technological advances, frequent new product introductions andenhancements, and significant price competition.  The introduction of products incorporatingsuperior or alternative technologies (such as switching software), the creationor adoption of new technologies (such as the creation of virtual servers usinga combination of hardware and software, which is known as virtualization), theemergence of new industry standards, or changes in the market’s pricingstructure could render our existing products and technologies and the productsand technologies we have under development obsolete or unmarketable.

 

Our hardware productsgenerally combine components, such as printed circuit boards, semiconductors,memory, connectors, cable assemblies, power supplies, and enclosures, that aremanufactured by other companies and are generally available to our competitorsand potential competitors.  Our softwareproducts combine software or content from third parties, such as open sourcesoftware or technology, drivers, security, service desk, applicationvirtualization, or anti-virus information, which may also be generallyavailable to our competitors and potential competitors.  Our futuresuccess will depend in large part upon continued innovative application ofcommercially available components and third-party software or technologies,together with continued enhancements to our proprietary hardware, software,firmware, and other technologies, the expansion and enhancement of our existingproducts, and the development and introduction of new technologies and productsthat address changing industry trends (including virtualization) and customerneeds on a cost-effective and timely basis. By emphasizing customer-driven research and development, we have beenable to develop innovative, practical, and marketable products that have hadimmediate application and acceptance. Our failure to respond on a timely basis to technological changes orcustomer requirements could have a material adverse effect on our business,financial condition, results of operations, and cash flow.  In addition, the acquisition of or departurefrom the market of one or more of these third party technology providers couldhave a material adverse effect on our business, financial condition, products,results of operation and cash flow.

 

Due to our significantreliance on OEM relationships, some of our product development efforts arefocused on developing new hardware and software products or enhancements forOEM customers, which could delay or otherwise negatively affect our planneddelivery of non-OEM products.  At times,these new products or enhancements may not be available to, or readilymarketable to, other customers without significant modifications or delay.

 

Our engineering andproduct development efforts focus on anticipating the needs of our customers byproviding innovative, practical, and marketable products and technologies thathave immediate applications in their markets. By maintaining contact with customers throughout the installation andtechnical support process, we are able to identify and test potential designmodifications and improvements as well as new applications and extensions forexisting products and technologies.  Weexpect this process will enable us to develop new product categories andapplications based on existing technology developed to meet specific customerneeds.  Many of our products andtechnologies are designed to accommodate future modifications and additionalfeatures, which we believe facilitates the development and integration offuture modifications and features if we see a market need.

 

As of December 31,2007, we employed 690 people in our engineering departments.  In addition, we use independent contractorsfrom time to time.  As of December 31,2007, we were working with approximately 64 independent contractors on variousdevelopment projects.

 

A key component of ourengineering and product development strategy is the acquisition of newtechnologies and companies.  We intend tocontinue to evaluate opportunities to acquire technologies and companies, andit is likely that we will complete additional acquisitions in the future.  Acquiring new technologies and companies isinherently risky, especially if the technology or the products of the companydo not have significant time in the market. There can be no assurance that these acquisitions will be successful,will result in the timely development of commercially viable products ortechnologies that achieve market acceptance, or will otherwise improve orbenefit our financial condition or operating results.

 

The industry in which wecompete is subject to rapid technological developments, evolving standards,changes in customer requirements, and new product introductions andenhancements.  Our success depends inpart upon our ability to continue to enhance our existing products and to developand introduce new products that improve performance and reduce total cost ofownership on a cost-effective and timely basis, and to meet these challenges,we expect to make substantial

 

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investments in productdevelopment in the future.  We alsoexpect to continue to make acquisitions and investments where appropriate toprovide us with access to new technologies. There can be no assurance, however, that our product development efforts will lead to commercially viableproducts or technologies, will be completed on a timely basis, or will includethe features required to achieve market acceptance.

 

**Manufacturing**

 

We do not manufacture anyof our hardware products in their entirety. Instead, we manage product planning, purchasing, and shipping, and weperform final assembly, quality assurance, and testing on some of our hardwareproducts while we outsource some or all of these functions on otherproducts.  In order to avoid the capitalinvestment required to establish and maintain in-house manufacturingcapabilities, we rely on subcontractors throughout the world for the assemblyof printed circuit board assemblies, subassemblies, chassis, and equipmentenclosures.  We believe that our chosensubcontractors can typically perform these functions at a lower cost than wecan, while maintaining our high standards for quality and delivery.  Outsourcing our manufacturing functionsallows us to concentrate our resources on research and development, productdesign, quality assurance, sales and marketing, and customer service.  We (or our subcontractors) subject our mostcritical components and products to automated testing, equipment burn-inprocedures, comprehensive quality audits, functional testing, and regulatoryscreening to assure quality and reliability. As of December 31, 2007, we employed 168 people in ourmanufacturing, supply chain management, and logistics department.

 

We currently rely onseveral third party manufacturers, including Elcoteq Network Corporation,Plexus Corp., Kontron AG, and Likom Computer Products, for subassembly of ourhardware products.  These outsourcingarrangements, and any future outsourcing arrangements, involve numerous risks,including reduced control over product quality, delivery schedules, manufacturingyields, and costs.  The acquisition ordeparture from the market of one of these contract manufacturers could have amaterial adverse effect on our business, financial condition, products, resultsof operations, and cash flows.  Inaddition, while these third-party manufacturers have arrangements for warrantyobligations, we remain primarily responsible to our customers for warrantyobligations.  We attempt to diversify ouroutsourced manufacturing operations and believe we have an adequate supply ofalternative subcontractors.

 

We generally purchaseindustry-standard parts and components, including power supplies,semiconductors, memory, cable assemblies, line filters, enclosures, and printedcircuit boards, for the assembly of our products from multiple vendors andsuppliers through a worldwide sourcing program. Custom molded cables and certain turn-key products procured from outsidesources have significant delivery times (generally 10 to 12 weeks), and failureto obtain adequate supplies could adversely affect our product deliveries.  We buy components under purchase orders andgenerally do not have long-term agreements with our suppliers.  Circuit board assemblies are currentlyobtained from a number of sources, including Elcoteq Network Corporation,Plexus Corp., Kontron AG, and Likom Computer Products.  We believe that there are adequatealternative sources for our product components. Any termination of, or significant disruption in, the business oraffairs of our suppliers or our third-party manufacturers or in ourrelationship with them may prevent us from filling customer orders in a timelymanner since we generally do not maintain large inventories of our components.

 

In the past, we haveexperienced delays in the receipt of certain components, which have resulted indelays in related product deliveries.  Weattempt to manage these risks through developing alternative sources,committing internal resources to supply chain management, and maintaining qualityrelationships and close personal contact with each of our contractmanufacturers and suppliers.  There canbe no assurance, however, that delays in component and product deliveries willnot occur in the future, and the inability to obtain sufficient components orto develop alternative sources, if and as required in the future, could resultin delays or reductions in product shipments, which, in turn, could have amaterial adverse effect on our business, financial condition, results ofoperations, or cash flow.  Some of thecomponents for our products are available from a single supplier or a limitednumber of suppliers.

 

**Competition**

 

The market for ourhardware and software products is highly fragmented, competitive, rapidlychanging, and we expect these market characteristics to increase in thefuture.  We compete with numerous vendorsin each of our product categories.  Inthe market for hardware switching systems, we compete with companies such asRaritan Computer, Rose Electronics, Minicom Advanced Systems, AtenInternational, Belkin, Digi International, and Lantronix, and in the market forour systems management products we compete with companies such as Microsoft,Computer Associates, BMC Software, Novell, Tivoli, and Symantec.  In addition, certain of our OEM customers,such as Dell, Hewlett-Packard, and IBM, offer technologies and products thatare competitive with our products, and we expect these technologies andproducts to remain competitive in the features they offer.  Our products and technologies are also incompetition with products and technologies offered by hardware manufacturersand network management companies such as Intel, Microsoft, Cisco, and EMC.  Many of these competitors may havesubstantially greater financial, marketing, and technical resources than wehave.

 

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In the market for ourproducts, we compete primarily on the basis of technological capabilities,performance in relation to price, product features, quality, reliability,development capabilities, product availability, and customer service andsupport.  Our future success will behighly dependent upon timely completion, introduction, and distribution of newproducts, technologies, services, and features at competitive price andperformance levels that address changing industry trends and the evolving needsof our customers.  We continuallyexperience price competition and expect that pricing pressures could increasein the future.  As we continue to grow,especially internationally, we expect that we will encounter new competition indifferent geographic regions.

 

**Proprietary Technology**

 

Ourfuture success is dependent in part upon our ability to protect ourintellectual property and our proprietary rights in our products andtechnologies.  We seek to protect ourintellectual property rights by invoking the benefits of the patent, trademark,copyright, trade secret, and unfair competition laws of the United States andcertain foreign countries, all of which provide only limited protection.  We regularly file applications for and obtainpatents, copyrights, and trademarks in the United States and in selectedforeign countries where we believe filing for such protection isappropriate.  We have been issued over 50U.S. patents and have over 50 U.S. patent applications pending.  We have various corresponding patentapplications pending under the provisions of the Patent Cooperation Treaty,which permits the filing of corresponding foreign patent applications innumerous foreign countries within a limited time period.  We also have other foreign patentapplications pending.  There can be noassurance that any additional patents will be issued from any of our pendingapplications, that any patents will be issued in any additional countries whereour products or technologies can be sold or licensed, or that any claimsallowed in our patents or in any pending patent applications will be ofsufficient scope or strength for, or provide any meaningful protection or anycommercial advantage to, us.  Moreover,our competitors or other holders of intellectual property rights may challengethe validity of, or be able to design around, these patents or any otherpatents that may be issued to us.  Thelaws of certain foreign countries in which our products are or may bedeveloped, manufactured, or sold (particularly countries in Asia) may notprotect our products or intellectual property rights to the same extent as dothe laws of the United States and thus increase the likelihood of piracy of ourproducts and technologies.

 

In the past we have filedand, in the future we may, file additional lawsuits against other companiesregarding the alleged infringement or our proprietary rights.  Patent litigation, and any other litigationrelating to our intellectual property to which we become a party, is expensiveand subject to numerous risks and uncertainties, and there can be no assurancethat we will be successful in any such litigation.  There can be no assurance that the steps wetake to protect our intellectual property rights will be adequate to preventmisappropriation of our technologies or that we can use our intellectualproperty rights to successfully prevent competitors from commercializingtechnologies that are substantially equivalent or superior to our products andtechnologies.  Additionally, current orfuture competitors could develop their own proprietary technologies or obtainpatents that may prevent us from developing or selling our products andtechnologies.

 

We also seek to maintainour trade secrets and confidential information by nondisclosure policies andthrough the use of appropriate confidentiality and nondisclosure agreements.

 

**Employees**

 

As of December 31,2007, we had 1,069 full-time employees working in the United States.  Of our domestic full-time employees, 400 werein marketing, sales, and customer support, 419 were in engineering, research,and development, 110 were in manufacturing and logistical operations, and 140were in administration.  As of December 31,2007, we had 728 full-time employees working at our facilities outside of theUnited States.  Of our internationalfull-time employees, 327 were in marketing, sales, and customer support, 271were in engineering, research, and development, 58 were in manufacturing andlogistical operations, and 72 were in administration.  Our employees in Brazil (approximately 45)and the LANDesk employees in France (approximately 23) are covered bycollective bargaining agreements.  Noother employees are covered by collective bargaining agreements relating totheir employment by us.  We believe thatwe have good relations with our employees.

 

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**Backlog**

 

Backlog consists ofpurchase orders with delivery dates scheduled within the next six months.  None of our customers is obligated topurchase products from us except pursuant to binding purchase orders.  Because of the timing of orders and the possibilityof customer changes to delivery schedules, our backlog as of any particulardate is not representative of actual sales for any succeeding period.  Moreover, with recent industry-wideinitiatives by OEMs, distributors, and resellers to reduce inventories andshorten lead times, we do not view backlog as an important indicator of ourfuture results, and we do not believe it is a meaningful indicator of actualsales for any succeeding period.

 

**Item 1A.Risk Factors.**

 

*THISANNUAL REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS ANDUNCERTAINTIES THAT COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROMTHOSE DISCUSSED IN THIS ANNUAL REPORT.  THESE RISKS AND UNCERTAINTIESINCLUDE THE FOLLOWING:*

 

**We have acquired, and expect tocontinue to acquire, technologies, and companies and these acquisitions coulddisrupt our business or expose us to other risks.**

 

A key component of ourengineering and product development strategy and our future growth is theinvestment in or the acquisition of technologies and companies.  We intend to continue to execute our strategythrough the acquisition of technologies or companies or through investments incomplementary companies, products, personnel, or technologies, and it is likelywe will complete such acquisitions or investments in the future.  These acquisitions and investments involvemany risks and factors outside our control, including the following:

 

·                                          Difficulty integrating the acquiredcompany’s personnel, distribution channels, products, product roadmaps,technologies, systems, processes, and operations, including product delivery,order management, and information systems;

 

·                                          Difficulty in conforming the acquiredcompany’s financial policies and practices to our policies and practices and inimplementing and maintaining adequate internal systems and controls over thefinancial reporting and information systems of the acquired company;

 

·                                          Diversion of management’s attention anddisruption of our current business and the challenges associated with managingthe resulting larger company following any acquisition;

 

·                                          Difficulty in combining product andtechnology offerings and entering into new markets (such as software) orgeographical areas in which we have no or limited direct experience and whereour competitors may have stronger market positions;

 

·                                          Loss of management, sales, technical, orother key personnel (at either Avocent or in the acquired company) or the lossof customers, distributors, resellers, vendors, or other business relationshipsas a result of the acquisition;

 

·                                          Revenue from the acquired companies notmeeting our expectation, and the potential loss of the acquired companies’customers, distributors, resellers, suppliers, or other partners;

 

·                                          Delays or difficulties and the attendantexpense in evaluating, coordinating, and combining administrative,manufacturing, research and development and other operations, facilities, andrelationships with third parties in accordance with local laws and otherobligations while maintaining adequate standards, controls and procedures,including financial controls and controls over information systems;

 

·                                          Difficulty in completing projectsassociated with acquired in-process research and development;

 

·                                          Incurring amortization expense related tocertain intangible assets and recording goodwill and non-amortizable assetsthat will be subject to impairment testing and possible impairment charges;

 

·                                          Dilution of existing stockholders as aresult of issuing equity securities, including the assumption of any stockoptions or other stock awards to employees issued by the acquired company;

 

·                                          Overpayment for any acquisition orinvestment or unanticipated costs or liabilities;

 

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·                                          Assumption of liabilities of the acquiredcompany, including any potential intellectual property infringement claims orother litigation and any unrecorded tax obligations; and

 

·                                          Incurring substantial write-offs,restructuring charges, interest expense, amortization, and transactionalexpenses

 

Our integration plans andindemnification and escrow agreements might fail to adequately mitigate theserisks and factors, and our failure to manage these risks and challenges couldmaterially harm our business, financial condition, and results ofoperations.  Further, if we do notsuccessfully address these challenges in a timely manner, we may not fullyrealize all of the anticipated benefits or synergies on which the value of atransaction was based.  Futuretransactions could cause our financial results to differ materially fromexpectations of market analysts or investors for any given quarter.

 

**Intensecompetition from new and existing competitors or consolidation in the serverand systems management sectors could impair our ability to grow our business,to sustain our profitability, and to sell our products and technologies.**

 

The markets for ourproducts and technologies are highly fragmented, rapidly evolving, andintensely competitive, and we expect these characteristics to continue andincrease.  Aggressive competition from both hardware and software productsand technologies could lengthen the customer evaluation process and result inprice reductions and loss of sales, which would materially harm ourbusiness.  Our business is highly sensitive to the introduction of newproducts and technologies (such as virtualization), price changes, andmarketing efforts by numerous and varied competitors.  Accordingly, ourfuture success will be highly dependent upon our timely completion andintroduction of new products and technologies and features at competitiveprices and performance levels that address changing industry trends and theevolving needs of our customers.  We continue to experience aggressiveprice competition and increased customer sensitivity to product prices, andpricing and margin pressures are likely to increase in the future.  Becauseof this competition, we may have to continue to lower the prices of many of ourproducts and technologies or offer greater functionality within our products todeliver greater value to customers to stay competitive, while at the same timetrying to maintain or improve our revenue and gross margin.  Because ourbusiness model is based on providing innovative and high quality products, wemay spend a proportionately greater amount on research and development thansome of our competitors.  If we cannot proportionately decrease our coststructure on a timely basis in response to competitive price pressures, ourgross margin and profitability could be adversely affected.  In addition,if our pricing, functionality, and other factors are not sufficiently competitive,or if there is an adverse reaction to our product decisions, we may lose marketshare in certain areas, which could adversely affect our revenue and prospects.

 

We compete for sales ofswitching systems and extension products with companies such as RaritanComputer, Rose Electronics, Minicom Advanced Systems, Aten International,Belkin, Digi International, and Lantronix.  These products also facecompetition from software providers (such as Microsoft, Computer Associates,Tivoli, Symantec, Novell, AMI, and BMC Software), who may be able to offersoftware products competitive with our hardware products at a much lower costor even bundled for free, and from server manufacturers (including our OEMcustomers), who are able to offer their competitive technologies or products atthe time of the server sale.  These competitive software and hardwareproducts address many of the problems our switching systems and technologies,extension products, and remote access products are designed to address.

 

We compete for sales ofour systems management and security products with companies such as Microsoft,Computer Associates, BMC Software, Novell, and Symantec, many of whom havegreater financial, technical, and marketing resources, a larger customer base,a longer operating history, greater name recognition, and more establishedrelationships in the industry than we do, and may offer their own orthird-party competitive software products at a lower cost or bundled for freewith their other products.  Microsoft, in particular, has deliveredcompetitive products and announced its intention to continue to developcompetitive software.  If Microsoft issuccessful in delivering software products that are competitive with our products,our ability to grow our software business may be limited.

 

Our current and potentialcompetitors may be able to respond more quickly to new or emerging technologiesor products and to changes in customer requirements or to devote greaterresources to the research, development, promotion, sale, and support of theirproducts and technologies than we do.  In addition, current and potentialcompetitors have established or may establish cooperative relationships amongthemselves or with third parties that expand or enhance the ability of theirproducts and technologies to address the needs of our current and prospectivecustomers.  Some of these competitors can also bundle hardware, software,and services together, and offer a more complete set of hardware products andservices than we are able to offer. We may not be able to compete successfullyagainst current and future competitors and competitive pressure may materiallyharm our business, financial condition, operating results, and cash flows, orimpair our ability to achieve our desired results.

 

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Certain of our customers,such as Dell, Hewlett-Packard, IBM, Symantec, and Microsoft, presently offercompetitive hardware and/or software products and technologies that addressmany of the problems our products and technologies address.  Thesecustomers could decide to manufacture or enhance their own switching, IPMI orother embedded technologies, or systems management or security products, oroffer products or technologies supplied by competitors.  Companies withhardware manufacturing experience or network management products, many of whichare substantially larger than we are and have significantly more financialresources than we do, also offer products or technologies that compete with us. Established companies with hardware manufacturing or network managementexperience (such as Intel, Cisco, or EMC) could also offer new products, newtechnologies (such as virtualization), or new solutions that compete with, orreduce the demand for, our products and technologies.

 

There has beenconsolidation in the markets in which we compete, which we believe willcontinue and could lead to increased price competition and other forms ofcompetition as companies attempt to maintain or extend their market positionsin the rapidly changing IT industry.  Inaddition, we may face competition in the future from large establishedcompanies or from emerging companies that have not previously entered themarket or that do not currently have products that directly compete with ourproducts.  This could lead to morevariability in our operating results due to lengthening of the customerevaluation process and/or the loss of business to these competitors, which mayadversely affect our business, financial condition, and results of operations.

 

**Ourfailure to respond to rapid technological change or to introduce successful newproducts and technologies may result in reduced revenue or revenue growth.**

 

The process of developingor acquiring new products, software, and technologies and enhancing existingproducts, software, and technologies is complex, costly, and uncertain, and anyfailure by us to anticipate customers’ changing needs and emergingtechnological trends accurately could significantly harm our market share andresults of operations.  We must make long-term investments, develop orobtain appropriate intellectual property, and commit significant resourcesbefore knowing whether our predictions will accurately reflect customer demandfor our products and services.  After we develop a product, we must thenaccurately forecast volumes and configurations that meet customer requirements,manufacture appropriate hardware volumes quickly and at low cost and developcost-effective software solutions, and train our sales force andresellers.  Any delay in the development, production, marketing of, ortraining for new products or technologies could result in our not being amongthe first to market, which could further harm our competitive position.

 

Sales of switching,extension, and remote access products and technologies are characterized byrapid technological advances, frequent new product and technologicalintroductions and enhancements, and significant price competition.  If wedo not keep pace with these changes, we will lose customers, and our businesswill be adversely affected.  The introduction of products or technologiesincorporating superior alternatives such as switching software, the emergenceof new industry standards, or changes in pricing structure could render ourexisting products and technologies and those under development obsolete orunmarketable.  New technologies offered by us or our competitors couldcompete with our existing products at a lower price, which could reduce ourrevenue.

 

Our hardware productscombine components, such as printed circuit boards, connectors, semiconductors,memory, cable assemblies, power supplies and enclosures that are manufacturedby other companies and are generally available to competitors and potentialcompetitors.  Our software products combine software or content from thirdparties, such as open source software or technology, drivers, security, oranti-virus information, which may also be generally available to ourcompetitors and potential competitors.  Our future success will depend inlarge part upon continued innovative application of commercially availablecomponents and third party software or technology, and continued enhancementsto our proprietary hardware, software, firmware, and other technologies, theexpansion and enhancement of existing products and technologies, and ourdevelopment and introduction of new products and technologies that addresschanging industry trends and customer needs on a cost-effective and timelybasis.  If we fail to respond on a timely basis to technologicaldevelopments, changes in industry standards, customer requirements, competitiveproducts, product localization, or software innovations, we will losecustomers, and our business will be greatly harmed.  Similar results couldoccur if we experience significant delays in the development or introduction ofnew products or technologies.

 

Due to our significantreliance on OEM relationships, our hardware development efforts may often befocused on developing new products, technologies, or enhancements for OEMcustomers.  As a result, our OEM relationships may negatively affect ourability to develop new and enhanced products and technologies for our non-OEMcustomers.  Moreover, these new products, technologies, or enhancements forOEM customers may not be available to, or readily 

 

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marketable to, othercustomers without significant modification and delay.  The expansion,termination, or significant disruption of our relationship with certainOEMs or other customers for whom we devote significant product developmentresources is likely to result in lost opportunities with respect to thedevelopment of products, technologies, or enhancements for our other customers.

 

**We havelimited protection of proprietary rights and face risks of third partyinfringements.**

 

Our future successdepends in part upon our ability to protect proprietary rights in our productsand technologies.  We seek to protect our intellectual property rights byinvoking the benefits of the patent, trademark, copyright, trade secret, andunfair competition laws of the United States and other countries andprotections provided by confidentiality and nondisclosure agreements and otherlegal agreements.  These laws and practices, however, afford only limitedprotection.  There can be no assurance that the steps we have taken toprotect our intellectual property rights, or that the steps we take in thefuture, will be adequate to prevent or detect misappropriation of our intellectualproperty or technologies or that our competitors will not independently developproprietary or other technologies that are substantially equivalent or superiorto our products or technologies.  Inaddition, our proprietary information may be misused or improperly disclosed bythird parties entrusted with this information. There also can be no assurance that our proprietary rights will not bechallenged, invalidated, or avoided.

 

The U.S. Patent andTrademark Office has issued several patents to us for various aspects of ourproducts.  We have various corresponding patent applications pending underthe provisions of the Patent Cooperation Treaty, which permits the filing ofcorresponding foreign patent applications in numerous foreign countries withina limited time period.  We also have other United States and foreignpatent applications pending.  There can be no assurance that anyadditional patents will be issued from any of those pending applications orthat any patents will be issued in any additional countries where our productscan be sold.  Claims allowed in our patents or in any pending patentapplications may not be of sufficient scope or strength for, or providemeaningful protection or any commercial advantage to us or such claims may not beupheld if challenged.  Also, competitors may develop their ownintellectual property or technologies, obtain their own patents, or challengethe validity of, or be able to design around, our patents.  The laws ofcertain foreign countries in which our products are or may be developed,manufactured, or sold (particularly certain countries in Asia) may not protectour products or intellectual property rights to the same extent as do the lawsof the United States and thus increase the likelihood of piracy of our technologiesand products.

 

We may initiate claims orlitigation against other third parties for infringement of proprietary rightsor to establish the validity of proprietary rights.  Similarly, ourcompetitors or other third parties may initiate claims or litigation against usalleging infringement of their proprietary rights or improper use of theirintellectual property, and from time to time, third parties notify us that ourproducts may infringe their intellectual property rights, which regardless of merit,requires our time and resources to evaluate and respond.   Existing litigation, and any otherlitigation relating to intellectual property to which we become a party, issubject to numerous risks and uncertainties, including the risk ofcounterclaims or other litigation against us, and we may not be successful inany such litigation.  Dealing with adverse claims and litigation isexpensive, and the existing litigation or any other litigation by or against uscould result in significant additional expense, divert the efforts of technicaland management personnel, whether or not such litigation results in a favorabledetermination, harm our relationships with existing customers, and deter futurecustomers from purchasing or licensing our products.  In the event of anadverse result in any such litigation, we could be required to pay substantialdamages, suspend or cease the development, manufacture, use, marketing, andsale of any infringing products, expend significant resources to redesignproducts or develop non-infringing technology, discontinue the use of certainprocesses, or obtain licenses to the infringing technology.  There can beno assurance that we would be successful in such development or that suchlicenses would be available on reasonable terms, or at all, and any suchdevelopment or license could require us to expend substantial time and otherresources.  In the event that any third party makes a successful claimagainst us, or our customers, and a license is not made available on commerciallyreasonable terms, our business, financial condition, and results of operationscould be adversely affected.  Inaddition, any dispute involving our intellectual property could result in ourcustomers, distributors, or resellers becoming involved in the litigation,which could trigger indemnification obligations in certain of our sales,license, or service agreements.

 

The IT industry ischaracterized by vigorous pursuit and protection of intellectual propertyrights or positions, which has resulted in significant and often protracted andexpensive litigation.  We have in the past been, and we may from time totime in the future be, a party in litigation or other proceedings alleginginfringement of intellectual property rights owned by third parties.  Ifnecessary or desirable, we may seek licenses under such intellectual propertyrights.  However, licenses may not be offered on terms acceptable to us,or at all.  The failure to obtain a license from a third party fortechnology used by us could cause us to incur substantial liabilities and tosuspend or cease the manufacture of products requiring such technology. Additionally, current or future competitors could obtain patents or otherintellectual property rights that may prevent us from developing or selling ourproducts. The result of these litigation matters is difficult to predict and anunfavorable resolution could affect our operating results, business, orfinancial condition. The resolution of litigation involving the company mayimpact our operating results or financial condition.

 

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**Weare likely to experience fluctuations in operating results.**

 

We have in the pastexperienced substantial fluctuations in revenue, bookings, and operatingresults, on a quarterly and an annual basis, and we expect these fluctuationswill continue in the future.  Our operating results will be affected by anumber of factors, including, but not limited to:

 

·                                          The volume, timing, pricing, andcontractual terms of orders, particularly from OEMs, resellers, and other largecustomers, a significant portion of which tend to occur late in each quarter;

 

·                                          The timing of shipments;

 

·                                          The unpredictable nature of the salescycle for software products and the timing and completion of delivery ofsoftware products;

 

·                                          The timing of new product introductions,new technologies, and enhancements by us and by our competitors, and thepossibility that customers may defer purchases of our products in anticipationof these new products, new technologies, and enhancements;

 

·                                          Changes in or our failure to accuratelypredict product or distribution and reseller channel mixes, including changesin the mix of software licenses in which revenue is recognized upfront asopposed to subscription licenses that are deferred over time and changes in themix of revenue attributable to higher-margin products as opposed tolower-margin sales or services;

 

·                                          Changes in demand for our products andservices;

 

·                                          Changes in pricing policies or pricereductions;

 

·                                          Changes in laws, regulations, or othergovernment requirements;

 

·                                          Changes in renewal rates for softwareupgrade protection or maintenance;

 

·                                          Competition from new products,technologies, business models, and price reductions by competitors;

 

·                                          The availability and cost of supplies,components, or third-party code or content on commercially reasonable terms;

 

·                                          Compatibility or interoperability of ourproducts with third-party systems and applications;

 

·                                          Sales and marketing expenses related toentering into new markets, introducing new products, new technologies, andretaining current OEMs, resellers, and other large customers;

 

·                                          Fluctuations in sales of servers andpersonal computers due to changes in technology (such as virtualization),economic conditions, or capital spending levels;

 

·                                          The amount and timing of operatingexpenses and capital expenditures relating to the expansion of our business andoperations; and

 

·                                          Costs associated with legal proceedings,including legal fees and any adverse judgments or settlements.

 

Our operating resultswill continue to be affected by seasonal trends, by general conditions in theIT market, and by general economic conditions.  We have experienced, andwe expect to continue to experience, some degree of seasonality due to customerbuying cycles and delays in customer orders during unfavorable economicperiods.  We believe that the third and fourth quarters will generallyhave higher net sales levels due to customer budgeting and procurement cycles,which may 

 

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depress net sales inother quarters.  In addition, European sales are often weaker during thesummer months.  In the past, we have typically seen a sequential declinein revenue from the fourth quarter of a year to the first quarter of thefollowing year, and while it is difficult to predict revenue in any quarter, weexpect that this pattern will continue in the future.  Many of the factorsthat create and affect seasonal trends are beyond our control.

 

Our quarterly sales havealso reflected a pattern in which a disproportionate percentage of each quarter’stotal sales occur toward the end of the quarter, and this trend has become morepronounced in recent periods.  Ourincreased focus on the software market continues this trend with a greaterproportion of our software revenue coming from software license andsubscriptions booked in the last weeks or days of each quarter.  Thisuneven sales pattern makes prediction of revenue, earnings, and working capitalfor each financial period difficult, increases the risk of unanticipatedvariations in quarterly results and financial condition, and places pressure onour hardware inventory management and logistics systems.  If predicteddemand for hardware is substantially greater than orders, there will be excessinventory.  Alternatively, if hardware orders substantially exceedpredicted demand, we may not be able to fulfill all of the orders received inthe last few weeks of each quarter.  Other developments late in a quarter,such as a systems failure, component pricing movements, actions orannouncements from our competitors, global logistics disruptions, or largesales opportunities not being completed when predicted, could adversely impactinventory levels and results of operations in a manner that is disproportionateto the number of days in the quarter affected. In addition, accounting requirements associated with satisfying thevarious elements necessary to recognize software revenue may result insignificant fluctuations in our quarterly results.

 

In order to remaincompetitive and provide our increasingly sophisticated customers with moreoptions, we have made and expect to continue to make new products and newsoftware purchasing and licensing options available to our customers.  These new products and options may result inan increase in contracts where software revenue is deferred or cash is receivedover time as opposed to recognition of revenue or payment at or about the timeof the purchase or license.

 

We believe thatquarter-to-quarter comparisons of our historical financial results are notmeaningful indicators of our future operating results, and you should not relyon them as an indication of our future performance.  If our quarterlyoperating results fail to meet the expectations of equity research analysts,the price of our common stock could be negatively affected.

 

**Ourgross margins are expected to vary and may decline.**

 

Gross margins may vary ordecline from period-to-period and may be adversely affected by a number offactors, including:

 

·                                          The ratio of OEM sales to branded sales,since OEM sales typically have lower gross margins than branded sales;

 

·                                          The ratio of sales through indirectchannels to direct sales, since indirect sales typically have lower grossmargins than direct sales;

 

·                                          The ratio of sales in established marketsto sales in new markets with different pricing and cost structures;

 

·                                          Changes in product mix, because sales ofsome of our products and technologies will have lower gross margins than salesof other products or technologies (e.g. our software products tend to havehigher gross margins);

 

·                                          Increased price competition;

 

·                                          Changes in product costs and salesdiscounts;

 

·                                          Changes in raw materials, freight,regulatory, certification, import or export expenses, tariffs, and labor costs;

 

·                                          Introduction of new products, services,business models, and technologies by us and by our competitors; and

 

·                                          The level of and costs for third-partytechnology and code used in our software products.

 

·                                          The level of and costs for outsourcing ofour manufacturing and assembly services for our hardware products.

 

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We expect that our grossmargins may vary and may decline in the future primarily due to the factorslisted above and to increased competition and the introduction of new productsand technologies that may affect product prices and demand for our products.

 

**Asubstantial portion of our business consists of sales to a limited number of resellersand distributors that are not obligated to continue doing business with us, andthese sales vary considerably from quarter to quarter.**

 

A substantialportion of our sales consists of sales of our branded products to a limitednumber of resellers and distributors.  Sales to resellers anddistributors represented approximately 56% of net sales in 2007, 56% ofnet sales in 2006, and 48% of net sales in 2005.  The loss of significantrevenue opportunities with these resellers and distributors could negativelyimpact our results of operations.  Inaddition, many of these customers also have or distribute competingproducts.  If resellers and distributorselect to increase the marketing of competing products or reduced marketing ofour products, our ability to grow our business will be negatively impacted andwill impair one of our substantial revenue sources.

 

Our reseller anddistributor business is subject to many risks, including:

 

·                                          Concentration of business in a limitednumber of resellers and distributors could result in significant damage to ourbusiness upon the termination of a reseller relationship;

 

·                                          Termination of reseller and distributoragreements or reduced or delayed orders;

 

·                                          Difficulty in predicting sales toresellers and distributors who do not have long-term commitments to purchasefrom us, which requires us to maintain sufficient inventory levels to satisfyanticipated demand;

 

·                                          Lack of visibility of end user customersand revenue recognition and channel inventory issues related to sales byresellers and distributors;

 

·                                          Resellers and distributors electing toresale or increase their marketing of competing products or technologies orreduced marketing of our products; and

 

·                                          Changes in corporate ownership, financialcondition, credit worthiness, payment patterns, business direction, salescompensation related to our products, or product mix by the resellers anddistributors.

 

Any of these risks couldhave a material adverse effect on our business, financial condition, andresults of operations.  We have experienced, and expect to continue toexperience, pricing pressures and significant variability in orders from ourresellers and distributors, which may in the future have a material adverseeffect on our quarterly sales and operating results.

 

The loss of one or morelarge reseller or distributors could materially harm our business.  Whilewe have reseller and distributor agreements, none of our resellers ordistributors are obligated to purchase products from us.  Consequently,any reseller or distributor could cease doing business with us at anytime.  Our dependence upon a few resellers and distributors could resultin a significant concentration of credit risk, thus a substantial portion ofour trade receivables outstanding from time to time may be concentrated among alimited number of customers.  In addition, the inability to accuratelyforecast the timing and volume of orders for sales of branded products toresellers and distributors during any given quarter could adversely affectoperating results for such quarter and, potentially, for future periods. If we underestimate sales, we will not be able to fill orders on a timelybasis.  This could cause customer dissatisfaction and loss of futurebusiness.  If we overestimate sales, we will experience increased costsfrom inventory storage, waste, and obsolescence.

 

**We willneed to expand sales through distributors and resellers in order to develop ourbusiness and increase revenue.**

 

We expect to relyincreasingly on distributors and resellers, VARs (including LANDesk VARs whoare also referred to as “Expert Service Providers” or “ESPs”), and systemsintegrators for the distribution and sale of our branded hardware and softwareproducts.  Our strategy contemplates the expansion of our distributor andreseller network both domestically and internationally, particularly in Asia,and an increase in the number of customers licensing our products through theseexpanded channels.  Our future success will depend in part on our abilityto attract, train, and motivate new distributors and 

 

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resellers and expand ourrelationships with current distributors and resellers.  We may not besuccessful in expanding our distributor and reseller relationships.  Wewill be required to invest significant additional resources in order to expandthese relationships, and the cost of this investment may exceed the marginsgenerated from this investment. Conducting business through indirect sales channels presents a number ofrisks, including:

 

·                                          Difficulties in replacing any lost orterminated distributors or resellers;

 

·                                          Existing or new distributors andresellers may not be able to effectively sell our current or future products orservices;

 

·                                          Potential distributors and resellersdeciding not to enter into relationships with us because of our existingrelationships with other distributors and resellers with which they compete;

 

·                                          Our ability to provide proper trainingand technical support to our distributors and resellers;

 

·                                          The possibility of damage or impairmentto our market position, brands or trademarks as a result of the actions of ourdistributors and resellers;

 

·                                          Distributors and resellers electing toplace greater emphasis on products or services offered by our competitors; and

 

·                                          The lack of direct control over thebusiness practices, marketing, sales and services offered by distributors andresellers.

 

As we expand ourdistribution and reseller channels, we will also need to expand our salesorganization and invest substantial resources toward this expansion.  We may experience difficulty recruiting,training, and retaining qualified sales personnel, and any failure to obtain,train, and keep qualified personnel could limit our ability to sell products.

 

In addition, distributorsand resellers of our hardware products often have rights of return, and in thefuture, these returns from our existing or any new distributors and resellersmay have a material adverse effect on our business, financial condition, andresults of operations.  Our agreements with our current distributors andresellers are generally nonexclusive and may be terminated on short notice byeither party without cause, and any new distributor or reseller agreements arelikely to contain similar provisions.  Distributors and resellers are notobligated to purchase products from us and frequently offer products fromseveral different companies, including competitors’ products, and distributorsand resellers may give higher priority to the sale of our competitors’ products. A reduction in sales efforts or efficiency by our distributors or resellerscould lead to a reduction in our sales and could materially adversely affectour business, financial condition, and results of operations.

 

**Asubstantial portion of our business consists of sales to a limited number ofOEM customers that are not obligated to continue doing business with us, andthese sales vary considerably from quarter to quarter.**

 

A substantial portion ofour sales is concentrated among a limited number of OEM customers.  Salesto these OEMs represented approximately 35% of net sales in 2007, 40% ofnet sales in 2006, and 48% of net sales in 2005.  Sales to Hewlett-Packardrepresented approximately 12% of net sales in 2007, 14% of our net sales in2006, and 20% of our net sales in 2005.  Sales to Dell representapproximately 12% of net sales in 2007, 14% of net sales in 2006, and 15% ofour net sales in 2005.

 

We have experienced, andwe expect to continue to experience, period-to-period variability in sales to theseOEM customers.  Any cancellation, rescheduling, or reduction of orders byOEM customers in the future could materially adversely affect our operatingresults.  Although our OEM customers typically place orders for productsup to several months prior to scheduled shipment dates, these orders aresubject to cancellation.

 

Our OEM business issubject to many risks, including:

 

·                                          Contract termination or reduced ordelayed orders;

 

·                                          Short order cycles and difficulty inpredicting sales because our OEM customers do not have long-term commitments topurchase from us;

 

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·                                          Changes in the OEMs’ internal productlife cycles including the delay of planned new product introductions anduncertainty over product end-of-life decisions;

 

·                                          Adoption of competing products ortechnologies developed by third parties for the OEMs, acquisition or internaldevelopment of competing products or technologies by the OEMs, or changes inthe OEMs’ marketing of competing products or reduced marketing of our products;

 

·                                          Changes in corporate ownership, financialcondition, credit worthiness, payment patterns, business direction, salescompensation related to our products, or product mix by the OEMs.

 

Any of these risks couldhave a material adverse effect on our business, financial condition, andresults of operations.  We have experienced, and expect to continue toexperience, pricing pressures and significant variability in orders from ourOEM customers, which may in the future have a material adverse effect on ourquarterly sales and operating results.

 

The loss of one or morelarge OEM customers would materially harm our business.  While we havecontracts with some of our existing OEM customers, none of our OEM customers isobligated to purchase products from us except pursuant to binding purchaseorders.  Consequently, any OEM customer could cease doing business with usat any time.  Our dependence upon a few OEMs also results in asignificant concentration of credit risk, thus a substantial portion of ourtrade receivables outstanding from time to time may be concentrated among alimited number of customers.  In addition, OEM customers have longerpayment cycles that increase the likelihood of aged or problem accountsreceivable.

 

We use multiplewarehouses for many of our OEM customers to fulfill their hardware orders undera just-in-time inventory management system, which requires us to maintainsufficient inventory levels of our hardware products at each of thesewarehouses to satisfy our OEMs anticipated customer demand, and we generallyrecognize revenue only when these OEM customers take possession of our hardwareproducts.  We are required to plan production, order components, andundertake our manufacturing activities prior to the time that these ordersbecome firm or the products are accepted.  In addition, our OEM customershave requested, and are likely to continue to request from time to time, thatwe delay shipment dates or cancel orders for hardware products that are subjectto firm orders.  As a result, at any time we may be holding a significantamount of OEM-branded hardware products in inventory, and our sales toOEMs for future quarters are difficult to predict.  The inability toaccurately predict the timing and volume of hardware orders for our OEMcustomers during any given quarter could adversely affect operating results forthat quarter and, potentially, for future quarters.  If we underestimatesales, we may not be able to fill orders on a timely basis.  This couldcause customer dissatisfaction and loss of future business.  If weoverestimate sales, we may experience increased costs from inventory storage,waste, and obsolescence.

 

**We aredependent upon third-party suppliers and outsourced manufacturing for our hardwareproducts.  Disruption of our access to these supplies and services, orproblems with the quality of supplies or services, could prevent us fromfilling customer orders and harm our business.**

 

The principal componentsof our hardware products are electronic components, power supplies,semiconductors, memory, cable assemblies, line filters, enclosures, and printedcircuit boards, all of which are purchased from outside vendors.  Wegenerally buy components under purchase orders and generally do not havelong-term agreements with our suppliers.  Also, we generally do notmaintain large inventories of components.  Any termination of, orsignificant disruption of, our relationships with the suppliers of our productcomponents may prevent us from filling customer orders in a timely manner whichcould result in customer dissatisfaction and lost sales.

 

We have occasionallyexperienced, and we may in the future experience, shortages or delays indelivery of components.  Although alternate suppliers are available formost of the components and services needed to produce our products, the numberof suppliers of some components is limited, and qualifying a replacementsupplier and receiving components from alternate suppliers could take severalmonths.

 

We have limited abilityto control quality issues (particularly with respect to faulty componentsmanufactured by third parties), and we depend upon suppliers to delivercomponents that are free from defects, competitive in functionality and cost,and in compliance with specifications and delivery schedules.  Disruptionin supply, a significant increase in the cost of one or more components,failure of a third party supplier to remain competitive in functionality orprice, or the failure of a supplier to comply with any of our procurement needscould delay or interrupt our ability to manufacture and deliver our products tocustomers on a timely basis, thereby delaying our revenue recognition andadversely affecting our business, financial condition, and results of operations.

 

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We rely on third partymanufacturers for subassembly of products and for final assembly, qualityassurance, and testing of some of our products.  These outsourcingarrangements and any future outsourcing arrangements involve numerous risks,including the economic and financial viability of these manufacturers, reducedcontrol over product quality, delivery schedules, manufacturing yields, andcosts.  Moreover, although arrangements with such manufacturers maycontain provisions for warranty obligations on the part of such manufacturers,we are primarily responsible to our customers for warranty obligations.

 

**Ourhardware products are subject to warranty claims and returns.  Increasedwarranty claims or returns could harm our business.**

 

We typically offer a30-day unconditional money-back guarantee on our appliance products sold inNorth America.  We also offer warranties for parts and service on all ourhardware products, ranging from one to three years (and, in the case of some ofour Equinox branded products, five years).  Although our historical returnexperience has not been significant, our returns may increase in thefuture.  An increase in returns would have an adverse effect on our salesand could negatively affect our financial results.

 

For our softwareproducts, sales are final and we do not generally allow any returns.  We provide a 90-day limited warranty on themedia used to deliver the software, which is not applicable to electronic downloads,and we generally provide a 90-day limited warranty that our products willfunction in accordance with the user documentation.

 

In the future, we may, asa result of competitive pressures, requirements in certain geographies, orcustomer demands, change our warranty policies or our warranty terms to providecoverage that is greater in scope and duration than the coverage we currentlyoffer.  If we were to increase our warranty coverage, our risk of warrantyclaims, and therefore our warranty expense and reserves, would likely increase.

 

**Wemust meet the increased demands on customer service operations or customersatisfaction and sales could suffer.**

 

Continued growth of oursales is likely to be accompanied by increasing demands on customer service operations. As a result of our commitment to a high level of customer service, we will needto invest significant resources in the maintenance and improvement of ourcustomer service resources.  Any failure to maintain adequate customerservice could cause customer dissatisfaction, result in reduced sales ofproducts, reductions in the renewals of software maintenance and supportagreements, and, accordingly, materially adversely affect our business,financial condition, and results of operations.

 

**If we areunable to successfully develop our international distribution and resellernetworks and international sales efforts, results of operations may suffer.**

 

We are working todevelop, integrate, and expand our international distribution and resellernetworks in an effort to increase international sales of our products.  Wemay not be successful in developing or expanding the international distributionand reseller network or in marketing and selling products in foreign markets,particularly Asia.  If the revenue generated by our international sales isnot adequate to recover the expense of establishing, expanding, and maintainingan international distribution and reseller network, our business, financialcondition, and results of operations could be materially adverselyaffected.  If international sales become a more significant component ofnet sales, our business could become more vulnerable to the risks inherent indoing business on an international level, including:

 

·                                          Difficulties in managing foreigndistributors and resellers;

 

·                                          Longer payment cycles and problems incollecting accounts receivable;

 

·                                          The effects of seasonal customer demand;

 

·                                          Differing license terms and conditions tomeet local requirements;

 

·                                          Changes in regulatory requirements;

 

·                                          Difficulties in meeting the requirementsof different international product regulations, including import and exportrequirements, tariffs, and other trade barriers;

 

·                                          Risks relating to the protection of ourintellectual property rights;

 

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·                                          The impact on our marketing expenses andour research and development resources as we localize our product offerings tomeet local user requirements such as language translations and hardwarecompatibility issues;

 

·                                          Fluctuations in currency exchange rates;and

 

·                                          Potentially adverse tax consequences andpolitical instability.

 

The existence oroccurrence of any one or more of these factors could have a material adverseeffect on our business, financial condition, and results of operations.

 

**Due tothe international nature of our business, political or economic changes orother factors could harm our future revenue, increase our costs and expenses,and impair our financial condition.**

 

We are a global companywith sales, manufacturing, and research and development efforts around theworld.  Sales outside the United Statesgenerate approximately half of our revenue, over half of our manufacturing takesplace outside the United States, and we have research and development centersin several locations outside the United States.  Accordingly, ourbusiness, operating results, future revenue, gross margin, expenses, andfinancial condition could suffer due to a variety of international factors,including:

 

·                                          Ongoing instability or changes in acountry’s or region’s economic or political conditions, including inflation,recession, interest rate fluctuations, and actual or anticipated military orpolitical conflicts, particularly in areas where we have offices or otherfacilities;

 

·                                          Currency fluctuations, which couldcontribute to variations in sales of products and technologies and could alsoaffect our reported results expressed in U.S. dollars;

 

·                                          Longer accounts receivable cycles andfinancial instability among customers;

 

·                                          Tax or trade regulations, tariffs,duties, and procedures and actions affecting production, pricing, and marketingof or payments for products;

 

·                                          Local labor conditions and otherregulations;

 

·                                          Differing technology standards or customerrequirements;

 

·                                          Limited or unfavorable intellectualproperty protection in certain foreign countries including the loss ofproprietary information due to piracy or misappropriation;

 

·                                          Fluctuations in freight costs anddisruptions at important geographic points of exit and entry;

 

·                                          Natural or manmade disasters, such asearthquakes, tsunamis, flooding, hurricanes, typhoons, fires, power shortages,blackouts, telecommunications failures, terrorism, or computer viruses;

 

·                                          Medical epidemics, such as avian flu orSevere Acute Respiratory Syndrome (SARS);

 

·                                          Seasonal reductions in business activityin certain foreign countries, such as the summer months in Europe;

 

·                                          Compliance with a wide variety of complexlaws, treaties, and regulations that increase the risks of doing business incertain foreign countries;

 

·                                          Restrictions against repatriation ofearnings from our international operations;

 

·                                          Difficulties in staffing and managinginternational operations, including the difficulty in managing a geographicallydispersed workforce;

 

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·                                          Possible non-compliance with our Code ofConduct or other corporate policies due to inconsistent laws, interpretations,and/or application of corporate standards in foreign countries;

 

·                                          Increased financial accounting andreporting burdens and complexities; and

 

·                                          The need to localize our products.

 

The factors describedabove also could disrupt our product development and manufacturing, keysuppliers, and OEMs and resellers located outside of the United States. For example, we rely on manufacturers in Asia and Europe for the assemblyand manufacture of many of our hardware products, and we conduct substantialsoftware development and testing operations in China.  Accordingly, we are directly affected byeconomic, political, and military conditions in China.  Any interruption or curtailment of tradebetween China and its present trading partners could materially adverselyaffect our product development, product releases, support, business, operatingresults, and financial condition.

 

Continued or increasedinternational political instability, evidenced by the threat or occurrence ofterrorist attacks, enhanced national security measures in the United States,sustained military action or other conflicts, or strained internationalrelations may impair our ability to do business, increase our costs andadversely affect our stock price. Increased international instability may negatively impact our ability toobtain adequate insurance at reasonable rates or require us to take extrasecurity precautions for our domestic and international operations.

 

**Fluctuationsin the value of foreign currencies could result in currency exchange losses.**

 

Currently, a majority ofour international business is conducted in U.S. dollars.  However, as weexpand our international operations, it is likely that international businesswill increasingly be conducted in foreign currencies.  In particular, theintroduction of the euro has led many of our European customers to request orinsist that our sales to them be denominated in euros instead of U.S. dollarsand sales from our software operations are frequently conducted in foreigncurrencies.  Fluctuations in the value offoreign currencies relative to the U.S. dollar have caused, and are expected toincreasingly cause, currency transaction gains and losses.  In addition,currency fluctuations could also affect our reported results expressed in U.S.dollars.  While we attempt to hedge ourforeign currency exposure, we cannot predict the effect of exchange ratefluctuations upon future quarterly and annual operating results, and we mayexperience currency losses in the future.

 

**Thesales cycle for our software products is unpredictable, making it difficult toforecast operating results for any given period.**

 

The sales cycle for oursoftware products is typically ninety to one hundred eighty days orlonger.  This sales cycle is subject to anumber of significant risks over which we have little or no control, including:

 

·                                          Customers’ budgetary constraints,fluctuations, or uncertainty, internal acceptance requirements, and procurementprocedures;

 

·                                          Concerns about the actions orannouncements of our competitors and their products;

 

·                                          Concerns about the future or performanceof our company; and

 

·                                          Changes in economic conditions generallyand in the technology market specifically.

 

Moreover, our softwarerevenue is heavily weighted toward the end of each quarter, with as much assixty percent of LANDesk’s revenue recorded in the third month of a quarter,making it difficult to forecast operating results for any quarter or giveaccurate guidance.  For largeopportunities, especially for enterprise-wide sales, the sales cycle is oftensignificantly longer than our average sales cycle.  In addition, these large opportunities aremore difficult to forecast, and if we do not correctly forecast the timing in agiven period, the amount of revenue we recognize in a period could be higher orlower than we expect, which could significantly affect our operating resultsfor the then current period and future periods over which revenue would havebeen recognized.  In addition, the termsand conditions of the legal agreements for these large opportunities are oftenbased on our customers’ purchase agreements and may contain terms that aregenerally less favorable to us than our standard terms and conditions. As aresult, revenue recognition may be delayed or otherwise negatively affected,and if we fail to meet expectations, the price of our common stock could benegatively affected.

 

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**Asignificant percentage of our software revenue is dependent on sales toexisting customers or the renewal of annual software upgrade protection ormaintenance services by existing customers.**

 

Our LANDesk Division hashistorically derived, and plans to continue to derive, a significant portion ofour total software revenue from existing customers who purchase additionalproducts or annual maintenance or upgrade protection.  We depend on our installed base of softwarecustomers for future revenue from the purchase of annual software upgradeprotection or maintenance services.  Aswe introduce new software products, our current customers may not require ordesire the functionality of our new products and may choose not to licensethese products or renew their agreements for maintenance or upgradeprotection.  If our customers do notpurchase additional products or increased numbers of products already in use,or renew annual software upgrade protection or maintenance services, ourability to increase or maintain revenue levels could be limited to only newcustomers.

 

Maintenance revenuerelated to the licensing of our software products is a significant part of ourcurrent and future operating revenue.  Ingeneral, maintenance fees increase with the increase in the use of oursoftware.  Accordingly, we receive highermaintenance fees with new license agreements and as existing customers installmore of our software products on additional systems.  Due to increased discounting for larger salesopportunities, maintenance fees on a per unit basis for such large deals can belower than average.  In addition,customers are generally provided reduced annual maintenance percentages forentering into long-term maintenance agreements. Declines in our license bookings, increases in long-term maintenanceagreements, customers electing to migrate to competitive products or findalternatives to our products, and/or increased discounting could lead toreduced software maintenance revenue and reduced gross margins.

 

**Oursoftware products are designed with interoperability or compatibility with manythird-party platforms, systems, and applications, the absence of which may harmour business.**

 

Our software products aredesigned for use with specific third-party platforms, systems, andapplications.  We believe the breadth ofour integration with such platforms, systems and applications is a significantcompetitive advantage.  Any significantchange in these third party products could result in the loss ofinteroperability or compatibility with our products, making our products lessattractive, increasing our research and development costs in order to modifyour products, license new solutions, or develop new products, and potentiallyharming our future revenue.  Our failureto anticipate, manage and adapt to these risks could result in significantdelays in our product releases, changes in our product roadmaps, loss ofcurrent customers for whom the lost compatibility is an issue, and damage toour operating results.

 

**Oursoftware products include licensed third-party content or code upon which werely for the interoperability, integration, development, or updates of ourproducts, and disruption of our access to such code or content could delayproduct releases, inhibit our compatibility with third party products, and harmour business.**

 

The principal componentsof our software products are proprietary code and content.  We do, however, rely on some licensedthird-party code, content, or other intellectual property, and we expect to usesuch third-party code, content, or intellectual property in future products.Although we believe that there are usually adequate alternative sources for thethird-party technology licensed to us, any significant interruption in theavailability of these third-party software products on commercially acceptableterms or any defects in these products could delay development of futureproducts or enhancement of our future products and harm our revenue.  Use of such third party code, content, orother intellectual property presents risks such as:

 

·                                          Owners or licensees of third-partysystems could adopt more restrictive policies or impose unfavorable orunacceptable terms and conditions for access to their products making it moredifficult for us to make our products compatible with their products andresulting in higher research and development costs for us for the enhancementor modification of our existing products and the development of new products;

 

·                                          Functionality provided by third-partycode, content, or other intellectual property in our products may becomeobsolete, defective, or incompatible with future versions of our products, maynot be adequately maintained or updated, and we may be unable to find viablealternatives or develop our own proprietary solution;

 

·                                          Quality, warranty, and support terms varydramatically when licensing third party code, content, or other intellectualproperty and we have limited ability to control quality issues with third-partycode, content, or other intellectual property and must we depend on our ownresearch and development personnel to evaluate and select third-party code,content, or other intellectual property that we believe is of the most value toour customers; and

 

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·                                          Technical difficulties in integrating ourproducts and third party code, content, or other intellectual property tocreate a combined solution, and the risk that customers will not perceive theneed for such integrated solutions.

 

Any significanttermination of a third-party license, change in third-party license provisions,increase in the cost of such third-party code, content or other intellectualproperty, failure of a code, content or other intellectual property provider toremain competitive in functionality, or defect in or a quality issue coulddelay or interrupt our ability to develop and deliver software products tocustomers on a timely basis.  This coulddelay our revenue recognition and adversely affect our business, financialcondition, and results of operations and possibly expose us to claims underlicense agreements with our customers and possibly increased litigation feesand expenses.  Our failure to anticipate,manage, and adapt to these risks could result in significant delays in ourproducts releases, changes in our product roadmaps, and damage to our operatingresults.

 

**Softwareerrors or bugs, and possible product liability claims related to such errors orbugs, could result in increased costs, damage to our reputation, and loss ofmarket share.**

 

Our software products aregenerally large and intricate programs. As a result, our current software products, updates, upgrades, or futureproducts may contain errors, failures, or “bugs,” some of which may not becomeknown until after the product has been released by us for use bycustomers.  While we routinely test ourproducts for such errors and identify and correct bugs through our customersupport group, these problems are inevitable. Any significant errors may result in, among other things, loss of, ordelay in, the market acceptance or our products, lost revenue and sales of ourproducts, reallocation of, or increases in, development and customer supportresources, impairment to our reputation, loss of future renewal or maintenancerevenue, and increased service and warranty costs.  Errors could also result in significantdelays in the release of updates, upgrades, or new products while such errorsare corrected.  Moreover, because ourproducts primarily support other systems and applications, any software errorsor bugs in these other systems or applications may affect the performance ofour software, and it may be difficult or impossible to determine where theerrors reside.  As a result, product errors,failures, or bugs could result in significant harm to our business and have amaterial adverse effect on our results of operations.

 

We may be subject tolegal actions or claims for damages related to product errors which could,whether or not successful, increase costs and distract our management and ourdevelopment and support teams and could harm our business, result in unexpectedexpenses and damage our reputation.  Ourlicense agreements with our customers typically contain provisions designed tolimit exposure to potential product liability claims, and, to the extentpermitted by governing law, our standard agreements in many jurisdictions alsoprovide that we will not be liable for indirect or consequential damages causedby the failure of our products.  Incertain jurisdictions, however, warranty and limitation of liability provisionsare not effective.

 

**Use offree or open source software or technology in our products or in thedevelopment of our products may reduce our ability to control the quality andsupport for products and may result in damage to our operating results.**

 

Free or “open source”software is software that is made widely available by its authors or otherthird parties and is often licensed on an “as is” basis for a nominal fee or,in some cases, at no charge.  We haveincorporated some free and open source software into our products, allowing usto enhance certain solutions without incurring substantial additional researchand development costs.  In addition, wemay use free or open source tools in the development of our products.  While we have not experienced any materialproblems as a result of our use of free or open source software, use of free oropen source software entails significant risks including:

 

·                                          Free or open source software ortechnology becoming competitive with our proprietary technology, which couldcause sales of our products to decline or force us to reduce the fees we chargefor our products, which could have a material adverse impact on our revenue andoperating margins;

 

·                                          Requiring that we make available thesource code for any modifications or derivative works we make to or from thefree or open source software, and that we license or contribute suchmodifications or derivative works under the terms of a particular free or opensource license or other license granting third parties certain rights offurther use;

 

·                                          Our proprietary software could becombined with open source software in such a way that we would be required torelease the source code of our proprietary software; and

 

·                                          The lack of any warranty, maintenance, orsupport for most open source software or technology.

 

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We have establishedprocesses to help minimize these risks to the extent within our control,including a review process for screening requests from our developmentorganizations for the use of free or open source, but we cannot be sure thatall free or open source software, technology, or tools are submitted forapproval prior to use in our products or in the development of our products orthat all use is in compliance with our corporate policies. These risks, if noteliminated, could negatively affect our ability to sale and license ourproducts and could materially impact our business.

 

**Executiveofficers and other key personnel may depart, which could adversely affect ourresults of operations and harm our ability to grow the business.**

 

We are greatly dependenton the ability to retain key management, sales, and technical personnel, andour future success is highly dependent upon the personal efforts of ourmanagement, sales, and technical personnel and other key employees.  Theloss of services of key personnel could have a material adverse effect on ourbusiness, financial condition, and results of operations.  We haveattempted to mitigate these risks by offering key employees retention bonuses(payable only if they continue employment with us for specified periods) andequity awards, but there is the risk that we could nevertheless lose keymanagement, sales, and technical employees.

 

We have historically usedstock options and are currently using restricted stock units, including bothtime-based and performance-based shares, as a key component in our executiveand employee compensation programs in order to align employees’ interests withthe interests of our stockholders, encourage employee retention, and providecompetitive compensation packages.  Many of our employee stock options arefully vested, but most of these outstanding and vested options are currentlyunderwater.  This could affect our ability to retain present employees. In addition, we are now required to record a charge to earnings for employeestock option grants and other equity incentives.  Moreover, applicablestock exchange listing standards relating to obtaining stockholder approval ofequity compensation plans could make it more difficult or expensive for us tomake equity awards to employees in the future.  As a result, we may incurincreased compensation costs, change our equity compensation strategy, or findit difficult to attract, retain, and motivate employees, any of which couldmaterially adversely affect our business.

 

As we expand ourinternational operations, we will be required to recruit and retain experiencedmanagement, sales and technical personnel in our international offices, and weexpect that the identification, recruitment, training and retention of suchpersonnel will require significant management time and effort andresources.  Competition for employeeswith the skills required, particularly management, engineering and othertechnical personnel, is intense, and there can be no assurance that we will beable to attract and retain highly skilled employees in sufficient numbers tosustain our current business or to support future growth.  We may need topay recruiting or agency fees and offer additional compensation or incentivesto attract and retain these and other employees, resulting in an increase toour operating expenses.

 

In addition, for the lastseveral years, we have acquired several companies and these acquisitions haveresulted in increased responsibilities and placed significant strain on ourmanagerial, operational, and financial resources and resulted in new andincreased responsibilities for management personnel.  There can be noassurance that our management, personnel, systems, procedures, and controlsare, or will be, adequate to support our existing and future operations or thatwe will continue to grow.  If we fail torecruit and retain sufficient and qualified managerial, operational, or financialpersonnel or to implement or maintain internal systems that enable us toeffectively manage our growing business and operations worldwide, our financialresults in any given period may be adversely affected and our business andfinancial condition could be materially harmed.

 

**Ourmanagement changes may disrupt our business or affect our profitability.**

 

In January 2008,John R. Cooper, our Chief Executive Officer and the Chairman of the Board ofDirectors, announced his resignation, effective March 31, 2008.  His resignation and the transition to a newchief executive officer could create uncertainty and confusion among ouremployees, customers, and stockholders.  In addition, the process ofidentifying Mr. Cooper’s successor could distract us and adversely affector delay customer purchase decisions or decisions about the strategic directionor our business and raise concerns among our employees, customers, andstockholders, all of which could affect our sales, profitability, or results ofoperations.

 

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**Difficultiesencountered during changing economic conditions could adversely affect ourresults of operations.**

 

Our ability toeffectively manage during changing economic conditions will require us tocontinue to implement and improve our operational, financial, and informationsystems and internal controls and will likely require additional managementpersonnel.  In addition, we believe that we must continue to developimproved engineering, financial, marketing, sales, and customer service capabilitiesin order to develop new products and technologies, secure new customers, andeffectively serve the evolving needs of present and future customers.  Wemay not be successful in strengthening these capabilities.  Withoutadequate management, engineering, financial, product development, marketing,sales, and customer service capabilities, our ability to effectively manageduring changing economic conditions, expand and enhance our product lines,further penetrate existing markets, and develop new markets will besignificantly limited.  If we are unable to effectively manage duringchanging economic conditions, our business, financial condition, and results ofoperations could be materially adversely affected.

 

Because our business andoperating results depend to a significant extent on the general conditions inthe server market, any adverse change in the server market due to adverseeconomic conditions, declining capital spending levels, or other factors couldhave a material adverse effect on our business, financial condition, andresults of operations.  In addition, we continue to see industry-wideinitiatives by OEMs and by distributors and resellers of our hardware productsto reduce their inventories and to shorten their lead times, thereby reducing earlycommitments to firm orders by our major OEM and our distributor and resellercustomers.

 

**Our line of credit couldadversely affect us and our operations.**

** **

In the second quarter of2006, we obtained a $250,000,000 unsecured, five-year, revolving, bank line ofcredit, and we used borrowings under this line of credit to fund a portion ofthe LANDesk acquisition and the purchase of our shares under ourrecently-expanded stock repurchase program. The balance on our line of credit was $95 million as of December 31,2007.  Interest expense on borrowings andadditional future borrowings under the line of credit could adversely affectour future net income, margins, expenses, and financial conditions by:

 

·                                          Requiring us to dedicate a substantialportion of our cash flow from operations to payments on our indebtedness, whichwould reduce the availability of our cash flow to fund internal growth throughworking capital and capital expenditures and for other general corporatepurposes;

 

·              Increasingour vulnerability to economic downturns in our industry;

 

·                                          Increasing our vulnerability to interestrate increases to the extent any of our variable rate debt is not hedged;

 

·                                          Placing us at a competitive disadvantagecompared to our competitors that have less debt in relation to cash flow;

 

·                                          Limiting our flexibility in planning foror reacting to changes in our business and our industry;

 

·                                          Limiting, among other things, our abilityto borrow additional funds, refinance the line of credit, or obtain otherfinancing capacity; and

 

·                                          Subjecting us to a risk of noncompliancewith financial and other restrictive covenants in our indebtedness.

 

**The line of credit containsaffirmative and negative covenants, including limitations on our ability to (i) makedistributions, investments, and other payments unless we satisfy certainfinancial tests or other criteria, (ii) incur additional indebtedness, and(iii) make acquisitions and capital expenditures.  All of these restrictions could affect ourability to operate our business and may limit our ability to take advantage ofpotential business opportunities as they arise. The failure to comply with these covenants could result in an event ofdefault which, if not cured or waived, could have a material adverse effect onus.**

** **

Our ability to complywith these provisions of our line of credit may be affected by changes in theeconomic or business conditions or other events beyond our control.  If we do not comply with these covenants andrestrictions, we could be in default under our line of credit, and our debt,together with accrued interest, could then be declared immediately due andpayable.  There can be no assurance thatwe will be able to obtain sufficient funds to enable us to repay or refinanceour debt obligations on commercially reasonable terms or at all.  We also face interest rate risk on our bankline of credit which currently bears interest at a variable rate of LIBOR plus70 basis points.  We have partiallyhedged this exposure to interest rate risk with an interest rate swap, whichhas a notional amount of $80 million, through a well established financialinstitution.

 

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**Unanticipatedchanges in our tax rates or exposure to additional income tax liabilities couldaffect our profitability.**

 

We are subject to incometaxes in both the United States and various foreign jurisdictions, and ourdomestic and international tax liabilities are subject to the allocation ofexpenses in different jurisdictions.  Our effective tax rates could beadversely affected by changes in the mix of earnings in countries withdiffering statutory tax rates, in the valuation of deferred tax assets andliabilities, in tax laws and treaties, or by material audit assessments, whichcould affect our profitability.  In addition, the amount of income taxeswe pay is subject to audit in various jurisdictions, and a material assessmentby a governing tax authority could affect our profitability.

 

**Failure tomaintain adequate internal systems and effective internal controls over ourfinancial reporting and information systems could result in our management andauditors being unable to certify the effectiveness of our internal controlsover financial reporting and information systems, which could harm our businessreputation and cause our stock price to decline.**

 

Section 404 of theSarbanes-Oxley Act of 2002 requires that we implement and maintain adequateinternal systems and effective internal controls over financial reporting andinformation systems.  The absence of suchcontrols could have a material adverse effect on our business, financialcondition, and results of operations.  Inaddition, correction of any “significant deficiencies” or “material weaknesses”(as defined under PCAOB guidelines) could require additional remedial measuresincluding hiring additional personnel, which could be costly andtime-consuming.  If a significantdeficiency or material weakness exists at any year-end (including a materialweakness identified prior to year-end for which there is an insufficient periodof time to evaluate and confirm the effectiveness of the corrections or relatednew procedures), our management and our auditors will be unable to reportfavorably as to the effectiveness of our control over financial reporting orinformation systems.  This could resultin a loss of investor confidence in the accuracy and completeness of ourfinancial reports and our management, which could result in a decline of ourstock price, damage to our business reputation, and potential litigation.

 

**Changesin accounting standards or the interpretation of accounting standards,especially changes related to revenue recognition, could cause significantimpact on our revenue or earnings.**

 

Based on ourinterpretation of current accounting standards, we believe we have properlyreported our current sales and license revenue. New accounting standards or regulations, changes to current accountingstandards, or different interpretations of existing accounting standards in thefuture could result in corresponding changes in our revenue recognition orother accounting policies that could have a material adverse effect on ourfinancial condition and operating results.

 

**Unforeseenenvironmental costs could negatively affect our future earnings.**

 

Some of our operationsuse substances regulated under various federal, state, and international lawsgoverning the environment, including those governing the discharge ofpollutants into the air and water, the management and disposal of hazardoussubstances and wastes, and the cleanup of contaminated sites.  Many of ourproducts are subject to various federal, state, and international lawsgoverning chemical substances in products, including those regulating themanufacture and distribution of chemical substances and those restricting thepresence of certain substances in electronics products.  We could incursubstantial costs, including cleanup costs, fines, civil or criminal sanctions,third-party property damage, or personal injury claims if we were to violate orbecome liable under environmental laws or if our products become non-compliantwith environmental laws.  We also face increasing complexity in ourproduct design and procurement operations as we adjust to new and futurerequirements relating to the materials composition of our products, includingthe restrictions on lead and certain other substances that will apply tospecified electronics products put on the market in the European Union as of July 1,2006 (Restriction of Hazardous Substances Directive) and similar legislation inChina and other countries.  The ultimate costs under environmental lawsand the timing of these costs are difficult to predict, and liability undersome environmental laws relating to contaminated sites can be imposedretroactively and on a joint and several basis.

 

We could also facesignificant costs and liabilities in connection with product take-backlegislation.  The European Union has finalized the Waste Electrical andElectronic Equipment Directive (WEEE), which makes producers of electricalgoods, including computers and peripherals, financially responsible forspecified collection, recycling, treatment, and disposal of past and futurecovered products.  This deadline to enact and implement the directive byindividual European Union governments generally was August 13, 2004,although extensions were granted to some countries (such legislation, togetherwith the directive, the “WEEE Legislation”), and producers are financiallyresponsible under the WEEE Legislation beginning in August 2005. Similar legislation has been or may be enacted in other geographies, includingin the United States and Japan, the cumulative impact of which could besignificant for us.  We have incurred some costs and will continue toincur costs under the WEEE legislation but the amount and timing of these costsare difficult to predict.

 

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**Provisionsin our charter documents and in Delaware law may discourage potentialacquisition bids for us and may prevent changes in management that stockholdersmay favor.**

 

Provisions in our charterdocuments could discourage potential acquisition proposals and could delay orprevent a change in control transaction that stockholders may favor. These provisions could have the effect of discouraging others from makingtender offers for shares, and as a result, these provisions may prevent themarket price of our common stock from reflecting the effects of actual orrumored takeover attempts and may prevent stockholders from reselling theirshares at or above the price at which they purchased their shares.  Theseprovisions may also prevent changes in management that stockholders mayfavor.  Our charter documents do not permit stockholders to act by writtenconsent, limit the ability of stockholders to call a stockholders meeting, andprovide for a classified Board of Directors, which means stockholders can onlyelect, or remove, a limited number of directors in any given year. Furthermore, the Board of Directors has the authority to issue up to fivemillion shares of preferred stock in one or more series.  The Board ofDirectors can fix the price, rights, preferences, privileges, and restrictionsof such preferred stock without any further vote or action by ourstockholders.  The issuance of shares of preferred stock may delay orprevent a change in control transaction without further action by ourstockholders.

 

In addition, Delaware lawmay inhibit potential acquisition bids for us.  Delaware law preventscertain Delaware corporations, including Avocent, from engaging, under certaincircumstances, in a business combination with any interested stockholder forthree years following the date that such stockholder became an interestedstockholder.

 

**Ourstock price may be volatile.**

 

Our stock has experiencedsignificant volatility in price, in particular whenever there has been adifference between our actual financial results and the published expectationsof analysts.  We have also experiencedchanges in our stock price as a result of speculation in the press orinvestment community about our strategic position, financial position, resultsof operations, business, or significant transactions or acquisitions.  The stock market in general has experiencedprice and volume fluctuations that have negatively affected the market price ofmany publicly-held companies in ways seemingly unrelated to the actualoperating performance of these companies. These factors, as well as generaleconomic and political conditions and the announcement of proposed andcompleted acquisitions or other significant transactions, or any difficultiesassociated with such transactions, by us or our current or potentialcompetitors, may materially adversely affect the market price of our commonstock in the future. Additionally, volatility, lack of positive performance inour stock price or changes to our overall compensation program including ourstock incentive program may adversely affect our ability to retain keyemployees, virtually all of whom are compensated, in part, based on theperformance of our stock price.

 

**Item 1B.Unresolved Staff Comments.**

 

None

 

**Item2.  Properties.**

 

Our world-wide headquarters, occupying approximately181,000 square feet and containing administrative, sales, marketing, researchand development, manufacturing, and distribution facilities, is located inHuntsville, Alabama, on a 35-acre tract of land owned by us in CummingsResearch Park.

 

Our Redmond, Washingtonfacility, which consists of approximately 82,000 square feet of leased space inan industrial office building, contains administrative, sales, marketing,research and development, and distribution operations and is leased through March 2009.  The base rent under the lease isapproximately $775,000 per year, plus taxes, insurance, and maintenance ofapproximately $200,000 per year.

 

Our LANDesk facility in Salt Lake City, Utah, consistsof approximately 71,000 square feet in an office building, and containsadministrative, sales, marketing, and research and development operations.  The current base rent under the lease isapproximately $1,062,000 per year, plus taxes, insurance, and maintenance ofapproximately $433,000 per year and is leased through July 2014.

 

Our primary international administrative, sales,marketing, research and development, manufacturing, and distribution operationsare located in a 129,000 square foot building owned by us in the free tradezone in Shannon, Ireland.

 

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We also own a 45,000square foot building on 6.5 acres of land in Sunrise, Florida.  Our Sunrise facility contains sales,marketing, research and development operations. In addition, we lease office space in Fremont, California (administrative,sales, marketing, and research and development), Austin, Texas (sales,marketing, and technical), Taipei, Taiwan (administrative, sales, marketing,and research and development operations), São Paulo, Brazil (administrative,sales, marketing, and research and development operations) and Beijing andShanghai, China (sales, marketing, and research and development operations).

 

We also lease sales offices in various United Statesand international locations, none of which is material to our operations.

 

We believe that these facilities are sufficient tosupport our current operations.

 

**Item 3.  Legal Proceedings.**

** **

In March 2006, TFSElectronic Manufacturing Services, Inc. (“TFS”) filed a Third-PartyComplaint and an Objection to Claim of Avocent Corporation with the UnitedStates Bankruptcy Court, District of Arizona.  As a result of thecomplaint, an adversary proceeding was commenced against us in theTFS bankruptcy case in an effort to disallow our claim in its entirety. TFS also seeks damages in an undetermined amount for our alleged breach ofcontract, negligence, negligent misrepresentations, breaches of warranty,unjust enrichment, disparagement of TFS’ business, and quantum merit.  TFSis seeking recovery of actual damages, punitive damages, attorneys’ fees, pre-and post-judgment interest, costs from us. .For purposes of discovery, thematter was been consolidated with a separate matter between TFS and TopSearchPrinted Circuits (HK), Ltd., pending in the United States District Court forthe District of Arizona.  A mediationsession was held in October 2007 and concluded without resolution, and theDistrict Court subsequently severed the two matters.  TFS’ claim againstus is now back in the Bankruptcy Court and discovery is currently underway.

 

In January 2007,we filed a complaint for patent infringement in the United States DistrictCourt for the Western District of Washington against Aten Technology, Inc.,Aten International Co., Ltd, Belkin Corporation, Rose Electronics and itsgeneral partners, and Trippe Manufacturing Company.  The defendants filedcounterclaims alleging non-infringement, unenforceability, andinvalidity.  In May 2007, we entered into a Settlement and LicenseAgreement with Trippe Manufacturing, and dismissed Trippe from the lawsuit.  In October 2007, the District Courtstayed the action pending a re-examination of our patents by the Patent andTrademark Office (the “PTO”).  That re-examination is currently underway.

 

In March 2007,KBM Enterprises, formerly a contract manufacturer forAvocent, filed a complaint against Avocent in the Circuit Court of MadisonCounty, Alabama, seeking $9.5 million for costs allegedly incurred byKBM in its manufacturing efforts on behalf of Avocent.  We have filed ananswer and counterclaims against KBM and one of its principals, and discoveryis currently underway.

 

In April 2007, wefiled a complaint for declaratory judgment against Aten International Co., Ltd.in the United States District Court for the Northern District of Alabama. We are seeking a declaratory judgment that two patents owned by Aten andasserted against Avocent are invalid and that certain of products alleged byAten to infringe do not infringe these patents.  In August 2007, Aten’smotion to dismiss for lack of personal jurisdiction was granted, and we haveappealed that ruling to the Federal Circuit Court of Appeals.  Oral arguments were held in February 2008.

 

In November 2007,Gemini IP, LLC filed a complaint for patent infringement in the United StatesDistrict Court for the Eastern District of Texas, Sherman Division, againstAvocent Corporation and our subsidiary LANDesk Software, Inc.  Thecomplaint alleges infringement of a Gemini patent through the sale of a LANDeskproduct.  The complaint seeks injunctiverelief, damages, attorneys’ fees, and costs.  Avocent Corporation wasdismissed from the lawsuit in January 2008, and we have made a claim forindemnification against the LANDesk escrow account.

 

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**PART II**

 

**Item 5.  Market For Registrant’s Common Equity andRelated Stockholder Matters and Issuer Purchases of Equity Securities.**

 

**Price Range of Common Stock;Holders of Record**

 

Our common stock isquoted on the NASDAQ National Market System under the symbol “AVCT.” The followingtable shows the high and low sales prices of our common stock for eachquarterly period within the last two fiscal years as reported by the NASDAQNational Market System.

 
| ** **                             | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------------------------------|------------|----------|------------|---------|------------|
| Quarter ended  December 31, 2007  |       | $        | 35.68      |    | $          | 21.50 |   |
| Quarter ended  September 28, 2007 |       | $        | 31.82      |    | $          | 26.17 |   |
| Quarter ended  June 29, 2007      |       | $        | 29.96      |    | $          | 23.73 |   |
| Quarter ended  March 30, 2007     |       | $        | 35.64      |    | $          | 26.25 |   |
|                                   |       |     |       |    |       |
| Quarter ended  December 31, 2006  |       | $        | 38.50      |    | $          | 29.37 |   |
| Quarter ended  September 29, 2006 |       | $        | 31.71      |    | $          | 23.82 |   |
| Quarter ended  June 30, 2006      |       | $        | 34.40      |    | $          | 21.98 |   |
| Quarter ended  March 31, 2006     |       | $        | 34.86      |    | $          | 27.15 |   |

 

As of February 15, 2008, Avocent had approximately 10,510stockholders including 260 stockholders of record and 10,250 stockholders innominee name.

 

**Stock Performance Graph**

 

The following graphcompares the cumulative total stockholder return data for our common stock tothe cumulative return of (i) the NASDAQ US Index and (ii) the NASDAQComputer Index for the period beginning January 1, 2003, and ending on December 31,2007.  The graph assumes that $100 wasinvested at a per share price of $22.22 on January 1, 2003, theclosing price on December 31, 2002, and the reinvestment of anydividends.  The stock price performanceon the following graph is not necessarily indicative of future stock priceperformance.

 

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**COMPARISONOF 5 YEAR CUMULATIVE TOTAL RETURN***

Among AvocentCorporation. The NASDAQ Composite Index

And The NASDAQComputer Manufacturers Index

 

 

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* $100 Invested on12/31/02 in stock or index-including reinvestment of dividends.Fiscal year ending December 31.

 
| ** **                  | ** ** | **12/02** | ** ** | **12/03** | ** ** | **12/04** | ** ** | **12/05** | ** ** | **12/06** | ** ** | **12/07** | ** ** |
|-----------------------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|
|                        |       |      |       |      |       |      |       |      |       |      |       |      |       |
| AVOCENT  CORPORATION        |       | 100.00    |       | 164.36    |       | 182.76    |       | 122.37    |       | 152.34    |       | 104.91    |       |
| NASDAQ STOCK  MARKET (U.S.) |       | 100.00    |       | 149.75    |       | 164.64    |       | 168.60    |       | 187.83    |       | 205.22    |       |
| NASDAQ COMPUTER  MFG’S |       | 100.00    |       | 162.04    |       | 170.46    |       | 159.04    |       | 197.20    |       | 247.15    |       |

 

The information containedabove under the caption “Stock Performance Graph” is being “furnished” to theSecurities and Exchange Commission and shall not be deemed to be “solicitingmaterial” or to be “filed” with the Securities and Exchange Commission, norshall such information be incorporated by reference into any future filing underthe Securities Act of 1933, as amended, or the Securities Exchange Act of 1934,as amended, except to the extent that we specifically incorporate it byreference into such filing.

 

**Dividend Policy**

 

We have not declared orpaid any cash dividends in the past, and for the foreseeable future, we expectto retain earnings to finance the expansion and development of ourbusiness.  The payment of dividends iswithin the discretion of our Board of Directors and will depend on, among otherfactors, our earnings, capital requirements, and operating and financialcondition.

 

**Equity Compensation PlanInformation**

 

Please see Item 12 ofthis Annual Report on form 10-K for disclosures relating to our equitycompensation plans.  Such information isincorporated by reference from our 2008 proxy statement.

 

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**Recent Purchases of TreasuryStock**

 

In the fourth quarter of2004 our Board of Directors approved a stock repurchase program whereby we may,from time to time, purchase our common stock in the open market, in privatelynegotiated transactions or otherwise, at prices that we deem appropriate.  Since the program’s initial approval through December 31,2007, our Board has authorized a total of 15 million shares to be repurchased,including 2 million additional shares approved by our Board in February 2007and 3 million approved in November 2007. The plan has no expiration date. Details of purchases under the plan during 2007 are as follows:

 
| **Period:**                                           | ** ** | **Total Number of  Shares Purchased  During the Period** | ** ** | **Average Price Paid  Per Share for  Period Presented** | ** ** | **Total Cumulative  Number of  Shares Purchased  as  Part of Publicly  Announced Plan** | ** ** | **Maximum  Number of  Shares  Remaining to  Purchase  Under the  Plan** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
|                                                  |       |                                                                              |       |                                                                             |       |                                                                                                                  |       |                                                                                   |       |
| January 1,  2007 — January 26, 2007    |       | —                                                                            |       | $                                                                                | —     |                                                                                                                  | 9,813,733  |                                                                                   | 186,267    |   |
| January 27,  2007 — February 23, 2007  |       | 186,267                                                                           |       | $                                                                                | 35.03      |                                                                                                                  | 10,000,000 |                                                                                   | 2,000,000  |   |
| February 24,  2007 — March 30, 2007    |       | 300,000                                                                           |       | $                                                                                | 29.71      |                                                                                                                  | 10,300,000 |                                                                                   | 1,700,000  |   |
| Quarter ended  March 30, 2007                    |       | 486,267                                                                           |       | $                                                                                | 31.75      |                                                                                                                  |       |                                                                                   |       |   |
|                                                  |       |                                                                              |       |                                                                             |       |                                                                                                                  |       |                                                                                   |       |
| March 31,  2007 — April 27, 2007       |       | 100,000                                                                           |       | $                                                                                | 24.93      |                                                                                                                  | 10,400,000 |                                                                                   | 1,600,000  |   |
| April 28,  2007 — May 25, 2007         |       | —                                                                            |       | $                                                                                | —     |                                                                                                                  | 10,400,000 |                                                                                   | 1,600,000  |   |
| May 26,  2007 — June 29, 2007          |       | —                                                                            |       | $                                                                                | —     |                                                                                                                  | 10,400,000 |                                                                                   | 1,600,000  |   |
| Quarter ended  June 29, 2007                     |       | 100,000                                                                           |       | $                                                                                | 24.93      |                                                                                                                  |       |                                                                                   |       |   |
|                                                  |       |                                                                              |       |                                                                             |       |                                                                                                                  |       |                                                                                   |       |
| June 30,  2007 — July 27, 2007         |       | 200,000                                                                           |       | $                                                                                | 29.11      |                                                                                                                  | 10,600,000 |                                                                                   | 1,400,000  |   |
| July 28,  2007 — August 24, 2007       |       | 100,000                                                                           |       | $                                                                                | 27.16      |                                                                                                                  | 10,700,000 |                                                                                   | 1,300,000  |   |
| August 25,  2007 — September 28, 2007  |       | —                                                                            |       | $                                                                                | —     |                                                                                                                  | 10,700,000 |                                                                                   | 1,300,000  |   |
| Quarter ended  September 28, 2007                |       | 300,000                                                                           |       | $                                                                                | 28.46      |                                                                                                                  |       |                                                                                   |       |   |
|                                                  |       |                                                                              |       |                                                                             |       |                                                                                                                  |       |                                                                                   |       |
| September 29,  2007 — October 26, 2007 |       | 100,000                                                                           |       | $                                                                                | 28.77      |                                                                                                                  | 10,800,000 |                                                                                   | 1,200,000  |   |
| October 27,  2007 — November 23, 2007  |       | 1,300,000                                                                         |       | $                                                                                | 25.24      |                                                                                                                  | 12,100,000 |                                                                                   | 2,900,000  |   |
| November 24,  2007 — December 31, 2007 |       | 600,000                                                                           |       | $                                                                                | 24.83      |                                                                                                                  | 12,700,000 |                                                                                   | 2,300,000  |   |
| Quarter ended  December 31, 2007                 |       | 2,000,000                                                                         |       | $                                                                                | 25.30      |                                                                                                                  |       |                                                                                   |       |   |
| Year ended  December 31, 2007                    |       | 2,886,267                                                                         |       | $                                                                                | 26.70      |                                                                                                                  |       |                                                                                   |       |   |

 

In January 2008,our Board authorized the purchase of an additional 4 million shares under theprogram.  These additional shares are notincluded in the table above.  Wepurchased an additional 3 million shares at an average cost of $16.03 from January 1,2008 through February 15, 2008.

 

**Item 6.  Selected Financial Data.**

(Amounts in thousands,except per share data and amounts in note (1) below.)

 
| ** **                     | ** ** | **2007** | ** ** | **2006** | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|-----------|------------|----------|------------|----------|------------|
| Net sales                      |       | $        | 600,875    |     | $          | 519,195   |       | $        | 369,888    |     | $          | 365,255 |   | $ | 304,238 |   |
| Net income (1)                 |       | $        | 45,929     |     | $          | 45,532    |       | $        | 48,349     |     | $          | 18,040 |   | $ | 38,547 |   |
| Basic net income  per share    |       | $        | 0.91       |     | $          | 0.94      |       | $        | 0.98       |     | $          | 0.37 |   | $ | 0.83 |   |
| Diluted net  income per share  |       | $        | 0.90       |     | $          | 0.92      |       | $        | 0.96       |     | $          | 0.36 |   | $ | 0.81 |   |
| Total assets                   |       | $        | 1,078,433  |     | $          | 1,158,854 |       | $        | 773,751    |     | $          | 770,781 |   | $ | 660,763 |   |
| Unsecured bank  line of credit |       | $        | 95,000     |     | $          | 150,000   |       | $        | —     |     | $          | — |   | $ | — |   |

 

----

(1)                               Forthe periods presented, we recognized pre-tax charges for acquired in-processresearch and development expenses for the following acquisitions: $3.9 millionfor Soronti, Inc. in 2003; and $6.5 million for Crystal Link Technologies,$21.7 million for OSA Technologies, Inc. and $1.1 million for SonicMobility Inc. in 2004; $2.1 million for Cyclades Corporation and $18.6 millionfor LANDesk Group Limited in 2006 (*see Note 3 to theconsolidated financial statements*).

 

34

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**Item 7.    Management’s Discussion and Analysis of Financial Condition andResults of Operations**.

 

**Overview**

 

AvocentCorporation designs, manufactures, licenses, and sells software and hardwareproducts and technologies that provide connectivity and centralized managementof information technology (IT) infrastructure. We (meaning Avocent and its wholly-owned subsidiaries) provide connectivity and systems management,endpoint security, and service management products and technologies thatcentralize control of servers, desktop computers, serial devices, wirelessdevices, mobile devices, and network appliances, thus increasing the efficiencyof IT resources.  Server manufacturersresell private-labeled Avocent KVM (keyboard, video, and mouse) switches andembedded software and hardware technology in their systems, and companies largeand small depend on our software and hardware products and technologies formanaging their growing IT infrastructure.

 

Our technologicalinnovations include Internet Protocol (IP) based switching, centralizedmanagement, and intuitive software interfaces. With more than two decades of experience, we have grown through productinnovations, global expansion, and strategic acquisitions.  Formed as a result of the merger in 2000between Apex Inc. and Cybex Computer Products Corporation, we subsequentlyacquired Equinox Systems Inc. in 2001, 2C Computing, Inc. in 2002, Soronti, Inc.in 2003, Crystal Link Technologies, OSA Technologies, Inc., and SonicMobility, Inc. in 2004, and Cyclades Corporation and LANDesk Group Limitedin 2006.

 

Most of our revenue isderived from sales to a limited number of OEMs (who purchase our products on aprivate-label or branded basis for integration and sale with their ownproducts), sales through our reseller and distributor network, and sales to alimited number of direct customers. Sales to our OEM customers accounted for 35% of sales in 2007, 40% in2006, and 48% in 2005.  Sales to ourbranded customers accounted for 65% of sales in 2007, 60% in 2006, and 52% in2005.  We do not have contracts with manyof our branded customers, and in general, our OEM and branded businesscustomers are obligated to purchase products from us only pursuant to bindingpurchase orders.  The loss of, ormaterial decline in orders from, these customers would have a material adverseeffect on our business, financial condition, results of operations, and cashflows.  Our top five customers includeboth OEM and branded customers and accounted for 52% of sales in 2007, 56%  in 2006, and 64% in 2005.

 

We sell products toresellers, distributors, end-users, and OEMs in the United States, Canada,Europe, and Asia as well as in other foreign markets.  Sales within the United States accounted forapproximately 56% of sales in 2007 and 57% in both 2006 and 2005.  Sales outside of the United States accountedfor 44% of sales in 2007 and 43% in both 2006 and 2005.  Outside the United States, no other countryaccounted for more than 10% of 2007, 2006, or 2005 sales.

 

With continued industry-wideinitiatives to reduce all channel inventories and to shorten lead times, trendswith our major customers are, generally, to reduce the number of weeks offorward-committed firm orders.  Thistrend continues to affect our business with certain distributors,OEMs, and other server manufacturers, and we believe that it will continueto make our future sales more difficult to predict and inventory levels moredifficult to manage.

 

We experience significantprice competition in the market for all of our products, and we expect thatpricing pressures will continue in the future. In addition, general economic conditions are not predictable, and weexpect our revenue growth rate to fluctuate in relation to economic conditionsand IT related spending trends.

 

Many of our executiveofficers and directors are vested in significant amounts of options to purchaseshares of our common stock and restricted shares and continue to vest inadditional options and shares on a regular basis.  These officers and directors have informed usthat they have sold, and may sell, additional shares of our common stock toprovide liquidity and diversify their portfolios.  Additionally, many of the stock optionspreviously granted to employees are now fully vested.  During 2006 and 2007 our Board of Directorsgranted both time-based and performance-based restricted stock units (RSUs)with two and three year vesting periods. We did not meet the financial objectives established for theperformance-based share units granted in 2007. Therefore, these grants were not earned, and no expense was recognizedin 2007 for these performance-based RSUs.

 

During the firstquarter of 2007, we merged our Embedded Software and Solutions Division intoour Management Systems Division and our Mobile Technologies Division into ourLANDesk Division.  During 2007, we hadthe following four divisions:

 

·                                          Management Systems Division, which includes ourbranded and OEM KVM, embedded software, serial console, power control, andmanagement appliance businesses;

 

·                                          LANDesk Division, which includes****systems,security, and service management solutions for desktops, servers, and mobiledevices across the enterprise;

 

35

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·                                          Connectivity and Control Division, which focuses onexpanding the markets for our serial, extension, and wireless broadcast, pointof sale, and audio-visual products; and

 

·                                          Desktop Solutions Division, which develops newtechnologies to enable desktop over IP solutions, including blade computers.

 

**Our largest division on a revenue basis, the ManagementSystems Division, contributed 77% of our consolidated net revenue in 2007, 89%in 2006, and 95% in 2005.  LANDesk, ournewest division acquired in August 2006, contributed 18% of ourconsolidated net revenue in 2007 and 8% of net revenue to 2006 for the fourmonths it was part of Avocent.  LANDesk revenueis heavily weighted toward the end of each quarter, with as much as 60% of aquarter’s revenue recorded in the third month. LANDesk 2006 results included revenue from both September andDecember, the third month of our third and fourth quarters.  As a result, LANDesk revenue as a percent oftotal sales did not increase from 2006 to 2007 as might be expected.  The other divisions and unallocated revenuecomprised the remaining 5% of our consolidated net revenues in 2007, 4% in 2006and 5% in 2005.  See Note 16 in the notesto the c**onsolidated financial statementscontained in Item 8 of this document.

** **

**In the first quarter of 2008, we discontinued our DesktopSolutions Division and transferred some of its personnel and a portion of itstechnology into the Management Systems Division.**  We believeour remaining divisions allow us to focus on new technology and growthopportunities and to add product and shareholder value in the future.  We believe this structure enhances customerservice, speeds delivery of products to market and better focuses our research,development, and marketing resources.

** **

**Results of Operations**

 

Our consolidatedstatements of income, stockholders’ equity, and cash flows reflect the resultsof acquired companies from the respective dates of acquisition.  The following table sets forth, for theperiods indicated, selected statement of income data expressed as a percentageof net sales:

 
| ** **                                            | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                            | ** ** | **2007**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                             |       | 100.0                                       | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                         |       | 36.9                                        |       | 38.0 |   | 40.8 |   |
| Gross profit                                          |       | 63.1                                        |       | 62.0 |   | 59.2 |   |
| Operating  expenses:                                  |       |                                        |       |   |   |   |   |
| Research and  development expenses                    |       | 14.6                                        |       | 12.3 |   | 15.4 |   |
| Acquired  in-process research and development expense |       | —                                      |       | 4.0 |   | — |   |
| Selling, general  and administrative expenses         |       | 34.7                                        |       | 28.6 |   | 24.4 |   |
| Acquisition  integration expenses                     |       | —                                      |       | 0.8 |   | — |   |
| Amortization of  intangible assets                    |       | 5.4                                         |       | 4.4 |   | 5.0 |   |
| Total operating  expenses                             |       | 54.7                                        |       | 50.1 |   | 44.8 |   |
| Income from  operations                               |       | 8.4                                         |       | 11.9 |   | 14.4 |   |
| Income from  settlement of lawsuit                    |       | —                                      |       | — |   | 1.4 |   |
| Net investment  income                                |       | 0.6                                         |       | 1.6 |   | 2.5 |   |
| Net realized  investment losses                       |       | —                                      |       | (0.1 | ) | (0.1 | ) |
| Interest expense                                      |       | (1.3                                        | )          | (0.6 | ) | — |   |
| Other expense,  net                                   |       | (0.1                                        | )          | (0.1 | ) | (0.1 | ) |
| Income before  provision for income taxes             |       | 7.6                                         |       | 12.7 |   | 18.1 |   |
| Provision for  income taxes                           |       | —                                      |       | 3.9 |   | 5.0 |   |
| Net income                                            |       | 7.6                                         | %          | 8.8 | % | 13.1 | % |

 

*Years Ended December 31,2007 and 2006   ($ Data in all tablespresented in 000’s)*

 

*Netsales.*  Our net sales consist of sales of keyboard,video, and mouse (KVM) console switching systems, digital connectivity productsand technologies, software licenses and subscriptions, support and maintenanceagreements, serial connectivity devices, wireless extension products, IPMI,extension, remote access and management products and technologies, androyalties from licensing our intellectual property.

 

36

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| ** **                         | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2007**                                    | ** ** | **% of  Sales** | ** ** | **2006** | ** ** | **% of  Sales** | ** ** |
| Net sales,  customer distribution: |       |                                        |       |   |   |   |   |   |   |
| Branded                            |       | $                                           | 393,799    |   | 65 | % | $ | 311,885 |   | 60 | % |
| OEM                                |       | 207,076                                     |       | 35 | % | 207,310 |   | 40 | % |
|                               |       |                                        |       |   |   |   |   |   |   |
|                               |       | $                                           | 600,875    |   | 100 | % | $ | 519,195 |   | 100 | % |

 

The increase in our netsales in 2007 resulted directly from the contribution of revenue from ourCyclades acquisition, completed March 30, 2006, and our LANDeskacquisition, completed August 31, 2006, which was partially offset by adecline in revenue from our traditional legacy Avocent products.  Within our customer distribution channels,our branded sales (including LANDesk branded sales) increased 26% from 2006 to2007, while our OEM sales remained flat from 2006 to 2007.  A significantly smaller portion of LANDesk business comes from OEM customerscompared to Avocent’s historical customer base, which also explains the changein the percentage mix of our sales.

 
| ** **                                                         | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                         | ** ** | **2007**                                    | ** ** | **% of  Sales** | ** ** | **2006** | ** ** | **% of  Sales** | ** ** |
| Divisional net  sales:                                             |       |                                        |       |   |   |   |   |   |   |
| Management  Systems Division                                       |       | $                                           | 463,609    |   | 77 | % | $ | 460,178 |   | 89 | % |
| LANDesk Division                                                   |       | 111,906                                     |       | 18 | % | 40,368 |   | 8 | % |
| Other business  units                                              |       | 22,633                                      |       | 4 | % | 16,658 |   | 3 | % |
| Corporate and  unallocated                                         |       | 4,601                                       |       | 1 | % | 3,677 |   | 1 | % |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | (1,874                                      | )          | — |   | (1,686 | ) | (1 | )% |
|                                                               |       |                                        |       |   |   |   |   |   |   |
|                                                               |       | $                                           | 600,875    |   | 100 | % | $ | 519,195 |   | 100 | % |

 

Froma divisional perspective, revenue from our Management Systems Divisionincreased slightly from 2006 to 2007. The slight increase is primarily due to the inclusion of a full year ofCyclades revenue in 2007 compared with three quarters of Cyclades revenue in2006, which was offset somewhat by a decline in sales of our legacy Avocentproducts.  Revenue within the ManagementSystems Division is comprised primarily of our traditional KVM products, ourserial management products, and our embedded software and solutions.  Within our Management Systems Division,revenues from ourtraditional KVM business and serial management products were slightly up in2007, but we experienced lower than expected KVM and serial revenues in thefourth quarter of 2007 as a result of slowness in our North American brandedbusiness.  Revenue from our embedded software and solutions product line, whichincludes our embedded KVM and IPMI solutions and the Agilent product lineacquired in the first quarter of 2006, decreased slightly in 2007 from2006.  This was primarily due tothe declining sales of the Agilent RMB product (acquired in March 2006) asit nears the end of its product life cycle. Revenue by product line for our Management Systems Division for theyears ended December 31,  2007 and2006 are as follows:

 
| ** **                                      | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                    | ** ** | **2006** | ** ** |
| Management  Systems Division (MSD) net revenue: |       |                                        |       |   |   |
| KVM                                             |       | $                                           | 354,876    |   | $ | 352,402 |   |
| Serial  management                              |       | 49,603                                      |       | 46,534 |   |
| Embedded  software and solutions                |       | 32,983                                      |       | 33,766 |   |
| Other                                           |       | 26,147                                      |       | 27,476 |   |
| Total MSD net  revenue                          |       | $                                           | 463,609    |   | $ | 460,178 |   |

 

TheLANDesk Division’s revenue and bookings are comprised of license-based revenue,primarily from the LANDesk Management Suite product, andsubscription-based revenue, primarily from the LANDesk Security Suite andLANDesk Patch Manager products and from maintenance and support agreementsrelated to LANDesk Management Suite. LANDesk was acquired in August 2006, which explains the largeincrease in revenues from 2006 to 2007 as we recorded a full year of revenue in2007 compared to four months of revenue in 2006.  Our LANDesk Division’s growth in bookings hascome primarily from the subscription-based revenue, outpacing the growth inlicense-based revenue.  This change inmix has an impact on the revenue we recognize because subscription andmaintenance revenue is deferred and amortized over the subscription term.  The growth in subscription and maintenancerevenue also results in an increase to deferred revenue recorded on the balancesheet.  Deferred revenue increased to$66.1 million at December 31, 2007 from $54.5 million at December 31,2006.  Revenue by product line for our LANDesk Division forthe years ended December 31,  2007and 2006 was as follows:

 
| ** **                     | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|
| ** **                     | ** ** | **2007**                                    | ** ** | **2006** | ** ** |
| LANDesk Division  net revenue: |       |                                        |       |   |   |
| Licenses and  royalties        |       | $                                           | 42,514     |   | $ | 20,545 |   |
| Maintenance and  services      |       | 45,911                                      |       | 13,319 |   |
| Subscription  revenue          |       | 23,481                                      |       | 6,504 |   |
| Total LANDesk  net revenue     |       | $                                           | 111,906    |   | $ | 40,368 |   |

 

37

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Our other business units,which are more entrepreneurial in nature, continue to focus on productdevelopment and creating markets for those products already developed.  Combined, these business units grew 36% from2006 to 2007.

 

International sales grew20% in 2007 from 2006, while sales within the United States grew 13% in 2007from 2006.  Having a full year revenuecontribution in 2007 from our Cyclades and LANDesk acquisitions, compared toonly a partial year in 2006, contributed to our revenue growth in both the U.S.and internationally.  However, thedecline in North America branded sales experienced in the fourth quarter of2007 somewhat offset the growth we experienced in the United States for theprior three quarters of 2007.

 
| ** **                             | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                    | ** ** | **% of  Sales** | ** ** | **2006** | ** ** | **% of  Sales** | ** ** |
| Net sales,  geographical distribution: |       |                                        |       |   |   |   |   |   |   |
| United States                          |       | $                                           | 333,915    |   | 56 | % | $ | 295,825 |   | 57 | % |
| International                          |       | 266,960                                     |       | 44 | % | 223,370 |   | 43 | % |
|                                   |       |                                        |       |   |   |   |   |   |   |
|                                   |       | $                                           | 600,875    |   | 100 | % | $ | 519,195 |   | 100 | % |

 

*Grossprofit.*  Gross profit is affected by a variety offactors, including the ratio of sales among our distribution channels, as OEMsales typically have lower gross margins than our branded sales; absorption offixed costs as sales levels fluctuate; product mix and component costs; laborcosts; new product introductions by us and by our competitors; increasing salesof our software products which tend to have higher gross margins; and ouroutsourcing of manufacturing and assembly services.

 
| ** **                                                         | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                         | ** ** | **2007**                                    | ** ** | **Gross  Margin  %** | ** ** | **2006** | ** ** | **Gross  Margin  %** | ** ** |
| Management  Systems Division                                       |       | $                                           | 280,166    |   | 60.4 | % | $ | 281,216 |   | 61.1 | % |
| LANDesk Division                                                   |       | 98,724                                      |       | 88.2 | % | 36,853 |   | 91.3 | % |
| Other business  units                                              |       | 8,459                                       |       | 37.4 | % | 5,647 |   | 33.9 | % |
| Corporate and  unallocated                                         |       | 4,530                                       |       |   |   | 3,319 |   |   |   |
| Intangible  amortization – LANDesk software                   |       | (10,985                                     | )          |   |   | (3,577 | ) |   |   |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | (1,874                                      | )          | — |   | (1,686 | ) |   |   |
| Gross profit  dollars and margin %                                 |       | $                                           | 379,020    |   | 63.1 | % | $ | 321,772 |   | 62.0 | % |
|                                                                    |            |                                             |            |  |  |  |  |  |  |  |  |  |  |

 

The improvement in grossmargin resulted primarily from the addedsales of software with related service and maintenance revenue from our LANDeskacquisition.  The gross margins for theLANDesk products are typically in the high 80% range.  The LANDesk contribution to increased grossmargin was partially offset by the additional costs included in cost ofsales from amortization of other intangibleassets recorded as a result of the LANDesk acquisition related to developedtechnology and internally developed software for resale.  We recorded $11.0 million of amortization ofintangibles in cost of goods sold in 2007 and $3.6 million in 2006.  As a result of the timing of the acquisitionin August 2006, we recorded four months of intangible amortization in 2006and a full year in 2007.

 

38

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*Operatingexpenses.*

 
| ** **                                            | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                            | ** ** | **2007**                                    | ** ** | **% of  Sales** | ** ** | **2006** | ** ** | **% of  Sales** | ** ** |
|                                                  |       |                                        |       |   |   |   |   |   |   |
| Research and  development expense                     |       | $                                           | 87,888     |   | 14.6 | % | $ | 63,866 |   | 12.3 | % |
| Acquired  in-process research and development expense |       | —                                      |       | — |   | 20,700 |   | 4.0 | % |
| Selling,  general, and administrative expense         |       | 208,783                                     |       | 34.7 | % | 148,345 |   | 28.6 | % |
| Acquisition  integration expenses                     |       | —                                      |       | — |   | 3,904 |   | 0.8 | % |
| Amortization of  intangible assets                    |       | 32,162                                      |       | 5.4 | % | 23,049 |   | 4.4 | % |
|                                                  |       |                                        |       |   |   |   |   |   |   |
| Total operating  expenses                             |       | $                                           | 328,833    |   | 54.7 | % | $ | 259,864 |   | 50.1 | % |

 

*Researchand development expenses.*  Research and developmentexpenses include compensation for engineers, support personnel, outsidecontracted services, and materials costs, all of which are expensed asincurred.  The increase in research anddevelopment expense is due primarily to having a full year impact of additionalcosts from the Cyclades and LANDesk acquisitions in 2007 compared to a partialyear impact in 2006.  LANDesk researchand development costs were $26.9 million in 2007 compared to $9.4 million in2006.  Continued investments in targetprojects to expand and enhance our existing products also contributed to theincrease in 2007 from 2006.

 

*Acquiredin-process research and development expense.*  There were noacquired in-process research and development expenses during 2007.  Acquired in-process research and developmentexpenses in 2006 were comprised solely of the write-off of in-process researchand development expenses related to our acquisitions, including $2.1 millionfor Cyclades and $18.6 million for LANDesk.

 

*Selling,general and administrative expenses.*  Selling,general and administrative expenses include personnel materials, services andother related costs for administration, finance, information systems, humanresources, sales and marketing and general management, certain merger andacquisition related expenses, rent, utilities, legal and accounting expenses,bad debts, advertising, promotional material, trade show expenses, and relatedtravel costs.  The increase in selling,general and administrative expenses is primarily related to increased headcountand associated costs as a result of the acquisitions of Cyclades and LANDesk wecompleted during 2006 as we recorded a full year of these costs in 2007 versusa partial year of these expenses in 2006. LANDesk selling general and administrative costs were $65.5 million in2007 compared to $21.7 million in 2006. We also experienced higher costs as a result of increased equity-basedcompensation costs, which were $3.4 million higher in 2007 than 2006, asdetailed in the table below.  Inaddition, we paid disproportionately higher commissions to LANDesk salespersonnel compared to the increase in revenue as a result of higher bookings ofnew products sales.  A substantialportion of the revenue associated with bookings is deferred, while thecommissions are paid at the time of booking. We also selectively increased our participation in targeted marketingprograms and events during 2007, which added to our increased costs.

 

***Acquisition integration expenses***.  There wereno acquisition integration expenses incurred during 2007.  We recorded acquisition integration expensesin 2006 related to costs associated with the integration of Cyclades intoAvocent.  These costs also includeseverance accruals resulting from the headcount reductions associated withduplicate positions eliminated during the year.

** **

*Amortizationof intangible assets.*  Amortization in 2007 includesprimarily the amortization of the identifiable intangible assets created as aresult of OSA, Sonic Mobility, Cyclades, and LANDesk acquisitions.  Amortization in 2006 includes primarily theamortization of the identifiable intangible assets created as a result ofEquinox, 2C, Soronti, Crystal Link, OSA, Sonic Mobility, Cyclades, and LANDeskacquisitions.  The increase inamortization expense relates primarily to a full year of amortization in 2007compared to a partial year in 2006 for the identifiable intangible assetsrecorded in the acquisitions of Cyclades and LANDesk.

 

39

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*Stock Compensation. *We record stockcompensation expense based on the department in which an employee works.  Stock compensation expenses for 2007 and 2006were as follows:

 
| ** **                                   | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                    | ** ** | **% of  Sales** | ** ** | **2006** | ** ** | **% of  Sales** | ** ** |
| Stock  compensation:                         |       |                                        |       |   |   |   |   |   |   |
| Cost of sales                                |       | $                                           | 1,134      |   |   |   | $ | 978 |   |   |   |
| Research and  development expense            |       | 5,825                                       |       |   |   | 4,302 |   |   |   |
| Selling, general  and administrative expense |       | 12,682                                      |       |   |   | 9,307 |   |   |   |
|                                         |       |                                        |       |   |   |   |   |   |   |
|                                         |       | $                                           | 19,641     |   | 3.3 | % | $ | 14,587 |   | 2.8 | % |

 

Webegan granting restricted stock units (RSUs) in 2006 and granted additionalRSUs in 2007.  Compensation expense forthese grants is recognized over the vesting periods, and these grants typicallyhave two or three year vesting periods. The increase in stock compensation is the result of the additionalgrants made in 2007.  For 2007, werecorded expense for RSUs granted in both 2006 and 2007, while in 2006 werecorded expense for RSUs granted in 2006.

 

*Netinvestment income. *Net******investmentincome declined from $7.8 million in 2006 to $3.8 million in 2007.  Thedecrease in investment income in 2007 was the result of lower cash andinvestments due to funding the purchase of Cyclades late in the first quarterof 2006 and the cash component of the LANDesk acquisition in the third quarterof 2006, continued purchases of treasury shares, and repayments of our line ofcredit.

 

*Interestexpense. *Interest expense was $8.1 million in 2007 and $3.6million in 2006.  Interest expenseresults from our borrowings under our $250 million unsecured line of creditobtained in 2006, which we used to finance a portion of the LANDesk acquisitionand purchase treasury shares.  We had a full year of outstanding debt in2007 versus a partial year in 2006.

 

*Provisionfor income taxes.*  The provision for income taxes was a benefitof $148,000 in 2007 compared to a provision of $20.2 million in 2006.  Theeffective tax rate in 2007 was approximately (0.32%), compared to an effectivetax rate of approximately 30.7% in 2006.  As discussed in Note 10to the consolidated financial statements, the decrease in the effective taxrate was primarily due to the recognition of a $6.5 million tax benefitattributable to the LANDesk acquisition for previously expensed in-processR&D of $18.6 million and a change in our mix and amount of pre-tax profitamong our U.S. and international companies. The tax benefit resulted from elections made in the second quarter of2007 under Internal Revenue Code Section 338(g) related to previouslyexpensed in-process R&D that until the elections were made wasnondeductible for U.S. tax purposes. Deferred tax liabilities have also been adjusted as a result of theseelections.

 

*Netincome.*  Net income in 2007 was $45.9 millioncompared to $45.5 million in 2006, as a result of the above factors.  Net income as a percentage of sales for 2007was 7.6%, compared to 8.8% for 2006.

 

*Years Ended December 31,2006 and 2005*   *($ Data in all tablespresented in 000’s)*

 

*Netsales.*  Our net sales consist of sales of KVM consoleswitching systems, digital connectivity products and technologies, softwarelicenses and subscriptions, support and maintenance agreements, serialconnectivity devices, wireless extension products, IPMI, extension, and remoteaccess and management products and technologies, and royalties from licensingour intellectual property.

 
| ** **                         | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                    | ** ** | **% of  Sales** | ** ** | **2005** | ** ** | **% of  Sales** | ** ** |
| Net sales,  customer distribution: |       |                                        |       |   |   |   |   |   |   |
| Branded                            |       | $                                           | 311,885    |   | 60 | % | $ | 191,901 |   | 52 | % |
| OEM                                |       | 207,310                                     |       | 40 | % | 177,987 |   | 48 | % |
|                               |       |                                        |       |   |   |   |   |   |   |
|                               |       | $                                           | 519,195    |   | 100 | % | $ | 369,888 |   | 100 | % |

 

40

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The increase in sales in2006 resulted directly from the contribution of revenue from our Cycladesacquisition, completed March 31, 2006, our LANDesk acquisition, completed August 31,2006, and increased revenue from our traditional products.  Branded sales increased 63% from 2005 to2006.  OEM sales grew 16% from 2005 to2006.  OEMsales were 40% of sales in 2006, compared to 48% of sales in 2005.  The Cyclades and LANDesk businesses have asignificantly smaller portion of their sales to OEM customers than Avocent hashistorically had, which explains the change in the percentage mix of oursales.  The continued growth ofour digital product line contributed to our sales growth for 2006.  Sales of our digital products andtechnologies accounted for $280.4 million or 54% of sales in 2006 compared with$196.7 million or 53% of sales in 2005.

 
| ** **                                                         | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                         | ** ** | **2006**                                    | ** ** | **% of  Sales** | ** ** | **2005** | ** ** | **% of  Sales** | ** ** |
| Divisional net  sales:                                             |       |                                        |       |   |   |   |   |   |   |
| Management  Systems Division                                       |       | $                                           | 460,178    |   | 89 | % | $ | 352,095 |   | 95 | % |
| LANDesk Division                                                   |       | 40,368                                      |       | 8 | % | — |   | — |   |
| Other business  units                                              |       | 16,658                                      |       | 3 | % | 14,532 |   | 4 | % |
| Corporate and  unallocated                                         |       | 3,677                                       |       | 1 | % | 3,261 |   | 1 | % |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | (1,686                                      | )          | (1 | )% | — |   | — |   |
|                                                               |       |                                        |       |   |   |   |   |   |   |
|                                                               |       | $                                           | 519,195    |   | 100 | % | $ | 369,888 |   | 100 | % |

 

Froma divisional perspective, revenue from our Management Systems Division,increased 31%  in 2006 from 2005.  Revenue within Management Systems iscomprised primarily of our traditional KVM business, our serial management products,and our embedded software and solutions. Within our Management Systems Division, revenue from our traditional KVM productsincreased $40.7 million in 2006 from 2005. Revenue from our serial management products, consisting mostly of ourCyclades products, increased $42.4 million in 2006 from 2005.  Revenuefrom our embedded software and solutions products includes our embedded KVM andIPMI solutions and the Agilent product line acquired in the first quarter of2006.  The increase in revenue was attributedprimarily to the increased contribution of the embedded KVM solutions asadoption of these platforms by our OEM customers increases and to the Agilentproduct line.  Sales by product line forour Management Systems Division for the years ended December 31,  2006 and 2005 were as follows:

 
| ** **                                      | ** ** | **For the years ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                      | ** ** | **December 31,  2006**            | ** ** | **December 31,  2005** | ** ** |
| Management  Systems Division (MSD) net revenue: |       |                                   |       |   |   |
| KVM                                             |       | $                                      | 352,402    |   | $ | 311,734 |   |
| Serial  Management                              |       | 46,534                                 |       | 4,124 |   |
| Embedded  software and solutions                |       | 33,766                                 |       | 21,882 |   |
| Other                                           |       | 27,476                                 |       | 14,355 |   |
| Total MSD net  revenue                          |       | $                                      | 460,178    |   | $ | 352,095 |   |

 

TheLANDesk Division resulted from our LANDesk acquisition on August 31,2006.  LANDesk’s revenue and bookingswere comprised of license-based revenue, primarily from the LANDesk Management Suite product,and subscription-based revenue, primarily LANDesk Security Suite productand from maintenance support agreements related to LANDesk Management Suite,with the growth in bookings from the subscription-based revenue outpacing thelicense-based revenue.  This change inmix has an impact on revenue recognized as subscription revenue is deferred andamortized over the subscription term.  Revenue byproduct line for our LANDesk Division for the years ended December 31,  2006 and 2005 are as follows:

 
| ** **                     | ** ** | **For years ended** | ** ** |
|--------------------------------|------------|-------------------------------|------------|
| ** **                     | ** ** | **December 31,  2006**   | ** ** | **December 31,  2005** | ** ** |
| LANDesk Division  net revenue: |       |                          |       |   |   |
| Licenses and  royalties        |       | $                             | 20,545     |   | $ | — |   |
| Maintenance and  services      |       | 13,319                        |       | — |   |
| Subscription  revenue          |       | 6,504                         |       | — |   |
| Total LANDesk  net revenue     |       | $                             | 40,368     |   | $ | — |   |

 

41

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Our other businessunits, which are more entrepreneurial in nature, continued to focus on productdevelopment and creating markets for those products already developed.  Combined, these business units grew from$14.5 million in revenue during to 2005 to $16.7 million in revenue during2006.

 

Both International andU.S. sales increased 40% from 2005 to 2006. The Cyclades and LANDesk acquisitions and increased sales of our digitalproducts were again the primary drivers for our revenue growth in both the U.S.and internationally.

 
| ** **                             | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                    | ** ** | **% of  Sales** | ** ** | **2005** | ** ** | **% of  Sales** | ** ** |
| Net sales,  geographical distribution: |       |                                        |       |   |   |   |   |   |   |
| United States                          |       | $                                           | 295,825    |   | 57 | % | $ | 210,844 |   | 57 | % |
| International                          |       | 223,370                                     |       | 43 | % | 159,044 |   | 43 | % |
|                                   |       |                                        |       |   |   |   |   |   |   |
|                                   |       | $                                           | 519,195    |   | 100 | % | $ | 369,888 |   | 100 | % |

 

*Grossprofit.*  Gross profit is affected by a variety offactors, including the ratio of sales among our distribution channels, as OEMsales typically have lower gross margins than our branded sales; absorption offixed costs as sales levels fluctuate; product mix and component costs; laborcosts; new product introductions by us and by our competitors; increasing salesof our software products which tend to have higher gross margins; and ouroutsourcing of manufacturing and assembly services.

 
| ** **                                                         | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                         | ** ** | **2006**                                    | ** ** | **Gross  Margin  %** | ** ** | **2005** | ** ** | **Gross  Margin  %** | ** ** |
| Management  Systems Division                                       |       | $                                           | 281,216    |   | 61.1 | % | $ | 209,708 |   | 59.6 | % |
| LANDesk Division                                                   |       | 36,853                                      |       | 91.3 | % | — |   |   |   |
| Other business  units                                              |       | 5,647                                       |       | 33.9 | % | 5,876 |   | 40.4 | % |
| Corporate and  unallocated                                         |       | 3,319                                       |       |   |   | 3,261 |   |   |   |
| Intangible  amortization – LANDesk software                   |       | (3,577                                      | )          |   |   | — |   |   |   |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | (1,686                                      | )          |   |   | — |   |   |   |
| Gross profit  dollars and margin %                                 |       | $                                           | 321,772    |   | 62.0 | % | $ | 218,845 |   | 59.2 | % |

 

Thisincrease in gross margins resulted from the following factors:

 

·                 A shift in revenuemix toward our higher margin digital and serial products from our lower marginanalog products (sold through our Management Systems Division);

·                 Added sales from ourLANDesk acquisition, whose products are primarily software with relatedservice, support, and maintenance revenue;

·                 Added sales from ourCyclades branded products, which are sold primarily through our branded channeland, as a result, have a higher gross margin; and

·                 Increased revenuefrom our embedded solutions, which have higher margins than our traditional KVMproducts (sold through our Embedded Software and Solutions Division).

 

These increases to grossmargins were somewhat offset by these factors:

 

·                 An additional $3.6 million of costsincluded in cost of sales from amortization of other intangible assets recorded as a result of the LANDesk acquisitionrelated to developed technology and internally developed software for resale;

 

42

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·                 Additional costs incurred to transitionthe manufacturing of Cyclades products to Avocent contract manufacturers andtransition order fulfillment of Cyclades products to Avocent facilities, whichwill result in cost savings; and

 

·                 Additional product costs fromimplementing recent environmental regulations, particularly in Europe.

 

*Operatingexpenses.*

 
| ** **                                            | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                    | ** ** | **% of  Sales** | ** ** | **2005** | ** ** | **% of  Sales** | ** ** |
|                                                  |       |                                        |       |   |   |   |   |   |   |
| Research and  development expense                     |       | $                                           | 63,866     |   | 12.3 | % | $ | 56,885 |   | 15.4 | % |
| Acquired  in-process research and development expense |       | 20,700                                      |       | 4.0 | % | — |   | — |   |
| Selling,  general, and administrative expense         |       | 148,345                                     |       | 28.6 | % | 90,354 |   | 24.4 | % |
| Acquisition  integration expenses                     |       | 3,904                                       |       | 0.8 | % | — |   | — |   |
| Amortization of  intangible assets                    |       | 23,049                                      |       | 4.4 | % | 18,509 |   | 5.0 | % |
|                                                  |       |                                        |       |   |   |   |   |   |   |
| Total operating  expenses                             |       | $                                           | 259,864    |   | 50.1 | % | $ | 165,748 |   | 44.8 | % |

 

*Researchand development expenses.*  Research and developmentexpenses include compensation for engineers, support personnel, outsidecontracted services, and materials costs, all of which are expensed asincurred.  The increase in the amountspent on research and development is due to the additional costs from theCyclades and LANDesk acquisitions, including costs related to the Cycladesproduct integration efforts and the inclusion of equity-based compensation in2006, following our adoption of SFAS 123R on January 1, 2006.  LANDesk research and development costs were$9.4 million for the four months in 2006 following the acquisition.  The additional costs from the acquisitionswere partially offset by reduced headcount and certain research and developmentsite closings undertaken during the second half of 2005.  As previously stated, we continue to believethat the timely development of innovative products and enhancements to existingproducts is essential to maintaining our competitive position.

 

*Acquiredin-process research and development expense.*  Acquisitionrelated expenses in 2006 were comprised solely of the write-off of in-processresearch and development expenses related to our acquisitions, including $2.1million for Cyclades and $18.6 million for LANDesk.  There were no acquired in-process researchand development expenses during 2005.

 

*Selling,general and administrative expenses.*  Selling, generaland administrative expenses include personnel costs for administration,finance, information systems, human resources, sales and marketing and generalmanagement, certain merger and acquisition related expenses, rent, utilities,legal and accounting expenses, bad debts, advertising, promotional material,trade show expenses and related travel costs. The increase in selling, general and administrative expenses isprimarily related to increased headcount as a result of the acquisitions wecompleted during 2006.  We alsoexperienced higher costs as a result of expensing equity-based compensationawards in 2006 and adding Cyclades and LANDesk’s selling, general andadministrative expenses.  LANDesk sellinggeneral and administrative costs were $21.7 million for the four months in 2006following the acquisition.  However,these higher costs were somewhat offset by the savings resulting from ourCyclades integration efforts later in 2006.

 

***Acquisition integration expenses***.  We recordedacquisition integration expenses in 2006 related to costs associated with theintegration of Cyclades people, processes, and products into Avocent.  These costs also included severance accrualsresulting from the headcount reductions associated with duplicate positionseliminated during the year.  There wereno such charges incurred during 2005.

** **

*Amortizationof intangible assets.*  Amortization in 2006 primarilyincluded the amortization of the identifiable intangible assets created as aresult of Equinox, 2C, Soronti, Crystal Link, OSA, Sonic Mobility, Cyclades,and LANDesk acquisitions.  Amortizationin 2005 was primarily comprised of the amortization of the identifiableintangible assets created as a result of Equinox, 2C, Soronti, Crystal Link,OSA, and Sonic Mobility acquisitions. The increase in amortization expense primarily related to the intangibleassets recorded in the acquisitions of Cyclades and LANDesk.

 

43

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*Stock Compensation. *We adopted SFAS 123(revised 2004), *Share-Based Payments,*on January 1, 2006 and as a result recorded stock compensation expense forall share-based payment awards made to employees and directors, includinggrants of employee stock options, restricted stock units, and performance-basedrestricted stock units, based on estimated fair values.  The compensation expense is recorded in eachline of our consolidated financial statements based on the department in whichan employee works.  The stockcompensation in 2005 related to the amortization of deferred compensationrecorded as a result of assumed options from acquisitions.

 
| ** **                                   | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                    | ** ** | **% of  Sales** | ** ** | **2005** | ** ** | **% of  Sales** | ** ** |
| Stock  compensation:                         |       |                                        |       |   |   |   |   |   |   |
| Cost of sales                                |       | $                                           | 978        |   |   |   | $ | — |   |   |   |
| Research and  development expense            |       | 4,302                                       |       |   |   | 1,138 |   |   |   |
| Selling, general  and administrative expense |       | 9,307                                       |       |   |   | 876 |   |   |   |
|                                         |       |                                        |       |   |   |   |   |   |   |
|                                         |       | $                                           | 14,587     |   | 2.8 | % | $ | 2,014 |   | 0.5 | % |
|                                              |            |                                             |            |  |  |  |  |  |  |  |  |  |

 

*Income from settlement of lawsuit**.** *Asa result of the settlement of a patent infringement lawsuit brought by Avocentagainst Raritan Computer Inc., we recognized $5.0 million of income in2005, comprised entirely of the payment we received in the second quarter of2005.  The terms of the settlementprovided for an initial payment of $5.0 million related to past product salesby Raritan, with quarterly revenue payments over five years based on Raritan’ssales of covered products.

 

*Netinvestment income. *Net******investmentincome declined from $9.2 million in 2005 to $7.8 million in 2006.  Thedecrease in investment income in 2006 was the result of lower cash andinvestments due to funding the purchase of Cyclades in the first quarter of2006 and the investment of the remaining funds in shorter term investments inorder to have cash on hand to fund the cash component of the LANDeskacquisition (which was paid in the third quarter of 2006) as well as fund thepurchase of treasury shares under our stock buyback program.

 

*Interestexpense. *Interest expense was $3.6 million in 2006.  There were no such expenses in 2005.  Interest expense results from our borrowingsunder our $250 million unsecured line of credit obtained in 2006, which we usedto finance a portion of the LANDesk acquisition.

 

*Provisionfor income taxes.*  The provision for income taxes was $20.2million in 2006 compared to $18.7 million in 2005.  Theeffective tax rate in 2006 was approximately 30.7%, compared to an effectivetax rate of approximately 27.9% in 2005.  The increase in our effectivetax rate over that of 2005 is primarily due to $20.7 million of in-processresearch and development for the LANDesk and Cyclades acquisitions which wasimmediately expensed upon purchase. These items were not expected to be deductible for tax purposes andtherefore increased the effective tax rate. The increase in provision for income taxes was also partly the result ofthe change in mix of our pre-tax profit among our U.S. and internationalcompanies and the Company recognized $1.2 million in valuation allowances oncertain deferred tax assets. Additionally, the Irish statutory tax rate on manufactured goodsincreased from 10% to 12.5% on January 1, 2006.  The increases were partially offset bydecreases in the effective tax rate attributable to employee stock optionexercises, tax exempt income from investment securities, and the U.S. researchcredit.

 

*Netincome.*  Net income in 2006 was $45.5 millioncompared to $48.3 million in 2005, as a result of the above factors.  Net income as a percentage of sales for 2006was 8.8%, compared to 13.1% for 2005.

 

**Liquidity and Capital Resources**

 

As of December 31,2007 our principal sources of liquidity consisted of approximately$111 million in cash, cash equivalents, and investments.  We also have a $250 million unsecured fiveyear revolving bank line of credit that is available for general corporatepurposes.  We plan to use borrowingsunder the line of credit to continue funding the purchase of shares in 2008under our stock repurchase program and for strategic acquisitions oftechnologies or companies that we believe will enhance and/or complement ourexisting products and technologies and increase our sales.  The line of credit currently bears aninterest rate of LIBOR plus 70 basis points. There was $95 million outstanding under the line of credit as of December 31,2007.  We classify the entire obligationas long term as it carries a five year term and has no payment schedule.  We expect to repay the borrowings from futurecash flows from operations.  A summary ofour cash flows is as follows:

 
| ** **                               | ** ** | **For the years ended** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|
| ** **                               | ** ** | **December 31,  2007**            | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
| Total cash  provided by (used in):       |       |                                   |       |   |   |   |   |
| Operating  activities                    |       | $                                      | 139,791    |   | $ | 65,701 |   | $ | 70,986 |   |
| Investing  activities                    |       | 8,352                                  |       | (51,132 | ) | 2,033 |   |
| Financing  activities                    |       | (126,013                               | )          | (67 | ) | (51,188 | ) |
| Effect of  exchange rate changes on cash |       | 1,752                                  |       | 374 |   | (130 | ) |
| Increase in cash  and cash equivalents   |       | $                                      | 23,882     |   | $ | 14,876 |   | $ | 21.701 |   |

 

44

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Our operatingactivities produced significant positive cash flow in 2007 and were primarilythe result of the reductions in ourinventories and accounts receivable balances. Inventories decreased $11.7million from December 31, 2006 to December 31, 2007.  The decrease in inventory was primarily theresult of actions of our operations group to concentrate on reducing inventorylevels throughout 2007, after having added inventory related to the transitionof Cyclades manufacturing to our contract manufacturers in 2006.  As a result of the decreased inventories, ourinventory turns increased to 6.6 in 2007 from 5.1 in 2006.  Our net accounts receivables balancedecreased by $16.6 million from December 31, 2006 to December 31,2007, as a result of lower sales during the latter part of the fourth quarter2007 and due to improved cash collections at each of our locations during 2007,specifically at LANDesk.  This resultedin an improvement in our Days Sales Outstanding (DSO) at the end of 2007 to 64days from 69 days at the end of 2006. Our payables increased slightly as we continue to focus on reducing ouroutstanding debt under our line of credit, while monitoring the payment ofaccounts payable to ensure timely payments of our payables.

 

Our investing activitiesproduced $8.4 million of positive cash flow in 2007, primarily as we convertedmatured investments to cash for use in paying down our borrowings under theoutstanding line of credit and for purchase of our treasury shares.  Our investing activities in 2006 includedcash payments related to our acquisitions of Cyclades and LANDesk.

 

Our financing activitiesused the cash provided by operations and investing activities to repay aportion of our line of credit and purchase treasury shares as previouslymentioned.  We repurchased 2.9 millionshares of our common stock during the year ended December 31, 2007 at acost totaling $77.1 million.  Thesetreasury shares were purchased on the open market through various brokers underthe stock repurchase program approved by our Board of Directors.  As of December 31, 2007 we had repurchased12.7 million shares under the program since the initial approval of the programin 2004.  Following our Board’s approvalof an additional 4 million shares for this program in January 2008, we areauthorized to repurchase a total of 19 million shares under this program.  Through February 15, 2008, we purchasedan additional 3 million shares subsequent to December 31, 2007 and expectto continue to repurchase shares from time to time.

 

We repurchased 7.0million shares of our common stock during the year ended December 31, 2006at a cost totaling $188.3 million.  Thesetreasury shares were purchased on the open market through various brokers underthe stock repurchase program approved by our Board of Directors.  As of December 31, 2006 we hadrepurchased 9.8 million shares under the program since the initial approval ofthe program in 2004.  In August 2006,we re-issued approximately 7.1 million shares of the repurchased stock above inconjunction with the LANDesk acquisition.

 

In the ordinary course ofour business, we may at any point in time have a significant amount ofcontractual commitments not yet recognized in our financial statements.  These commitments relate primarily to ourneed to schedule the purchase of inventories in advance of the related forecastedsales to customers.  We have longer leadtimes for the products we purchase from suppliers based in Asia than those fromsuppliers based in the U.S. and Europe. Our actual contractual commitments are typically limited to productsneeded for one to three months of forecasted sales.  The liabilities for these inventory purchasesalong with the related inventory assets are typically recognized upon ourreceipt of the products.  We also have,at any point in time, a variety of short-term contractual commitments forservices such as advertising, marketing, accounting, legal, and research anddevelopment activities.  The liabilitiesfor these services and the related expenses are typically recognized upon ourreceipt of the related services.  None ofour purchase commitments requires payment beyond the next year.

 

45

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Thefollowing table sets forth annual payments we are required to make undercontractual obligations and other commercial commitments for operating leasesand purchases of inventory and services, in thousands, as of December 31,2007.

 
| ** ** | ** ** | **Operating  Leases** | ** ** | **Purchase  Commitments** | ** ** | **Long-Term  Debt  Obligations** | ** ** | **Interest  and Other** | ** ** | **Total** | ** ** |
|------------|------------|-----------------------|------------|---------------------------|------------|----------------------------------|------------|------------------------------|------------|-----------|------------|
|       |       |                  |       |                      |       |                             |       |                         |       |      |       |
| 2008       |       | $                     | 6,370      |                      | $          | 27,338                           |       | $                            | —     |      | $          | 13,649 |   | $ | 47,357 |   |
| 2009       |       | 5,195                 |       | —                    |       | —                           |       | 5,149                        |       | 10,344    |       |
| 2010       |       | 4,149                 |       | —                    |       | —                           |       | 5,149                        |       | 9,298     |       |
| 2011       |       | 1,423                 |       | —                    |       | 95,000                           |       | 2,389                        |       | 98,812    |       |
| 2012       |       | 1,367                 |       | —                    |       | —                           |       | —                       |       | 1,367     |       |
| Thereafter |       | 1,366                 |       | —                    |       | —                           |       | —                       |       | 1,366     |       |
|       |       |                  |       |                      |       |                             |       |                         |       |      |       |
| Total      |       | $                     | 19,870     |                      | $          | 27,338                           |       | $                            | 95,000     |      | $          | 26,336 |   | $ | 168,544 |   |
|            |            |                       |            |                           |            |                                  |            |                              |            |           |            |  |  |  |  |  |  |

 

We adopted FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes, aninterpretation of FASB Statement No. 109” (FIN 48) on January 1,2007.  As a result of adopting this FASBInterpretation, we recorded an increase to reserves for uncertain tax positionsof $2.9 million.  This increase was recorded as an increase to the January 1,2007 accumulated deficit balance.  As of December 31 , 2007 we hadtotal reserves for uncertain tax positions related to gross unrecognized taxbenefits of $10.7 million of which $8.9 million, if recognized, would affectthe effective tax rate.  We recognize potential accrued interest andpenalties related to unrecognized tax benefits from our global operationswithin income tax expense.  As of December 31,2007, we had accrued interest payable related to the unrecognized tax benefitsof approximately $3.1 million.  Of these liabilities recorded in relationto FIN 48, $8.5 million is included as payable in 2008 in the table above.  (*see Note10 in the notes to the consolidated financial statements in Part II, Item8*).”

 

We may also use a portion of our cash and investmentsand our line of credit for strategic acquisitions of technologies and companiesthat we believe will enhance and/or complement our existing products andtechnologies and increase our sales.

 

**Non-GAAP Operational Measures**

 

To supplement our consolidated financialstatements presented in accordance with GAAP, we present investors with certainnon-GAAP operational measures which we use internally to manage our businesses,including net sales, gross profit, operating expenses, and the resultingoperating income, income before taxes, operational net income, and operationalearnings per share, all of which primarily exclude the effects of amortizationand depreciation related to purchase accounting adjustments, stock-basedcompensation and acquired in-process research and development expenses andincludes the amortization of the fair value adjustment to LANDesk deferredrevenue related to the purchase accounting adjustment to reduce deferredrevenue at the acquisition of LANDesk. Specifically, we use the following non-GAAP measures:

 
| ** **                                  | ** ** | **For the years ended** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|
| **Non-GAAP Operational Measures** | ** ** | **December 31,  2007**            | ** ** | **December 31,  2006** | ** ** |
|                                        |       |                                   |       |   |   |
| Operational net  sales                      |       | $                                      | 602,749    |   | $ | 520,881 |   |
| Operational  gross profit                   |       | $                                      | 393,013    |   | $ | 328,012 |   |
| Operational  operating income               |       | $                                      | 114,876    |   | $ | 126,109 |   |
| Operational net  income                     |       | $                                      | 89,813     |   | $ | 97,145 |   |
| Operational  diluted earnings per share     |       | $                                      | 1.76       |   | $ | 1.96 |   |

 

·                  Thenon-GAAP net sales operational measure consists of net sales increased by thepro forma amortization of deferred revenue of LANDesk at the date ofacquisition which was reduced to estimated fair value pursuant to purchaseaccounting under GAAP.  This deferredrevenue was completely amortized on a pro forma basis as of the third quarterof 2007.

 

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·                  Thenon-GAAP gross profit operational measure consists of the non-GAAP net salesoperational measure described above, less cost of sales excluding the impact ofstock-based compensation and amortization related to purchase accountingadjustments as they relate to cost of sales.

 

·                  Thenon-GAAP operating expense operational measure consists of GAAP operating expenses,excluding the impact of stock-based compensation and amortization anddepreciation related to purchase accounting adjustments as they relate to theparticular operating expense.

 

·                  Thenon-GAAP operating income operational measure consists of GAAP operating incomeadjusted for the non-GAAP operational measures described above.

 

·                  Thenon-GAAP net income operational measure consists of GAAP net income, adjustedby the non-GAAP operational measures described above and the tax effects ofthese non-GAAP operational measures, less the $6.5 million income tax benefitin the third quarter of 2007 related to previously expensed in-process researchand development costs that are now deductible for tax purposes plus the incometax benefit realized from deducting the amortization of LANDesk goodwill fortax purposes (which is not amortized under GAAP).

 

·                  Thenon-GAAP earnings per share operational measure is calculated by dividing thenon-GAAP net income operational measure described above by GAAP weightedaverage basic and diluted shares outstanding.

 

We provide the followingreconciliations between GAAP and our operational measures:

 
| ** **                              | ** ** | **For the Year Ended December 31, 2007** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **GAAP**                                                               | ** ** | ** ** | ** ** | **Purchase** | ** ** | **Non-GAAP** | ** ** |
| ** **                              | ** ** | **Financial**                                                          | ** ** | **Stock-based** | ** ** | **Accounting** | ** ** | **Operational** | ** ** |
| ** **                              | ** ** | **Measures**                                                           | ** ** | **Compensation** | ** ** | **Adjustments** | ** ** | **Measures** | ** ** |
|                                    |       |                                                                   |       |   |   |   |   |   |   |
| Operational net  sales                  |       | $                                                                      | 600,875    |   | — |   | 1,874 |   | $ | 602,749 |   |
| Operational  gross profit               |       | $                                                                      | 379,020    |   | 1,134 |   | 12,859 |   | $ | 393,013 |   |
| Operational  operating income           |       | $                                                                      | 50,187     |   | 19,642 |   | 45,047 |   | $ | 114,876 |   |
| Operational net  income                 |       | $                                                                      | 45,929     |   | 15,969 |   | 27,915 |   | $ | 89,813 |   |
| Operational  diluted earnings per share |       | $                                                                      | 0.90       |   | 0.31 |   | 0.55 |   | $ | 1.76 |   |

 
| ** **                              | ** ** | **For the Year Ended December 31, 2006** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **GAAP**                                                               | ** ** | ** ** | ** ** | **Purchase** | ** ** | **Non-GAAP** | ** ** |
| ** **                              | ** ** | **Financial**                                                          | ** ** | **Stock-based** | ** ** | **Accounting** | ** ** | **Operational** | ** ** |
| ** **                              | ** ** | **Measures**                                                           | ** ** | **Compensation** | ** ** | **Adjustments** | ** ** | **Measures** | ** ** |
|                                    |       |                                                                   |       |   |   |   |   |   |   |
| Operational net  sales                  |       | $                                                                      | 519,195    |   | — |   | 1,686 |   | $ | 520,881 |   |
| Operational  gross profit               |       | $                                                                      | 321,772    |   | 977 |   | 5,263 |   | $ | 328,012 |   |
| Operational  operating income           |       | $                                                                      | 61,908     |   | 14,586 |   | 49,615 |   | $ | 126,109 |   |
| Operational net  income                 |       | $                                                                      | 45,532     |   | 9,724 |   | 41,889 |   | $ | 97,145 |   |
| Operational diluted  earnings per share |       | $                                                                      | 0.92       |   | 0.19 |   | 0.85 |   | $ | 1.96 |   |

 

We believe that excluding depreciation andamortization associated with purchase accounting adjustments as well as the taximpact of certain purchase accounting elections for prior acquisitions providessupplemental information and an alternative presentation useful to investors’understanding Avocent’s core operating results and trends between periods.  Not only are these depreciation andamortization and tax impact adjustments based on amounts assigned in purchaseaccounting that may have little bearing on present or future replacement costs,but they also are based on management’s estimates of remaining useful lives.

 

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Similarly, we believe that excluding stock-basedcompensation expense provides supplemental information and an alternativepresentation useful to investors’ understanding of our core operating resultsand trends, especially when comparing those results on a consistent basis toresults for previous periods and anticipated results for future periods.

 

We also believe that, in excluding stock-basedcompensation expense and depreciation and amortization associated with purchaseaccounting adjustments (together with the related tax effects), our non-GAAPfinancial measures provide investors with transparency into the information andbasis used by management and our Board of Directors to measure and forecast ourresults of operations, to compare on a consistent basis our results of operationsfor the current period to that of prior periods, to compare our results ofoperations on a more consistent basis against that of other companies in makingfinancial and operating decisions, and to establish targets for managementincentive compensation.

 

These non-GAAP operational measures havehistorically been used as key performance metrics by Avocent’s seniormanagement as they evaluate both the performance of the consolidated financialresults as well as those of individual business segments.  These non-GAAP operational measures arereviewed individually as well as in total in measuring our performance againstinternal and external expectations for the period and the expectations for suchkey non-GAAP operational measures are the basis for any financial guidanceprovided by management for future periods. We believe that the use of each of these non-GAAP financial measuresprovides enhanced consistency and comparability with our past financialreports, and also facilitates comparisons with other companies in our industry,many of which use similar non-GAAP financial measures to supplement their GAAPresults.  We provide this information to investors to enable them toperform additional analyses of past, present and future operating performance,compare us to other companies, and evaluate our ongoing financial operations.

 

We believe that each of these operationalmeasures is useful to investors in their assessment of our operatingperformance and the valuation of our company.  Adjusted net sales, grossprofit, operating expenses and income, operational income before taxes,operational net income, and operational earnings per share are significantmeasures used by management for:

 

·                                          Reportingour financial results and forecasts to our Board of Directors;

 

·                                          Evaluatingthe operating performance of our company;

 

·                                          Managingand comparing performance internally across our businesses and externallyagainst our peers; and

 

·                                          Establishinginternal operating targets.

 

These non-GAAP operational measures, includingnet sales, gross profit, operating income, operational net income, andoperational earnings per share are used by Avocent as broad measures offinancial performance that encompass our operating performance, cash, capitalstructure, investment management, and income tax planning effectiveness. These operational measures are not calculated in accordance with GAAP, andshould be considered supplemental to, and not as a substitute for, or superiorto, financial measures calculated in accordance with GAAP.  Theseoperational measures have limitations in that they do not reflect all of thecosts or reductions to revenues associated with the operations of our businessas determined in accordance with GAAP. In addition, these operational measures may not be comparable tonon-GAAP financial measures reported by other companies.  As a result, oneshould not consider these measures in isolation or as a substitute for analysisof Avocent’s results as reported under GAAP.  We compensate for theselimitations by analyzing current and future results on a GAAP basis as well asa non-GAAP basis, prominently disclosing GAAP results and providingreconciliations from GAAP results to operational measures.  We expect tocontinue to incur expenses similar to the non-GAAP adjustments described above,and the exclusion or inclusion of these items from our non-GAAP financialmeasures should not be construed as an inference that these costs are unusualor infrequent.  Some of the limitations inrelying on our non-GAAP financial measures are:

 

·                                          Thenon-GAAP net sales operational measure is a measure which we have defined forinternal and investor purposes.  Afurther limitation associated with this measure is that it includes certainrevenues and the related impact on non-GAAP gross profit, operating income,income before taxes, net income, and earnings per share operational measuresthat impact our GAAP based measures.

 

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·                                          Thenon-GAAP gross profit, operating income, net income, and earnings per shareoperational measures are limited in that they do not include the impact ofstock-based compensation expense or specific costs and benefits associated withcertain purchase accounting adjustments.

 

We compensate for these limitations by prominentlydisclosing the reported GAAP results and providing investors withreconciliations from GAAP to the non-GAAP measures in the financial tablesabove.

 

**Critical Accounting Policies**

 

We believe the following critical accounting policiesaffect the more significant judgments and estimates used in the preparation ofour consolidated financial statements:

 

·                                          We review customer contracts to determineif all of the requirements for revenue recognition have been met prior torecording revenue from sales transactions. We generally record sales revenue for hardware products upon shipment ofour products, net of any discounts, since we generally do not have significantpost delivery obligations, the product price is fixed or determinable,collection of the resulting receivable is probable, and product returns arereasonably estimable.  We generally shipproducts upon receipt of a purchase order from a customer.  We record revenue in accordance with theapplicable terms of each respective customer contract.  Accordingly, revenue on products shipped FOBdestination is recorded when the customer takes possession of the goods, andrevenue on products shipped FOB shipping point is recorded when the goods leaveour facilities.  Shipping and handlingfees are included in net sales, and the related costs are included in cost ofsales in the accompanying consolidated statements of income.

 

We generally recordroyalty revenue from OEMs upon shipment of the related products in which oursoftware or firmware is embedded by the OEMs, based upon shipment data providedby the OEMs.  We generally defer revenue from the sale of extendedwarranty agreements, software subscriptions, and software support andmaintenance agreements.  The deferredrevenue is amortized into income on a pro rata basis over the applicablecontract lives.

 

We accrue for salesreturns as a reduction of sales and cost of sales based on our experience fromhistorical customer returns, which we believe provides a reasonable estimate offuture returns.  The sales agreements forour hardware products generally include a one-month unconditional returnpolicy.  The license agreements for oursoftware products are generally final, and the license fees are non-refundable.  We also allow additional rights of return tocertain distributors, which generally extend the return period to 90 days.  If actual future customer returns are lessfavorable than those projected by management, additional sales return costs maybe incurred.  Our allowance for salesreturns totaled $5.0 million and $6.0 million at December 31, 2007 and2006, respectively.  The reserve isincluded as a reduction in the carrying value of accounts receivable and salesin the accompanying consolidated balance sheets and statements of income,respectively.

 

We recognize softwarerevenue in accordance with Statement of Position 97-2, *“SoftwareRevenue Recognition”* (SOP 97-2), and Statement of Position 98-9, *“Modification of SOP 97-2, Software Revenue Recognition, with Respectto Certain Transactions” (*SOP 98-9). We derive a portion of our revenue from the license of software productsunder software license agreements and subscription agreements and from thedelivery of professional services and maintenance services.  When contracts contain multiple elements, andvendor-specific objective evidence (VSOE) of fair value exists for allundelivered elements, we account for the delivered elements in accordance withthe “Residual Method” prescribed by SOP 98-9 when VSOE does not exist for thedelivered element.  Multiple elementarrangements generally include post-contract customer support (or maintenance),and in some cases, subscriptions and other services.  Vendor-specific objective evidence of fairvalue is generally determined by sales of the same element or service soldseparately to other customers, or with respect to maintenance andsubscriptions, through a renewal rate specified in the related arrangement.

 

Software license revenueis recognized when persuasive evidence of an arrangement exists, the fee is fixedor determinable, collectibility is probable, and delivery and customeracceptance (including the expiration of an acceptance period), if requiredunder the terms of the contract, of the software products have occurred.  In instances where vendor obligations remain,revenue is deferred until the obligation has been satisfied.

 

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Revenue from professionalservices consists of non-recurring engineering services, training andimplementation services.  Non-recurringengineering and implementation service revenue is recognized as the servicesare performed for time and materials contracts or upon acceptance on fixedprice contracts.  Training revenue isrecognized as the services are performed.

 

Maintenance and subscriptionrevenue is recognized ratably over the term of the contract, which is generallytwelve to thirty six months.  Maintenancecontracts include the right to unspecified upgrades on a when-and-if availablebasis.  Ongoing support is also availableunder some maintenance agreements.

 

Priorto extending credit to a new customer, we perform a detailed credit review ofthe customer and establish credit limits based on the results of our creditreview.  We review collection experienceperiodically to determine if the customer’s payment terms and credit limitsneed to be revised.  We maintainallowances for doubtful accounts for estimated losses resulting from theinability of our customers to make required payments.  If the financial condition of our customerswere to deteriorate, resulting in an impairment of their ability to makepayments, additional allowances may be required.  If circumstances change with regard toindividual receivable balances that had previously been determined to beuncollectible (and for which a specific reserve had been established), areduction in our allowance for doubtful accounts may be required.  Our allowance for doubtful accounts was $2.5million and $2.4 million at December 31, 2007 and 2006, respectively.

 

Weparticipate in cooperative advertising and market development programs withcertain resellers, distributors and OEMs.  We use these programs toreimburse resellers, distributors and OEMs for the actual costs of certainforms of advertising, and in general, allow resellers, distributors and OEMsreimbursement up to a specified percentage of net purchases.  Because our costs associated with theseprograms are estimated and accrued at the time of sale, we include these costsin sales and marketing expenses in the accompanying consolidated statements ofincome.

 

·                                          We carry our inventory at the lower ofcost or market, with cost being determined using the first-in, first-outmethod.  We use standard costs formaterial, labor, and manufacturing overhead to value our inventory.  We review and revise our standard costs on aquarterly basis.  Therefore, ourinventory costs approximate actual costs at the end of each reporting period.  Wewrite down our inventory for estimated obsolescence or unmarketable inventoryto the estimated market value based upon assumptions about future demand andmarket conditions.  If actual futuredemand or market conditions are less favorable than those projected bymanagement, additional inventory write-downs may be required.  Our reserve for excess and obsolete inventorywas $7.3 million and $5.6 million at December 31, 2007 and 2006,respectively.

 

·                                          We provide for the estimated cost ofproduct warranties at the time revenue is recognized.  While we engage in extensive product qualityprograms and processes, including actively monitoring and evaluating thequality of our component suppliers and contract manufacturers, our warrantyobligation is affected by product failure rates, failure rates of purchasedcomponents integrated into our products, material usage, and other rework costsincurred in correcting a product failure. Should actual product failure rates, material usage, or other reworkcosts differ from our estimates, revisions to our estimated warranty liabilitymay be required.  Our warranty reservewas $1.9 million and $2.5 million at December 31, 2007 and 2006,respectively.

 

·                                           We hold investments in various publiclytraded debt securities, including corporate bonds.  We record an investment impairment chargewhen we believe an investment has experienced a decline in value that is otherthan temporary.  Future adverse changesin market conditions or poor operating results of underlying investments couldresult in losses or an inability to recover the carrying value of theinvestments that may not be reflected in an investments current carrying value,thereby possibly requiring an impairment charge in the future.  There were no other-than-temporary impairmentcharges recorded against these investments in 2007, 2006 or 2005.

 

·                                           We enter into interest rate swapagreements in accordance with our risk management policy to partially reducerisks related to our floating rate line of credit which is subject to changesin the market rate of interest.  We donot use derivative instruments for trading purposes.  We record the fair value of interest rateswap agreements in other assets or liabilities on the consolidated balancesheet.  Changes in the fair value ofinterest rate swap agreements that are designated and effective as cash flowhedges are recorded in 

 

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accumulated othercomprehensive income (loss) (“OCI”). Those changes are released from OCI to the consolidated statement ofincome as interest expense contemporaneously with the earnings effects of thehedged item (the underlying debt agreement). The settled amount of a swap that has been terminated prior to itsoriginal term continues to be deferred in OCI and is recognized in the consolidatedstatement of income over the term of the underlying debt agreement designatedas the hedged item.  Changes in the fairvalue of interest rate swap agreements that are not effective as hedges arerecorded immediately in the consolidated statement of income as interestexpense.  We have designated our interestrate swap agreement as a cash flow hedge. Cash flows from hedging activities are reported in the consolidatedstatement of cash flows in the same classification as the hedged item,generally as a component of cash flows from operations.

 

**·**                                          Our annual tests for goodwill impairment, performed in the fourthquarters of 2007, 2006 and 2005, determined that no adjustment for impairmentwas required.  Our testing indicated thatthe implied fair value of our goodwill exceeded its carrying value; accordingly,in accordance with SFAS 142, no further impairment analysis was required.  If economic conditions deteriorate andindicators of impairment become present, an adjustment to the carrying value ofgoodwill and other intangible assets may be required.

** **

**·**                                          We review long-livedassets for impairment under the guidance prescribed by SFAS No. 144, “*Accounting for the Impairment or Disposal of Long-Lived Assets*.”  We recognize impairment losses on long-livedassets used in operations when indicators of impairment are present and theundiscounted cash flows estimated to be generated by those assets are less thanthe assets’ carrying values.  Animpairment loss would be recognized in the amount by which the recorded valueof the asset exceeds the fair value of the asset, measured by the quoted marketprice of an asset or an estimate based on the best information available in thecircumstances.  There were no such lossesrecognized during 2007, 2006, or 2005.

** **

·                                        We account for income taxes using theasset and liability method.  We provide for income taxes currently payableand, in addition, provide deferred income taxes for temporary differencesbetween the tax basis of assets and liabilities and their reported amounts inthe consolidated financial statements and for known tax contingencies. Temporary differences relate principally to the allowance for doubtfulaccounts, allowance for sales returns, liability for warranty claims,unrealized gain (loss) on investments, accumulated depreciation, loss onwrite-down of investments, inventory reserves, acquired intangible assets,operating losses and state research credit carryforwards.  We intend to permanently reinvest earningsfrom our foreign subsidiaries in our international operations and, accordingly,no provision for any incremental net U.S. federal or state income taxes hasbeen made for these unremitted earnings.  Valuation allowances areestablished when necessary to reduce deferred tax assets to the amount expectedto be realized.  We have approximately $4.0 million and $4.2 million ofvaluation allowances recorded against deferred tax assets arising from certainforeign subsidiaries operating losses and certain state research credits at December 31,2007 and 2006, respectively.  Taxcontingencies are recorded to address potential exposures involving taxpositions taken that could be challenged by tax authorities.  These potential exposures result from thevarying applications of statutes, rules, regulations, and interpretations.  We adopted FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”on January 1, 2007.  As a result ofadopting this FASB Interpretation, we recorded an increase to reserves foruncertain tax positions of $2.9 million.  This increase was recorded as anincrease to the January 1, 2007 accumulated deficit balance.

 

**RecentlyIssued Accounting Standards**

 

In September 2006, the FASB issued SFAS No. 157,“*Fair Value Measurements”* (SFAS 157),which clarifies that fair value estimates should be based on the assumptionsmarket participants would use when pricing an asset or liability andestablishes a fair value hierarchy that prioritizes the information used todevelop those assumptions.  Under SFAS157, fair value measurements would be separately disclosed by level within thefair value hierarchy.  SFAS 157 iseffective for fiscal years beginning after November 15, 2007.  On February 12, 2008, the FASB delayed theeffective date of SFAS 157 for nonfinancial assets and liabilities, except foritems that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually), to fiscal years beginningafter November 15, 2008.  We do notexpect the adoption of SFAS 157  to havea material impact on our consolidated results of operations or financialcondition.

 

In February 2007, the FASB issued SFAS No. 159,“*The Fair Value Option for Financial Assetsand Financial Liabilities — Including an amendment of FASB Statement No. 115”*(SFAS 159).  SFAS No. 159permits an entity to elect fair value as the initial and subsequent measurementattribute for many financial assets and liabilities.  Entities electing the fair value option wouldbe required to recognize changes in fair value in earnings.  Entities electing the fair value option are 

 

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requiredto distinguish, on the face of the statement of financial position, the fairvalue of assets and liabilities for which the fair value option has beenelected and similar assets and liabilities measured using another measurementattribute.  SFAS 159 is effectivefor fiscal years beginning after November 15, 2007.  The adjustment to reflect the differencebetween the fair value and the carrying amount would be accounted for as acumulative-effect adjustment to retained earnings as of the date of initialadoption.  We are currently evaluatingthe impact, if any, of SFAS 159 on our consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 141(R),“*Business Combinations”*(SFAS 141(R)), which replaces SFAS 141.  SFAS 141(R) establishes principlesand requirements for how an acquirer in a business combination recognizes andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed, and any controlling interest; recognizes and measures thegoodwill acquired in the business combination or a gain from a bargainpurchase; and determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination.  FAS 141(R) isto be applied prospectively to business combinations for which the acquisitiondate is on or after an entity’s fiscal year that begins after December 15,2008.  We will assess the impact ofSFAS 141(R) if and when a future acquisition occurs, however theapplication of SFAS 141(R) will result in a significant change inaccounting for future acquisitions after the effective date.

 

**Item 7A.  Quantitative and Qualitative Disclosuresabout Market Risk.**

 

Our primary market riskis the interest rate risk on our bank line of credit which currently bearsinterest at a variable rate of LIBOR plus 70 basis points.  We have partially hedged this exposure tointerest rate risk with an interest rate swap, which has a notional amount of$80 million, through a well established financial institution.  We also face potential loss arising fromincreases in interest rates, which could have an adverse impact on the fairvalue of our investment securities.  Ourinvestment policy is to manage our investment portfolio to preserve principaland liquidity while maximizing the return on our investment portfolio throughthe investment of available funds.  We diversifyour investment portfolio by investing in a variety of highly-ratedinvestment-grade securities and through the use of different investmentmanagers.  Our investment securitiesportfolio is primarily invested in securities with maturities (or interest rateresets) of one year or less with at least an investment grade rating tominimize interest rate and credit risk as well as to provide for an immediatesource of funds.  Market risk, calculatedas the potential change in fair value in our investment portfolio resultingfrom a hypothetical 10% change in interest rates, was not material at December 31,2007.

 

In addition, we faceforeign currency exchange rate risk to the extent that the value of certainforeign currencies relative to the U.S. dollar affects our financialresults.  Our international operationstransact a portion of our business in currencies other than the U.S. dollar,predominantly the euro, and changes in exchange rates may positively or negativelyaffect our revenue, gross margins, operating expenses, and retained earningssince these transactions are reported by us in U.S. dollars.  We occasionally purchase foreign currencyforwards aimed at limiting the impact of currency fluctuations.  These instruments provide only limited protectionagainst currency exchange risks, and there can be no assurance that such anapproach will be successful, especially if a significant and sudden declineoccurs in the value of local currencies. As of December 31, 2007, we had three open forward contracts with afair value of approximately $8,000.

 

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**Item 8.  Financial Statements.**

 

**Index toConsolidated Financial Statements**

 
| Management’s Report on Internal Control over  Financial Reporting                                                                    |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Report of Independent Registered Public Accounting  Firm                                                                                  |   |
|                                                                                                                                      |   |
| Consolidated Financial Statements:                                                                                                        |   |
|                                                                                                                                      |   |
| Consolidated  Balance Sheets as of December 31, 2007 and 2006                                                                        |   |
| Consolidated  Statements of Income for the years ended December 31, 2007, 2006 and  2005                                             |   |
| Consolidated  Statements of Stockholders’ Equity and Comprehensive Income for the years ended  December 31, 2007, 2006 and 2005 |   |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2007, 2006 and  2005                                         |   |
| Notes to  Consolidated Financial Statements                                                                                               |   |
| Schedule II -  Valuation and Qualifying Accounts                                                                                          |   |

 

**Management’s Report on Internal Control overFinancial Reporting**

 

Management of AvocentCorporation is responsible for establishing and maintaining adequate internalcontrol over financial reporting.  TheCompany’s internal control over financial reporting is a process designed underthe supervision of Avocent’s principal executive and principal financialofficers to provide reasonable assurance regarding the reliability of financialreporting and the preparation of the Company’s consolidated financialstatements for external purposes in accordance with U.S. generally acceptedaccounting principles.

 

As of the end of theCompany’s 2007 fiscal year, management conducted an assessment of the Company’sinternal control over financial reporting based on the framework established inInternal Control - Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Based on this assessment,management has determined that the Company’s internal control over financialreporting as of December 31, 2007 was effective.

 

The Company’s internalcontrol over financial reporting includes policies and procedures that pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect transactions and dispositions of assets; provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with U.S. generally accepted accounting principles,and that receipts and expenditures are being made only in accordance with authorizationsof management and the directors of the Company; and provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use or disposition of the Company’s assets that could have a material effect onthe financial statements.

 

The effectiveness of theCompany’s internal control over financial reporting as of December 31,2007 has been audited by PricewaterhouseCoopers LLP, an independent registeredpublic accounting firm, as stated in their report which is presented in thisAnnual Report on Form 10-K.

 

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###  

### **Report ofIndependent Registered Public Accounting Firm**

###  

To the Board of Directorsand Stockholders of Avocent Corporation:

 

In our opinion, theaccompanying consolidated balance sheets and the related consolidatedstatements of income, stockholders’ equity and comprehensive income, and cashflows present fairly, in all material respects, the financial position ofAvocent Corporation and its subsidiaries at December 31, 2007 and December 31,2006, and the results of their operations and their cash flows for each of thethree years in the period ended December 31, 2007****inconformity with accounting principles generally accepted in the United Statesof America.  In addition, in our opinion,the financial statement schedule listed in the index appearing under Item 15(a) presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements.  Also in our opinion, the Company maintained,in all material respects, effective internal control over financial reportingas of December 31, 2007, based on criteria established in *Internal Control - Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO).  The Company’s management is responsible forthese financial statements, and financial statement schedule, for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting, included in theaccompanying Management’s Report on Internal Control over FinancialReporting.  Our responsibility is toexpress opinions on these financial statements, on the financial statementschedule,  and on the Company’s internalcontrol over financial reporting based on our integrated audits.  We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audits to obtain reasonable assurance about whether the financialstatements are free of material misstatement and whether effective internalcontrol over financial reporting was maintained in all material respects.  Our audits of the financial statementsincluded examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  Ouraudit of internal control over financial reporting included obtaining anunderstanding of internal control over financial reporting, assessing the riskthat a material weakness exists, and testing and evaluating the design andoperating effectiveness of internal control based on the assessed risk.  Our audits also included performing suchother procedures as we considered necessary in the circumstances. We believethat our audits provide a reasonable basis for our opinions.

 

As discussed in Note 2 tothe consolidated financial statements, the Company changed the manner in whichit accounts for share-based compensation in fiscal 2006, and the Companychanged the manner in which it accounts for uncertainty in income taxes infiscal 2007.

 

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles.  Acompany’s internal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements.  Also, projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

 
| /s/  PricewaterhouseCoopers LLP |   |
|---------------------------------|--------|
| Birmingham, Alabama             |
| February 21, 2008          |

 

54

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**AvocentCorporation**

**Consolidated Balance Sheets**

**December 31, 2007 and 2006**

**(Inthousands, except per share data)**

 
| ** **                                                                                                                                                                               | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **ASSETS**                                                                                                                                                                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                          |       |       |       |       |       |
| Cash and cash  equivalents                                                                                                                                                               |       | $          | 105,183    |       | $          | 81,301 |   |
| Investments  maturing within one year                                                                                                                                                    |       | 5,943      |       | 25,864     |       |
| Accounts  receivable, less allowance for doubtful accounts of $2,481 and $2,449 at  December 31, 2007 and 2006, respectively                                                        |       | 109,851    |       | 126,471    |       |
| Other receivables                                                                                                                                                                        |       | 10,799     |       | 13,365     |       |
| Inventories                                                                                                                                                                              |       | 30,103     |       | 41,765     |       |
| Other current  assets                                                                                                                                                                    |       | 4,399      |       | 3,904      |       |
| Deferred tax  assets, net                                                                                                                                                                |       | 5,928      |       | 7,355      |       |
| Total current  assets                                                                                                                                                                    |       | 272,206    |       | 300,025    |       |
|                                                                                                                                                                                     |       |       |       |       |       |
| Investments                                                                                                                                                                              |       | —     |       | 987        |       |
| Property and  equipment, net                                                                                                                                                             |       | 37,298     |       | 38,004     |       |
| Goodwill                                                                                                                                                                                 |       | 584,949    |       | 607,488    |       |
| Other intangible  assets, net                                                                                                                                                            |       | 167,982    |       | 209,674    |       |
| Deferred tax  asset, non-current                                                                                                                                                         |       | 13,297     |       | —     |       |
| Other assets                                                                                                                                                                             |       | 2,701      |       | 2,676      |       |
| Total assets                                                                                                                                                                             |       | $          | 1,078,433  |       | $          | 1,158,854 |   |
|                                                                                                                                                                                     |       |       |       |       |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current  liabilities:                                                                                                                                                                    |       |       |       |       |       |
| Accounts payable                                                                                                                                                                         |       | $          | 20,031     |       | $          | 16,260 |   |
| Accrued wages  and commissions                                                                                                                                                           |       | 25,072     |       | 25,511     |       |
| Accrued  liabilities                                                                                                                                                                     |       | 30,630     |       | 29,754     |       |
| Income taxes  payable                                                                                                                                                                    |       | 14,950     |       | 17,364     |       |
| Deferred  revenue, current                                                                                                                                                               |       | 54,738     |       | 44,453     |       |
| Total current  liabilities                                                                                                                                                               |       | 145,421    |       | 133,342    |       |
|                                                                                                                                                                                     |       |       |       |       |       |
| Unsecured bank  line of credit                                                                                                                                                           |       | 95,000     |       | 150,000    |       |
| Deferred tax  liabilities, net                                                                                                                                                           |       | —     |       | 30,377     |       |
| Deferred  revenue, non-current                                                                                                                                                           |       | 11,325     |       | 10,070     |       |
| Other  non-current liabilities                                                                                                                                                           |       | 1,025      |       | 1,222      |       |
| Total liabilities                                                                                                                                                                        |       | 252,771    |       | 325,011    |       |
|                                                                                                                                                                                     |       |       |       |       |       |
| Commitments and  contingencies*(Note 13 and Note 19)*                                                                                                                                    |       |       |       |       |       |
|                                                                                                                                                                                     |       |       |       |       |       |
| Stockholders’  equity:                                                                                                                                                              |       |       |       |       |       |
| Preferred stock,  par value $0.001 per share; 5,000 shares authorized; no shares issued and  outstanding                                                                                 |       | —     |       | —     |       |
| Common stock,  par value $0.001 per share; 200,000 shares authorized; 2007 — 53,910 shares  issued and 48,283 outstanding; 2006 — 53,382 shares issued and 50,641  outstanding |       | 54         |       | 53         |       |
| Additional  paid-in capital                                                                                                                                                              |       | 1,208,674  |       | 1,185,114  |       |
| Accumulated  other comprehensive income                                                                                                                                                  |       | 2,130      |       | 65         |       |
| Accumulated  deficit                                                                                                                                                                     |       | (218,719   | )          | (261,971   | )          |
| Treasury stock,  at cost; 2007 — 5,627 shares; 2006 — 2,741 shares;                                                                                                            |       | (166,477   | )          | (89,418    | )          |
| Total  stockholders’ equity                                                                                                                                                         |       | 825,662    |       | 833,843    |       |
|                                                                                                                                                                                     |       |       |       |       |       |
| Total  liabilities and stockholders’ equity                                                                                                                                         |       | $          | 1,078,433  |       | $          | 1,158,854 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

55

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**AvocentCorporation**

**Consolidated Statements of Income**

**Forthe Years Ended December 31, 2007, 2006 and 2005**

**(Inthousands, except per share data)**

 
| ** **                                                                                                                                            | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Net sales:                                                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Products and  services                                                                                                                                |       | $          | 502,007    |       | $          | 464,079    |       | $ | 347,858 |   |
| Licenses and  royalties                                                                                                                               |       | 98,868     |       | 55,116     |       | 22,030     |       |
| Total net sales                                                                                                                                       |       | 600,875    |       | 519,195    |       | 369,888    |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Cost of sales:                                                                                                                                        |       |       |       |       |       |       |       |
| Products and  services                                                                                                                                |       | 208,329    |       | 193,352    |       | 151,043    |       |
| Licenses and  royalties                                                                                                                               |       | 2,541      |       | 494        |       | —     |       |
| Amortization of  intangibles related to licenses and royalties                                                                                        |       | 10,985     |       | 3,577      |       | —     |       |
| Total cost of  sales (includes stock compensation expense of $1,134, $978 and $0 in 2007,  2006 and 2005, respectively)                               |       | 221,855    |       | 197,423    |       | 151,043    |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Gross profit                                                                                                                                          |       | 379,020    |       | 321,772    |       | 218,845    |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Research and  development expenses (includes stock compensation expense of $5,825, $4,302  and $1,138 in 2007, 2006 and 2005, respectively)           |       | 87,888     |       | 63,866     |       | 56,885     |       |
| Acquired  in-process research and development expense*(Note 3)*                                                                                       |       | —     |       | 20,700     |       | —     |       |
| Selling, general  and administrative expenses (includes stock compensation expense of $12,682,  $9,307 and $876 in 2007, 2006 and 2005, respectively) |       | 208,783    |       | 148,345    |       | 90,354     |       |
| Acquisition  integration expenses                                                                                                                     |       | —     |       | 3,904      |       | —     |       |
| Amortization of  intangible assets                                                                                                                    |       | 32,162     |       | 23,049     |       | 18,509     |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Total operating  expenses                                                                                                                             |       | 328,833    |       | 259,864    |       | 165,748    |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Income from  operations                                                                                                                               |       | 50,187     |       | 61,908     |       | 53,097     |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Income from  settlement of lawsuit                                                                                                                    |       | —     |       | —     |       | 5,000      |       |
| Net investment  income                                                                                                                                |       | 3,831      |       | 7,825      |       | 9,246      |       |
| Net realized  investment losses                                                                                                                       |       | —     |       | (254       | )          | (83        | )          |
| Interest expense                                                                                                                                      |       | (8,063     | )          | (3,621     | )          | —     |       |
| Other expense,  net                                                                                                                                   |       | (174       | )          | (166       | )          | (174       | )          |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Income before  provision for (benefit from) income taxes                                                                                              |       | 45,781     |       | 65,692     |       | 67,086     |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Provision for  (benefit from) income taxes                                                                                                            |       | (148       | )          | 20,160     |       | 18,737     |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Net income                                                                                                                                            |       | $          | 45,929     |       | $          | 45,532     |       | $ | 48,349 |   |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Net income per  common share:                                                                                                                         |       |       |       |       |       |       |       |
| Basic                                                                                                                                                 |       | $          | 0.91       |       | $          | 0.94       |       | $ | 0.98 |   |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Diluted                                                                                                                                               |       | $          | 0.90       |       | $          | 0.92       |       | $ | 0.96 |   |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Weighted average  common shares outstanding:                                                                                                          |       |       |       |       |       |       |       |
| Basic                                                                                                                                                 |       | 50,207     |       | 48,548     |       | 49,318     |       |
|                                                                                                                                                  |       |       |       |       |       |       |       |
| Diluted                                                                                                                                               |       | 51,089     |       | 49,475     |       | 50,254     |       |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

56

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**AvocentCorporation**

**Consolidated Statements ofStockholders’ Equity and Comprehensive Income**

**Forthe Years Ended December 31, 2007, 2006 and 2005**

**(Inthousands)**

 
| ** **                                          | ** ** | ** **            | ** ** | ** **                | ** ** | ** **          | ** ** | **Accumulated  Other** | ** ** | **Retained  Earnings** | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|-----------------------|------------|---------------------------|------------|---------------------|------------|------------------------|------------|------------------------|------------|------------------|------------|------------|------------|------------|------------|
| ** **                                          | ** ** | **Common Stock** | ** ** | **Additional Paid-** | ** ** | **Comprehensive**   | ** ** | **(Accumulated**       | ** ** | **Deferred**           | ** ** | **Treasury**     | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | **Shares**            | ** ** | **Amount**                | ** ** | **In Capital** | ** ** | **Income**             | ** ** | **Deficit)**           | ** ** | **Compensation** | ** ** | **Stock**  | ** ** | **Total**  | ** ** |
| Balance,  December 31, 2004                    |       | 50,332                |       | 50                        |       | $                   | 1,075,171  |                   | $          | (56                    | )          | $                | (355,852   | )          | $          | (2,038     | )          | $ | (3,978 | ) | $ | 713,297 |   |
| Net income                                          |       | —                |       | —                    |       | —              |       | —                 |       | 48,349                 |       | —           |       | —     |       | 48,349     |       |
| Change in  accumulated other comprehensive income   |       | —                |       | —                    |       | —              |       | (441                   | )          | —                 |       | —           |       | —     |       | (441       | )          |
| Issuances of  common stock                          |       | 1,280                 |       | 2                         |       | 25,089              |       | —                 |       | —                 |       | —           |       | —     |       | 25,091     |       |
| Income tax  benefit from exercise of stock options  |       | —                |       | —                    |       | 4,663               |       | —                 |       | —                 |       | —           |       | —     |       | 4,663      |       |
| Stock-based  compensation                           |       | —                |       | —                    |       | (24                 | )          | —                 |       | —                 |       | 2,038            |       | —     |       | 2,014      |       |
| Purchase of 2,675  shares of treasury stock         |       | —                |       | —                    |       | —              |       | —                 |       | —                 |       | —           |       | (77,651    | )          | (77,651    | )          |
| Balance,  December 31, 2005                    |       | 51,612                |       | 52                        |       | 1,104,899           |       | (497                   | )          | (307,503               | )          | —           |       | (81,629    | )          | 715,322    |       |
| Acquisition of  LANDesk Group Limited               |       | —                |       | —                    |       | 23,408              |       | —                 |       | —                 |       | —           |       | 180,529    |       | 203,937    |       |
| Net income                                          |       | —                |       | —                    |       | —              |       | —                 |       | 45,532                 |       | —           |       | —     |       | 45,532     |       |
| Change in  accumulated other comprehensive income   |       | —                |       | —                    |       | —              |       | 562                    |       | —                 |       | —           |       | —     |       | 562        |       |
| Issuances of  common stock                          |       | 1,770                 |       | 1                         |       | 37,645              |       | —                 |       | —                 |       | —           |       | —     |       | 37,646     |       |
| Income tax  benefit from exercise of stock options  |       | —                |       | —                    |       | 4,575               |       | —                 |       | —                 |       | —           |       | —     |       | 4,575      |       |
| Stock-based  compensation                           |       | —                |       | —                    |       | 14,587              |       | —                 |       | —                 |       | —           |       | —     |       | 14,587     |       |
| Purchase of 7,038  shares of treasury stock         |       | —                |       | —                    |       | —              |       | —                 |       | —                 |       | —           |       | (188,318   | )          | (188,318   | )          |
| Balance,  December 31, 2006                    |       | 53,382                |       | 53                        |       | 1,185,114           |       | 65                     |       | (261,971               | )          | —           |       | (89,418    | )          | 833,843    |       |
| Implementation of  FIN 48                           |       | —                |       | —                    |       | —              |       | —                 |       | (2,677                 | )          | —           |       | —     |       | (2, 677    | )          |
| Adjustment to  acquisition of LANDesk Group Limited |       | —                |       | —                    |       | 1,435               |       | —                 |       | —                 |       | —           |       | —     |       | 1,435      |       |
| Net income                                          |       | —                |       | —                    |       | —              |       | —                 |       | 45,929                 |       | —           |       | —     |       | 45,929     |       |
| Change in  accumulated other comprehensive income   |       | —                |       | —                    |       | —              |       | 2,065                  |       | —                 |       | —           |       | —     |       | 2065       |       |
| Issuances of  common stock                          |       | 528                   |       | 1                         |       | 1,669               |       | —                 |       | —                 |       | —           |       | —     |       | 1,670      |       |
| Income tax  benefit from exercise of stock options  |       | —                |       | —                    |       | 815                 |       | —                 |       | —                 |       | —           |       | —     |       | 815        |       |
| Stock-based  compensation                           |       | —                |       | —                    |       | 19,641              |       | —                 |       | —                 |       | —           |       | —     |       | 19,641     |       |
| Purchase of 2,887  shares of treasury stock         |       | —                |       | —                    |       | —              |       | —                 |       | —                 |       | —           |       | (77,059    | )          | (77,059    | )          |
| Balance,  December 31, 2007                    |       | 53,910                |       | $                         | 54         |                | $          | 1,208,674              |       | $                      | 2,130      |             | $          | (218,719   | )          | $          | —     |   | $ | (166,477 | ) | $ | 825,662 |   |
|                                                     |            |                       |            |                           |            |                     |            |                        |            |                        |            |                  |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                        | ** ** | **For the years ended** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------|------------|
| **Comprehensive income**                                     | ** ** | **December 31,  2007**            | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|                                                              |       |                                   |       |   |   |   |   |
| Net income                                                        |       | $                                      | 45,929     |   | $ | 45,532 |   | $ | 48,349 |   |
| Changes in  unrealized gain (loss) on investments, net of tax     |       | 91                                     |       | 412 |   | (215 | ) |
| Changes in  unrealized gain (loss) interest rate swap, net of tax |       | 66                                     |       | (456 | ) | — |   |
| Changes in  foreign currency translation adjustment               |       | 1,908                                  |       | 606 |   | (226 | ) |
| Total  comprehensive income                                       |       | $                                      | 47,994     |   | $ | 46,094 |   | $ | 47,908 |   |

 

The unrealized gain on investments in 2006 is net of$165 of realized losses (which is net of $89 tax benefit) that are included innet realized investment gains (losses) in the accompanying consolidatedstatement of income.  The unrealized losson investments in 2005 is net of $526 of realized losses (which is net of $284tax benefit) that are included in net realized investment gains (losses) in theaccompanying consolidated statement of income.

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

57

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**AvocentCorporation**

**Consolidated Statements of Cash Flows**

**Forthe Years Ended December 31, 2007, 2006 and 2005**

**(Inthousands)**

 
| ** **                                                                         | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                             |       |     |       |     |       |     |       |
| Net income                                                                         |       | $        | 45,929     |     | $          | 45,532   |       | $ | 48,349 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |     |       |     |       |     |       |
| Depreciation                                                                       |       | 9,690    |       | 8,689    |       | 7,037    |       |
| Amortization of  intangible assets                                                 |       | 43,629   |       | 26,626   |       | 18,509   |       |
| Stock-based  compensation                                                          |       | 19,641   |       | 14,587   |       | 2,014    |       |
| Acquired  in-process research and development expenses                             |       | —   |       | 20,700   |       | —   |       |
| Amortization of  premium (discount) on investments                                 |       | (156     | )          | (213     | )          | 934      |       |
| Net loss on  sales of investments                                                  |       | —   |       | 254      |       | 810      |       |
| Net loss on  sales of fixed assets                                                 |       | 404      |       | —   |       | —   |       |
| Net gain on sale  of property held for lease                                       |       | —   |       | —   |       | (727     | )          |
| Deferred income  taxes                                                             |       | (14,816  | )          | (8,261   | )          | (3,973   | )          |
| Income tax  benefit from exercise of stock options                                 |       | —   |       | —   |       | 4,663    |       |
| Excess tax  benefit from stock-based compensation                                  |       | (815     | )          | (4,575   | )          | —   |       |
| Changes in  operating assets and liabilities (net of effects of acquisitions):     |       |     |       |     |       |     |       |
| Accounts  receivable, net                                                          |       | 16,689   |       | (29,696  | )          | (7,763   | )          |
| Inventories, net                                                                   |       | 11,697   |       | (13,758  | )          | 54       |       |
| Other assets                                                                       |       | 1,983    |       | (1,339   | )          | (5,146   | )          |
| Accounts payable                                                                   |       | 3,768    |       | (12,387  | )          | 3,905    |       |
| Accrued  liabilities, wages and commissions                                        |       | (439     | )          | 8,347    |       | (1,697   | )          |
| Income taxes,  receivable and payable                                              |       | (3,894   | )          | (4,527   | )          | 2,776    |       |
| Other  liabilities                                                                 |       | 6,481    |       | 15,722   |       | 1,241    |       |
| Net cash  provided by operating activities                                         |       | 139,791  |       | 65,701   |       | 70,986   |       |
| Cash flows from  investing activities:                                             |       |     |       |     |       |     |       |
| Purchase of  LANDesk, net of cash acquired (1)                                     |       | —   |       | (202,194 | )          | —   |       |
| Purchase of  Cyclades, net of cash acquired                                        |       | —   |       | (91,982  | )          | —   |       |
| Purchase of  other intangibles                                                     |       | (3,791   | )          | (5,329   | )          | —   |       |
| Purchases of  property and equipment                                               |       | (9,025   | )          | (4,750   | )          | (3,798   | )          |
| Proceeds from  sale of property held for lease                                     |       | —   |       | —   |       | 1,912    |       |
| Purchases of  available-for-sale investments                                       |       | (75,512  | )          | (159,799 | )          | (360,839 | )          |
| Proceeds from  maturities and sales of available-for-sale investments              |       | 96,680   |       | 412,922  |       | 364,758  |       |
| Net cash  provided by (used in) investing activities                               |       | 8,352    |       | (51,132  | )          | 2,033    |       |
| Cash flows from  financing activities:                                             |       |     |       |     |       |     |       |
| Repayment of  short-term debt assumed in acquisitions                              |       | —   |       | (1,965   | )          | —   |       |
| Borrowings  (payments) under unsecured line of credit, net                         |       | (55,000  | )          | 150,000  |       | —   |       |
| Payment of debt  financing costs                                                   |       | —   |       | (2,005   | )          | —   |       |
| Excess tax  benefit from stock-based compensation                                  |       | 815      |       | 4,575    |       | —   |       |
| Proceeds from  employee stock option exercises                                     |       | 5,231    |       | 37,646   |       | 19,059   |       |
| Proceeds from  employee stock purchase plan                                        |       | —   |       | —   |       | 6,032    |       |
| Purchases of  treasury stock (2)                                                   |       | (77,059  | )          | (188,318 | )          | (76,279  | )          |
| Net cash used in  financing activities                                             |       | (126,013 | )          | (67      | )          | (51,188  | )          |
|                                                                               |       |     |       |     |       |     |       |
| Effect of  exchange rate changes on cash and cash equivalents                      |       | 1,752    |       | 374      |       | (130     | )          |
|                                                                               |       |     |       |     |       |     |       |
| Net increase in  cash and cash equivalents                                         |       | 23,882   |       | 14,876   |       | 21,701   |       |
| Cash and cash  equivalents, beginning of year                                      |       | 81,301   |       | 66,425   |       | 44,724   |       |
|                                                                               |       |     |       |     |       |     |       |
| Cash and cash  equivalents, end of year                                            |       | $        | 105,183    |     | $          | 81,301   |       | $ | 66,425 |   |
|                                                                               |       |     |       |     |       |     |       |
| Supplemental  disclosures of cash flow information:                                |       |     |       |     |       |     |       |
| Cash paid during  the year for income taxes                                        |       | $        | 18,562     |     | $          | 26,788   |       | $ | 14,487 |   |
|                                                                               |       |     |       |     |       |     |       |
| Cash paid during  the year for interest                                            |       | $        | 7,273      |     | $          | 2,986    |       | $ | — |   |

 

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(1) Supplementaldisclosure — In addition to the cash paid at the closing, we issued 7,073shares of our common stock valued at $199,528 to LANDesk shareholders in 2006.The issuance of common stock was recorded as non-cash consideration for theacquisition.

 

(2) Supplementaldisclosure — We recorded the purchase of 50 treasury shares at the end of 2005for $1,372 and recorded a liability in the same amount as the transactionsettled after year-end.  The cash-flowhas been adjusted for this non-cash transaction.

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**AvocentCorporation**

**Notes to Consolidated FinancialStatements**

**Forthe Years Ended December 31, 2007, 2006 and 2005**

**(InThousands, except per share data)**

 

**1.**                                      Nature of Business and Basis ofPresentation

** **

Avocent Corporation designs, manufactures, licenses, and sellssoftware and hardware products and technologies that provide connectivity andcentralized management of information technology (IT) infrastructure.  We (meaning Avocent and its wholly-ownedsubsidiaries) provide connectivity and systems management products andtechnologies that centralize control of servers, desktop computers, serialdevices, wireless devices, mobile devices, and network appliances, thusincreasing the efficiency of IT resources. Server manufacturers resell private-labeled Avocent KVM (keyboard,video, and mouse) switches and embedded software and hardware technology intheir systems, and companies large and small depend on our software andhardware products and technologies for managing their growing ITinfrastructure.

 

Theresults of acquired companies are included in the consolidated results from therespective dates of acquisition, including Cyclades Corporation (“Cyclades”),which was acquired on March 30, 2006 and LANDesk Group Limited. (“LANDesk”),which was acquired on August 31, 2006.

 

**2.**                                      Summary of Significant AccountingPolicies

** **

Ourprincipal accounting policies are as follows:

 

**Principlesof Consolidation**— Our consolidated financial statements include all our wholly-ownedsubsidiaries. All significant intercompany accounts and transactions have beeneliminated in consolidation.

 

**Cash andCash Equivalents**— We consider all highly liquid instruments with an original maturity of threemonths or less when purchased to be cash equivalents, except that certaininvestments with original maturities of less than 90 days are classified asshort term investments when such investments are a part of our investmentportfolio.

 

**Inventories** — Raw materials, work in process andfinished goods inventories are recorded using the lower of cost or market, withcost being determined using the first-in first-out (FIFO) method.  We use standard costs for material, labor andoverhead to value our inventory and review and revise our standards on aquarterly basis. Therefore, inventory costs approximate actual costs at the endof each reporting period.  We write down inventory for estimatedobsolescence or unmarketable inventory to the estimated market value based uponassumptions about future demand and market conditions.

 

**FinancialInstruments**— The carrying amounts reported in the balancesheets for cash and cash equivalents, short-term investments, accountsreceivable and accounts payable approximate fair value because of the immediateor short-term maturity of these financial instruments.  Our unsecured bank line of credit bears avariable interest rate; therefore, the carrying value of the debt obligationapproximates fair value.  Our interestrate swap and short term forward contracts are reported at fair value in theconsolidated financial statements.

 

**UnsecuredBank Line of Credit**—We classify the entire obligation under our unsecured line of credit as longterm as it carries a five year term and has no payment schedule.

 

**Investments**—****Ourinvestments consist primarily of bank deposits, corporate bonds, and U.S.government agency securities.  Debtsecurities that we have the positive intent and ability to hold to maturity areclassified as held-to-maturity securities and are reported at amortized cost.  Debt and equity securities not classified aseither held-to-maturity securities or trading securities and that have readilydeterminable fair values are classified as available-for-sale securities andare reported at fair value, with unrealized gains and losses excluded fromearnings and reported as a separate component of stockholders’ equity, net ofdeferred income taxes. All investments are classified as available-for-salesecurities at December 31, 2007 and 2006. Unrealized losses are charged against earnings when a decline in fairvalue is determined to be other than temporary. Certain investments with original maturities of less than 90 days areclassified as short term investments when such are a part of our investmentportfolio.  Realized gains and losses areaccounted for on the specific identification method.

 

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**Propertyand Equipment** —Property and equipment are carried at cost, less accumulated depreciation, andinclude expenditures that substantially increase the useful lives of existingassets. Maintenance and repairs are charged to current operations as incurred.Upon sale, retirement, or other disposition of these assets, the cost andrelated accumulated depreciation are removed from the respective accounts, andany gain or loss on the disposition is included in income from operations.

 

Depreciationexpense is computed using the straight-line method over the following estimateduseful lives:

 
| **Description**                  | ** ** | **Useful Life**                 | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| Land  improvements               |       | 30 years                             |       |
| Buildings                        |       | 39 years                             |       |
| Leasehold  improvements          |       | Lesser of lease term or  useful life |       |
| Computer  software and equipment |       | 3 — 5 years                     |       |
| Other equipment                  |       | 3 — 5 years                     |       |

 

**OtherIntangible Assets**— Other intangible assets include acquired intangible assets and capitalizedcosts directly incurred in obtaining an intangible.  Other intangible assets are amortized on astraight-line basis over the following estimated useful lives:

 
| **Description**                  | ** ** | **Useful Life**       | ** ** |
|----------------------------------|------------|----------------------------|------------|
| Developed  technology            |       | 3 — 5 years           |       |
| Core technology                  |       | 6 years                    |       |
| Patents and  trademarks          |       | 5 — 7 years           |       |
| Customer base  and certification |       | 3 — 7 years           |       |
| Maintenance  contracts           |       | 5 years                    |       |
| Non-compete  agreements          |       | 3 years (contract  period) |       |
| Other intangible  assets         |       | 3 — 7 years           |       |

 

**Long-LivedAssets —** Werecognize impairment losses on long-lived assets used in operations whenindicators of impairment are present and the undiscounted cash flows estimatedto be generated by those assets are less than the assets’ carrying values. Animpairment loss would be recognized in the amount by which the recorded valueof the asset exceeds the fair value of the asset, measured by the quoted marketprice of an asset or an estimate based on the best information available in thecircumstances.  There were no such lossesrecognized during 2007, 2006 or 2005.

 

**Goodwill** — We record goodwill when the cost of anacquired entity exceeds the net amounts assigned to the assets acquired(including other identified intangible assets) and liabilities assumed.  We performed an annual impairment test ofgoodwill in the fourth quarters of 2007, 2006 and 2005.  The tests conducted during 2007, 2006 and2005 concluded that there had been no impairment of goodwill and that noadjustments were required (*see Note 8*).

 

**Allowancefor Doubtful Accounts**—Prior to extending credit to a new customer, we perform a detailed creditreview of the customer and establish credit limits based on the results of thecredit review. We review collection experience periodically to determine if thecustomer’s payment terms and credit limits need to be revised. We maintainallowances for doubtful accounts for estimated losses resulting from theinability of our customers to make required payments. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may be required. Ifcircumstances change with regard to individual receivable balances that hadpreviously been determined to be uncollectible (and for which a specificreserve had been established), a reduction in our allowance for doubtfulaccounts may be required. Our allowance for doubtful accounts was $2,481 and$2,449 at December 31, 2007 and 2006, respectively.

** **

**Allowancefor Sales Returns**—Our hardware sales generally include a one-month unconditional returnpolicy.  We also allow additional rightsof return to certain of our distributors, which generally extend the returnperiod to 90 days. We reserve for estimated sales returns as a reduction ofrevenue and cost of sales at the time the product revenue is recognized basedon historical sales return experience, which management believes provides areasonable estimate of future returns. The allowance for sales returns totaled approximately $5,016 and $6,038at December 31, 2007 and 2006, respectively. The reserve is included as areduction in the carrying value of accounts receivable and sales in theaccompanying consolidated balance sheets and statements of income,respectively.

 

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**Liabilityfor Warranty Returns**— Our hardware products generally include warranties of one to three years forproduct defects. We accrue for warranty returns at cost to repair or replaceproducts. We also offer extended warranties to customers and recognize therevenue associated with the extended warranties over the life of the warranty *(see Note 9*).  Theliability for warranty returns totaled approximately $1,854 and $2,486 at December 31,2007 and 2006, respectively. These liabilities are included in accruedliabilities in the accompanying consolidated balance sheets.

 

**Stock-BasedCompensation**—****On January 1, 2006, we adopted SFAS 123 (revised2004), “*Share-Based Payment”*,(SFAS 123R) , which requires the measurement and recognition of compensationexpense for all share-based payment awards made to employees and directorsbased on estimated fair values.  Ourconsolidated statement of income for the years ended December 31, 2007 and2006 reflect the impact of SFAS 123R.  Inaccordance with the modified prospective transition method, our consolidatedstatements of income for prior periods have not been retroactively adjusted toreflect the impact of SFAS 123R.  Newawards are valued and accounted for prospectively upon adoption.  Prior outstanding stock option awards thatwere not fully vested as of January 1, 2006 will be recognized ascompensation expense in the consolidated statements of income over theirremaining requisite service periods. Prior to the adoption of SFAS 123R, werecorded the intrinsic value of stock-based compensation as expense, inaccordance with APB No. 25, as allowed under SFAS No. 123, “*Accounting for Stock-based Compensation Expense”*(SFAS123).  Under the intrinsic value method,no stock-based compensation expense had been recorded in our consolidatedstatements of income prior to January 1, 2006, other than as related todeferred compensation recorded as a result of options assumed uponacquisitions.

 

SFAS 123R requirescompanies to estimate the fair value of share-based payment awards on the dateof grant using an option pricing model for stock options or using the currentshare price for awards of restricted stock units.  The value of the portion of the award that isultimately expected to vest will be recognized as expense over the requisiteservice periods in our consolidated statements of income.  Stock-based compensation expense recognizedin our consolidated statements of income for 2007 and 2006 includescompensation expense for stock-based payment awards granted prior to, but notyet vested as of, January 1, 2006 based on the grant date fair valueestimated in accordance with the pro forma provisions of SFAS 123, andcompensation expense for the stock-based payment awards granted or modifiedsubsequent to December 31, 2005 based on the grant date fair valueestimated in accordance with the provisions of SFAS 123R.  Compensation expense for all stock option andtime-based restricted stock unit payment awards are recognized using theratable single-option approach. Compensation expense for performance-basedrestricted stock unit payment awards is recognized using the FIN 28traunche-based approach based on an estimate of expected outcomes and isadjusted prospectively as new information about the expected outcome becomesavailable.  Stock-based compensation expenserecognized in our consolidated statements of income for 2007 and 2006 is basedon awards ultimately expected to vest; therefore, the expense has been reducedfor estimated forfeitures.  SFAS 123Rrequires forfeitures to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates.

 

We use the Black-Scholesoption pricing model (the “Black-Scholes Model”) for the purpose of determiningthe estimated fair value of stock options on the date of grant under SFAS123R.  The Black-Scholes Model requiresthe input of certain assumptions that involve judgment.  Because our employee stock options havecharacteristics significantly different from those of traded options, andbecause changes in the input assumptions can materially affect the fair valueestimate, existing models may not provide reliable measures of fair value ofour employee stock options.  We willcontinue to assess the assumptions and methodologies used to calculate estimatedfair value of stock-based compensation. If circumstances change, and additional data becomes available overtime, we may change our assumptions and methodologies, which may materiallyimpact the fair value determination.

 

We elected to adopt thealternative transition method, as permitted by Financial Accounting StandardsBoard (“FASB”) Staff Position No. FAS 123R-3, *Transition Election Related to Accounting for the Tax Effects ofShare-Based Payment Awards,*to calculate the tax effects ofstock-based compensation pursuant to SFAS 123R for those employee awards thatwere outstanding upon adoption of SFAS 123R. The alternative transition method allows the use of simplified methodsto calculate the beginning capital-in-excess-of-par pool related to the taxeffects of employee stock-based compensation and to determine the subsequentimpact of the tax effects of employee stock-based compensation awards on thecapital-in-excess-of-par pool and the consolidated statements of cash flows.  Prior to the adoption of SFAS 123R, wereported all tax benefits resulting from the exercise of stock options as 

 

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operating cash flows inthe consolidated statements of cash flows. SFAS 123R requires cash flows resulting from the tax deductions inexcess of the related compensation cost recognized in the financial statements(excess tax benefits) to be classified as financing cash flows.  In accordance with SFAS 123R, excess taxbenefits recognized in periods after the adoption date have been classified asfinancing cash flows.  Excess taxbenefits recognized in periods prior to the adoption date are classified asoperating cash flows.  The income taxbenefits from stock option exercises totaled approximately $815, $4,575, and $4,663 for years ended December 31, 2007, 2006, and 2005, respectively.

 

**Concentrationsof Customer Base and Credit Risk —**The following identifies our customers that exceeded10% of our sales for the years 2007, 2006 and 2005:

 
| ** **                                  | ** ** | **For the years ended** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|
| ** **                                  | ** ** | **December 31,  2007**            | ** ** | ** ** | ** ** | **December 31,  2006** | ** ** | ** ** | ** ** | **December 31,  2005** | ** ** | ** ** | ** ** |
| Customers  greater than 10% of sales:       |       |                                   |       |   |   |   |   |   |   |   |   |   |   |
| Dell                                        |       | $                                      | 76,990     |   | 13 | % | $ | 71,926 |   | 14 | % | $ | 53,684 |   | 15 | % |
| Hewlett-Packard                             |       | 70,341                                 |       | 12 | % | 72,640 |   | 14 | % | 73,556 |   | 20 | % |
| Tech Data                                   |       | 67,642                                 |       | 11 | % | 64,143 |   | 12 | % | 38,531 |   | 10 | % |
| Ingram Micro (1)                            |       | —                                 |       |   |   | — |   |   |   | 39,289 |   | 11 | % |
| Total customers  greater than 10% of sales: |       | $                                      | 214,973    |   | 36 | % | $ | 208,709 |   | 40 | % | $ | 205,060 |   | 56 | % |

 

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*(1) Sales to this customer were less than 10% of sales in 2007 and2006.*

 

Salesto these customers are reported primarily through Management Systems Division,but also through our LANDesk Division. Accounts receivable from these customers represented approximately 27%and 30% of trade receivables at December 31, 2007 and 2006, respectively.  Our top five customers, which include threeOEMs and two distributors, accounted for 52% of sales in 2007, 56% in 2006 and64% in 2005.

 

We place cash andinvestments in several high-quality financial institutions and seek to limitthe credit exposure from any one institution, issuer or instrument.  We also face interest rate risk on our bankline of credit which currently bears interest at a variable rate of LIBOR plus70 basis points.  We have partiallyhedged this exposure to interest rate risk with an interest rate swap, whichhas a notional amount of $80 million, through a well established financialinstitution.

 

**IncomeTaxes** — Weaccount for income taxes using the asset and liability method. We provide forincome taxes currently payable and, in addition, provide deferred income taxesfor temporary differences between the tax basis of assets and liabilities andtheir reported amounts in the consolidated financial statements and for knowntax contingencies. Temporary differences relate principally to the allowancefor doubtful accounts, allowance for sales returns, liability for warrantyclaims, unrealized gain (loss) on investments, accumulated depreciation, losson write-down of investments, inventory reserves, acquired intangible assets, operatinglosses, goodwill amortized for tax purposes but not GAAP, and state researchcredit carryforwards.  We intend topermanently reinvest our earnings from foreign subsidiaries in ourinternational operations and, accordingly, no provision for any incremental netU.S. federal or state income taxes has been made for these unremitted earnings.Valuation allowances are established when necessary to reduce deferred taxassets to the amount expected to be realized. Tax contingencies are recorded to address potential exposures involvingtax positions taken which could be challenged by tax authorities.  These potential exposures result from thevarying applications of statutes, rules, regulations, and interpretations.  We adopted FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”on January 1, 2007. As a result of adopting this FASB Interpretation, werecorded an increase to reserves for uncertain tax positions of $2.9million.  This increase was recorded as an increase to the January 1,2007 accumulated deficit balance.

 

**ForeignCurrency** — Werecord transactions denominated in foreign currencies on a monthly basis usingthe average monthly exchange rate. Assets and liabilities denominated in foreigncurrencies are translated at the balance sheet dates using the closing rates ofexchange between those foreign currencies and the U.S. Dollar with anytransaction gains or losses reported in other income (expense). Adjustmentsfrom translating financial statements of international subsidiaries arerecorded as a separate component of stockholders’ equity.

 

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We useforward contracts to reduce our foreign currency exposure related to the netcash flows from our European and Asian operations. The majority of thesecontracts are short-term contracts (three months or less) and aremarked-to-market each quarter and included in receivables or payables, with theoffsetting gain or loss included in other income (expense) in the accompanyingconsolidated statements of income. At December 31, 2007 we had three suchcontracts outstanding with a fair value of $8. At December 31, 2006 we had one such contract outstanding with afair value of zero.

 

**Derivative Instruments and Hedging Activities**— We enter into interest rate swapagreements in accordance with our risk management policy to partially reducerisks related to our floating rate line of credit which is subject to changesin the market rate of interest.  We do notuse derivative instruments for trading purposes.  We record the fair value of interest rateswap agreements in other assets or liabilities on the consolidated balancesheet.  Changes in the fair value ofinterest rate swap agreements that are designated and effective as cash flowhedges are recorded in accumulated other comprehensive income (loss) (“OCI”).  Those changes are released from OCI to theconsolidated statement of income as interest expense contemporaneously with theearnings effects of the hedged item (the underlying debt agreement).  The settled amount of a swap that has beenterminated prior to its original term continues to be deferred in OCI and isrecognized in the consolidated statement of income over the term of theunderlying debt agreement designated as the hedged item.  Changes in the fair value of interest rateswap agreements that are not effective as hedges are recorded immediately inthe consolidated statement of income as interest expense.  We have designated our interest rate swapagreement as a cash flow hedge.  Cashflows from hedging activities are reported in the consolidated statement ofcash flows in the same classification as the hedged item, generally as acomponent of cash flows from income.

 

**RevenueRecognition** — Wegenerally record sales of our hardware products upon shipment of the relatedproduct, net of any discounts as we generally have no significant post deliveryobligations, the product price is fixed or determinable, collection of theresulting receivable is probable, and product returns are reasonably estimable.Product shipments occur upon receipt of a purchase order from a customer.Revenue on products shipped FOB destination is recorded when the customer takespossession of the goods, and revenue on products shipped FOB shipping point isrecorded when the goods leave our facilities. Our shipping and handling feesare included in net sales, and the related costs are included in cost of salesin the accompanying consolidated statements of income.

 

Wegenerally record royalty revenue from OEMs upon shipment of the relatedproducts in which our software or firmware is embedded by the OEMs, based uponshipment data provided by the OEMs.  We generally record license revenuefrom sales of our software upon shipment or electronic transfer of thesoftware.  We generally defer revenuefrom the sale of extended warranty agreements, software subscriptions, andsoftware support and maintenance agreements. The deferred revenue is amortized into income on a pro rata basis overthe applicable contract lives.

 

We recognize softwarerevenue in accordance with Statements of Position 97-2, “Software RevenueRecognition” (SOP 97-2), and 98-9, “Modification of SOP 97-2, Software RevenueRecognition, with Respect to Certain Transactions” (SOP 98-9). We deriverevenue from the license of software products under software license agreementsand subscription agreements and from the delivery of professional services andmaintenance services. When contracts contain multiple elements, and vendor-specificobjective evidence (VSOE) of fair value exists for all undelivered elements, weaccount for the delivered elements in accordance with the “Residual Method”prescribed by SOP 98-9 when VSOE does not exist for the delivered element.Multiple element arrangements generally include post-contract customer support(or maintenance), and in some cases, subscriptions and other services.Vendor-specific objective evidence of fair value is generally determined bysales of the same element or service sold separately to other customers, orwith respect to maintenance and subscriptions, through a renewal rate specifiedin the related arrangement. When VSOE of fair value does not exist for allundelivered elements in our multiple element contracts we generally deferrevenue related to the entire arrangement until the earlier of the point atwhich (a) such sufficient VSOE does exist or (b) all elements of thearrangement have been delivered and all other revenue recognition criteria havebeen met.

 

Software license revenueis recognized when persuasive evidence of an arrangement exists, the fee isfixed or determinable, collectibility is probable, and delivery and customeracceptance (including the expiration of an acceptance period), if requiredunder the terms of the contract, of the software products have occurred.  In instances where vendor obligations remain,revenue is deferred until the obligation has been satisfied.

 

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Revenue from professionalservices consists of non-recurring engineering, training and implementationservices. Non-recurring engineering and implementation service revenue isrecognized as the services are performed for time and materials contracts orupon acceptance on fixed price contracts. Training revenue is recognized as theservices are performed.

 

Maintenance andsubscription revenue is recognized ratably over the term of the contract, whichis generally twelve to thirty six months. Maintenance contracts include theright to unspecified upgrades on a when-and-if available basis, and ongoingsupport.

 

**Researchand Development Expense** — Research and development costs are expensed as incurred. In-processresearch and development obtained through acquisitions of other companies isexpensed upon consummation of the acquisition.

 

**SoftwareDevelopment Costs**—Development costs for software to be sold, integrated into our other productsor otherwise marketed are included in research and development costs and areexpensed as incurred. After technological feasibility is established, softwaredevelopment costs are capitalized. The capitalized costs are then amortized ona straight-line basis over the estimated product life, or using the ratio ofcurrent revenue to total projected product revenue, whichever is greater. Todate, the period between achieving technological feasibility, which we havedefined as the establishment of a working model which typically occurs whenbeta testing commences, and the general availability of such software has beenshort and software development costs qualifying for capitalization have beeninsignificant. Accordingly, through December 31, 2007, we have notcapitalized any software development costs. Certain developed software costs included in other intangible assets asa result of business combinations are amortized as a component of cost of salesin the accompanying statements of income.

 

**AdvertisingExpense****—** Advertising costs are expensed as incurred and areincluded as a component of selling, general and administrative expenses.Advertising expense totaled approximately $7,829, $7,807 and $7,517 for theyears ended December 31, 2007, 2006 and 2005, respectively.  We participate in cooperative advertising andmarket development programs with certain resellers, distributors and OEMs. These programs are used by us to reimburse resellers, distributors and OEMs forthe actual costs of certain forms of advertising, and generally allowresellers, distributors and OEMs reimbursement up to a specified percentage ofnet purchases. Our costs associated with these programs are estimated andaccrued at the time of sale, and are included in sales and marketing expensesin the accompanying consolidated statements of income.

 

**NetInvestment Income**—****Net investment income includes incomefrom interest, dividends, rental property held for lease and accretion of bondpremiums and discounts, net of related expenses.

 

**NetRealized Investment Gains (Losses) —**Net realized investment gains (losses) include gains(losses) realized upon sales or calls of investments and losses realized oninvestments when a decline in fair value is determined by management to beother than temporary.

 

**InterestExpense —**Interestexpense****consists of interest and amortizationof debt issuance costs related to the bank line of credit, and includes theeffects of the Company’s interest rate swap hedge.

 

**Loan Origination Costs****—**We recordcosts incurred directly related to obtaining the line of credit in accordancewith APB 21, “*Interest on Receivables andPayables.”  *Under this method, we capitalize loan originationcosts and amortize the costs over the life of the agreement under thestraight-line method as the related interest expense is not materiallydifferent than the expense calculated under the interest method.

 

**OtherIncome (Expense), net —**Other income (expense) consists primarily of foreign currency exchangegains or losses.

 

**ComprehensiveIncome —**Comprehensiveincome includes all changes in equity (net assets) during a period fromnon-owner sources. Items included in comprehensive income include net income,foreign currency translation adjustments, unrealized gains and losses onavailable-for-sale securities, and changes in the fair value of interest rateswaps.

 

**EarningsPer Share —**Earningsper common share, and earnings per common share assuming dilution, are based onthe weighted average number of common and common equivalent, when dilutive,shares outstanding during the year (see *Note 12*).

 

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**Use ofEstimates —** Thepreparation of our consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosures of contingent assets andliabilities at the dates of the financial statements and reported amounts ofrevenue and expenses during the reporting periods. Actual results could differfrom those estimates.

 

**Reclassifications**— Certainreclassifications have been made to the prior years consolidated financialstatements in order to conform to the 2007 presentation. Thesereclassifications had no effect on previously reported net income, net cashprovided by operating activities, net cash used in investing activities ortotal stockholders’ equity.

 

**Recently Issued Accounting Standards**—In September 2006, the FASB issued SFAS No. 157, “*Fair Value Measurements”* (SFAS 157), which clarifies thatfair value estimates should be based on the assumptions market participantswould use when pricing an asset or liability and establishes a fair valuehierarchy that prioritizes the information used to develop thoseassumptions.  Under SFAS 157, fair valuemeasurements would be separately disclosed by level within the fair valuehierarchy.  SFAS 157 is effective forfiscal years beginning after November 15, 2007.  On February 12, 2008, the FASB delayed theeffective date of SFAS 157 for nonfinancial assets and liabilities, except foritems that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually), to fiscal years beginningafter November 15, 2008.  We do notexpect the adoption of SFAS 157 to have a material impact on our consolidatedresults of operations or financial condition.

 

InFebruary 2007, the FASB issued SFAS No. 159, “*The Fair Value Option for Financial Assets andFinancial Liabilities — Including an amendment of FASB Statement No. 115”*(SFAS 159). SFAS No. 159 permits an entity to elect fair value as theinitial and subsequent measurement attribute for many financial assets andliabilities. Entities electing the fair value option would be required torecognize changes in fair value in earnings. Entities electing the fair valueoption are required to distinguish, on the face of the statement of financialposition, the fair value of assets and liabilities for which the fair valueoption has been elected and similar assets and liabilities measured usinganother measurement attribute. SFAS 159 is effective for fiscal yearsbeginning after November 15, 2007. The adjustment to reflect thedifference between the fair value and the carrying amount would be accountedfor as a cumulative-effect adjustment to retained earnings as of the date ofinitial adoption. We are currently evaluating the impact, if any, ofSFAS 159 on our consolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 141(R), “*Business Combinations”* (SFAS 141(R)),which replaces FAS 141. SFAS 141(R) establishes principles andrequirements for how an acquirer in a business combination recognizes andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed, and any controlling interest; recognizes and measures thegoodwill acquired in the business combination or a gain from a bargainpurchase; and determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination. FAS 141(R) is to be applied prospectively tobusiness combinations for which the acquisition date is on or after an entity’sfiscal year that begins after December 15, 2008. We will assess the impactof SFAS 141(R) if and when a future acquisition occurs, however the applicationof SFAS 141(R) will result in a significant change in accounting forfuture acquisitions after the effective date.

 

SeeNote 10 for FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes, an interpretation of FAS Statement 109” (FIN 48) discussion.

 

**3.            Acquisitions**

** **

**Cyclades Corporation** — On March 30, 2006, we acquiredCyclades Corporation, a privately-held company based in Fremont, California,with additional operations primarily in Sao Paulo, Brazil and Munich,Germany.  Cyclades employed approximately 325 people in 19 locationsaround the world.  The Cyclades productlines included serial, KVM and power management products.  The acquisition of Cyclades enhances ourposition in the Linux server and networking infrastructure management market,provides complementary products to our product lines, and allows us to providecustomers a more integrated platform for managing their IT infrastructure.  The results of Cyclades’ operations have beenincluded in the consolidated financial statements since the date ofacquisition.

 

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The acquisition was recorded under the purchase method of accounting,and the purchase price was allocated based on the fair value of the assetsacquired and liabilities assumed.  Inaccordance with generally accepted accounting principles, purchased research and development costsallocated to patented and patent-pending technology were capitalized and willbe amortized over the respective estimated useful lives.  The remaining amounts of purchased researchand development were expensed upon the closing of the transaction.  The goodwill recorded as a result of theacquisition will not be amortized but will be included in our annual review ofgoodwill for impairment.  Additionally,amortization of the other intangible assets acquired and the goodwill recordedis not tax deductible.  A summary of the total purchase consideration,excluding cash received, is as follows:

 
| Cash paid for  outstanding shares  |   | $      | 92,700 |   |
|------------------------------------|--------|--------|--------|--------|
| Acquisition  costs paid by Avocent |   | 1,690  |   |
|                               |   |   |   |
| Total  acquisition cost            |   | $      | 94,390 |   |

 

We funded theacquisition through available cash.  Onthe closing of the Cyclades transaction, we acquired $2,408 in cash held byCyclades.

 

The acquisitioncost was allocated to the estimated fair values of the assets acquired andliabilities assumed, as follows:

 
| ** **                           | ** ** | **Purchase  Price  Allocation** | ** ** | **Amortization  Period** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|--------------------------|------------|
| Tangible assets                      |       | $                               | 23,232     |                     | —     |   |
| In-process  research and development |       | 2,100                           |       | —                   |       |
| Developed  technology                |       | 19,000                          |       | 5 years                  |       |
| Customer base                        |       | 12,100                          |       | 5 years                  |       |
| Trademarks                           |       | 3,100                           |       | 5 years                  |       |
| Non-compete  agreements              |       | 4,100                           |       | 3 years                  |       |
| Goodwill                             |       | 62,420                          |       | —                   |       |
| Deferred taxes                       |       | (14,472                         | )          | —                   |       |
| Assumed  liabilities                 |       | (17,190                         | )          | —                   |       |
|                                 |       |                            |       |                     |       |
|                                 |       | $                               | 94,390     |                     |       |   |

 

An escrow account with $14,700 of the aboveconsideration was established to be held for indemnifiable claims for a periodof 21 months after the acquisition closing date.

 

The $2,100 in fair value of the in-process researchand development (“IPR&D”) received in the acquisition was determined usinga form of the discounted cash flow method known as the multi-period excessearnings method.  These amounts were forparticular research and development projects that have no alternative futureuses and were therefore expensed rather than capitalized at the time ofpurchase.

 

Cyclades’ in-process research and developmentactivities consisted of the development of its KVM/net 3.0 product line and itsPM45 product lines.  KVM/Net 3.0 is the next generation KVM overIP technology that leverages DSP processing technology and software-basedcompression algorithms.  PM45 is anintelligent power distribution unit that provides high current on a 3-phasemain power source.  The KVM/Net3.0 project was completed on scheduleduring 2006.  The PM45 project wascompleted as originally planned in late 2006. The development scope was altered before the PM45 was released in thefourth quarter of 2006, however the revised product was completed andreleased during 2007.

 

We recorded approximately $3,904 of costs associatedwith the integration of Cyclades people, processes and products into Avocentduring 2006.  These costs also includeseverance accruals resulting from headcount reductions associated withduplicate positions eliminated since the acquisition in March.  There were no such costs recorded in 2007.

 

**LANDesk Group Limited** — On August 31, 2006, we acquiredLANDesk Group Limited, a privately-held company based in Ireland with themajority of its operations in Salt Lake City, Utah. LANDesk employedapproximately 600 people, located primarily in the United States, China, andEurope.  The LANDesk product linesinclude software for the centralized management and protection of informationtechnology assets.  The acquisitionagreement provides for total initial consideration of approximately $407,382including $199,528 in stock, $202,010 in cash, and $5,844 in estimated fairvalue of assumed unvested employee stock options.  As specified within the acquisitionagreement, the potential of an earn-out payment to prior shareholders existedhad LANDesk achieved certain full year 2006 revenue targets.  Based on LANDesk’s 2006 revenue results, wedo not believe that LANDesk achieved the minimum revenue 

 

66

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target required to cause an earn-out payment and,accordingly, we have not accrued for any contingent consideration in theaccompanying consolidated financial statements. We do not believe any earn-out payment was earned or payable.  The LANDesk acquisition agreements also allowfor additional stock consideration to be paid to unvested option holders equalto the per share amounts ultimately released to the former LANDesk shareholdersfrom escrow.  We expect to incur futurecompensation expense related to the amounts expected to be paid to unvestedholders deemed to be attributable to future service.

 

The acquisition was recordedunder the purchase method of accounting, and the purchase cost was allocatedbased on the fair value of the assets acquired and liabilities assumed.  In accordance with generally acceptedaccounting principles, purchasedresearch and development costs allocated to patented and patent-pendingtechnology were capitalized and will be amortized over the respective estimateduseful lives.  The remaining amounts ofpurchased research and development were expensed upon the closing of thetransaction.  The goodwill recorded as aresult of the acquisition will not be amortized but will be included in Avocent’sannual review of goodwill for impairment. We have made certain elections that allow amortization of the otherintangible assets acquired and the goodwill recorded to be tax deductible.  We have indemnified former LANDeskshareholders for any personal tax consequences as a result of theseelections.  Our initial allocation of theacquisition cost did not take into consideration the tax impacts should theseelections have been made within the required time period (*see notes 8and 10*).  A summary of the total acquisition cost, excludingcash received, is as follows:

 
| Cash paid for  outstanding shares                                             |   | $       | 202,010 |   |
|-------------------------------------------------------------------------------|--------|---------|---------|--------|
| Avocent common  stock issued for outstanding shares                           |   | 199,528 |    |
| Acquisition  costs paid by Avocent                                            |   | 12,083  |    |
| Estimated value  of unvested options assumed related to prior service periods |   | 5,844   |    |
| Total estimated  acquisition cost                                             |   | $       | 419,465 |   |

 

The acquisition cost wasallocated to the estimated fair values of the assets acquired and liabilitiesassumed, as follows:

 
| ** **                                | ** ** | **Purchase  Price  Allocation** | ** ** | **Amortization  Period** | ** ** |
|-------------------------------------------|------------|---------------------------------|------------|--------------------------|------------|
| Tangible assets                           |       | $                               | 36,673     |                     | —     |   |
| In-process  research and development      |       | 18,600                          |       | —                   |       |
| Developed  technology                     |       | 35,400                          |       | 5 years                  |       |
| Internally  developed software for resale |       | 21,900                          |       | 6 years                  |       |
| Customer base                             |       | 78,400                          |       | 7 years                  |       |
| Trademarks                                |       | 23,600                          |       | 7 years                  |       |
| Maintenance contracts                     |       | 9,600                           |       | 5 years                  |       |
| Non-compete  agreements                   |       | 6,100                           |       | 3 years                  |       |
| Goodwill                                  |       | 252,355                         |       | —                   |       |
| Deferred taxes                            |       | (8,952                          | )          | —                   |       |
| Assumed  liabilities                      |       | (54,211                         | )          | —                   |       |
|                                      |       | $                               | 419,465    |                     |       |   |

 

We funded the acquisition through available cash,borrowings from our line of credit and the issuance of 7,073 shares of commonstock.  On the closing of the LANDesktransaction, we acquired $10,312 in cash held by LANDesk.  An escrow account with $60,000 of the abovestock consideration (based on the stock value determined at the time of theacquisition) was established to be held for indemnifiable claims for a periodof 18 months after the acquisition closing date.

 

The $18,600 in fair value of all of the in-processresearch and development (IPR&D) received in the acquisition was determinedusing a form of the discounted cash flow method known as the multi-periodexcess earnings method.  These amountswere deemed to be for particular research and development projects that have noalternative future uses and were therefore expensed rather than capitalized atthe time of purchase.

 

67

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LANDesk’s in-process research and developmentactivities consisted of the development of the following products:Virtualization, Hostbase Intrusion Prevention Services (HIPS) and ConfigurationManagement Database (CMDB) product lines. Virtualization is a technologythat presents a logical grouping of computing resources so that access can beprovided in ways that enhance utilization over the original resourceconfiguration.  HIPS technology is usedto monitor computer and network activities to look for signs of intrusion intothe computer system, which allows system administrators to identify potentialsystem security threats and weaknesses. CMDB is a repository for information about a company’s IT services andinfrastructures and their relationships to each other, allowing ITprofessionals the ability to assess the current state of the IT infrastructureat any time.  Both the Virtualization andHIPS products were completed in 2007, while it is anticipated the CMBDproduct will be completed during 2008.

 

**Pro Forma Financial Information —**The followingunaudited pro forma summary combines the results of operations of Avocent,Cyclades and LANDesk as if the acquisitions had occurred at the beginning ofeach period presented.  Certainadjustments have been made to reflect the impact of the purchase transactions.These pro forma results have been prepared for the years ended December 31,2006 and 2005 for comparative purposes only and do not purport to be indicativeof what would have occurred had the acquisitions been made at the beginning ofeach period presented, or of results which may occur in the future.

 
| ** **                | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |
| Net sales                 |       | $        | 590,829    |     | $          | 513,492 |   |
| Net income                |       | $        | 41,947     |     | $          | 15,753 |   |
| Income per basic  share   |       | $        | 0.76       |     | $          | 0.28 |   |
| Income per  diluted share |       | $        | 0.74       |     | $          | 0.28 |   |

 

The above amounts exclude acquired in-process researchand development expense of $18,600 related to the LANDesk acquisition and$2,100 related to the Cyclades acquisition.

 

**4.****            ****Inventories**

 

Inventories consist of the following at December 31,2007 and 2006:

 
| ** **      | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
| Raw materials   |       | $        | 1,394      |     | $          | 3,022 |   |
| Work in process |       | 1,058    |       | 1,411    |       |
| Finished goods  |       | 27,651   |       | 37,332   |       |
|            |       |     |       |     |       |
| Inventories     |       | $        | 30,103     |     | $          | 41,765 |   |

 

As of December 31, 2007and 2006, inventories above have been reduced by reserves for excess andobsolete inventories of $7,328 and $5,578, respectively.

 

**5.****            ****Investments**

 

All investments in publicly traded securities at December 31,2007 and 2006, are classified as available-for-sale and are carried at fairvalue.  We include certain investmentswith original maturities of less than 90 days as short term investments whensuch investments are a part of our investment portfolio.  Investments at December 31, 2007 and2006 are as follows:

 
| ** **                          | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|
| **Current investments:**       | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                |       |                            |       |   |   |   |   |   |   |
| Corporate bonds                     |       | $                               | 4,944      |   | $ | — |   | $ | — |   | $ | 4,944 |   |
| U.S. government  agency obligations |       | 1,000                           |       | — |   | (1 | ) | 999 |   |
|                                |       |                            |       |   |   |   |   |   |   |
| Totals                              |       | $                               | 5,944      |   | $ | — |   | $ | (1 | ) | $ | 5,943 |   |

 

68

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| ** **                          | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|
| **Current investments:**       | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                |       |                            |       |   |   |   |   |   |   |
| Corporate bonds                     |       | $                               | 12,283     |   | $ | — |   | $ | (18 | ) | $ | 12,265 |   |
| Municipal bonds                     |       | 1,154                           |       | — |   | (1 | ) | 1,153 |   |
| U.S. government  agency obligations |       | 12,520                          |       | — |   | (74 | ) | 12,446 |   |
|                                |       |                            |       |   |   |   |   |   |   |
| Totals                              |       | $                               | 25,957     |   | $ | — |   | $ | (93 | ) | $ | 25,864 |   |

 
| ** **                          | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|
| **Non-current investments:**   | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair**

**Value** | ** ** |
|                                |       |                            |       |   |   |   |   |   |   |
| U.S. government  agency obligations |       | $                               | 1,000      |   | $ | — |   | $ | (13 | ) | $ | 987 |   |
|                                |       |                            |       |   |   |   |   |   |   |
| Totals                              |       | $                               | 1,000      |   | $ | — |   | $ | (13 | ) | $ | 987 |   |

 

As of December 31, 2007 we had one investmentwith an unrealized loss, which was in this loss position for less than twelvemonths.  The loss was caused by slightupward variations in interest rates in the particular security since the timeit was acquired. This investment is of high credit quality, is insured orguaranteed by an agency of the US government, and we anticipate that we willrealize the full par value upon maturity of this security.

 

Net realized gains (losses) for the years ended December 31,2007, 2006, and 2005 were comprised of the following:

 
| ** **                              | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |     |       |
| Gross realized  gains                   |       | $        | —     |     | $          | 113      |       | $ | 20 |   |
| Gross realized  losses                  |       | —   |       | (367     | )          | (830     | )          |
| Net realized investment  gains (losses) |       | $        | —     |     | $          | (254     | )          | $ | (810 | ) |

 

**6.****            ****Property Held for Lease**

 

In the fourth quarter of 2005, we sold a building thatwe owned and had previously occupied in Huntsville, Alabama.  We had an agreement to lease the building toan unrelated party.  Rental income fromthis property was recorded on a monthly basis in accordance with the leaseterms.  Initial direct costs weredeferred and matched against rental income over the initial term of the lease*.*  Net rental income was reported within netinvestment income.  Rental incometotaled approximately $202 for the year ended December 31, 2005.  We received approximately $1,912 from thesale of the building, resulting in a gain on disposal of approximately $727 in2005.

 

69

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**7.****            ****Property and Equipment**

 

Property and equipment consists of the following at December 31,2007 and 2006:

 
| ** **                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Land and land  improvements      |       | $        | 6,819      |     | $          | 5,577 |   |
| Buildings                        |       | 21,088   |       | 24,289   |       |
| Leasehold  improvements          |       | 3,562    |       | 3,147    |       |
| Computer  software and equipment |       | 33,980   |       | 29,638   |       |
| Other equipment                  |       | 17,533   |       | 17,019   |       |
| Construction in  progress        |       | 905      |       | 358      |       |
|                             |       |     |       |     |       |
|                             |       | 83,887   |       | 80,028   |       |
| Less accumulated  depreciation   |       | (46,589  | )          | (42,024  | )          |
|                             |       |     |       |     |       |
| Property and  equipment, net     |       | $        | 37,298     |     | $          | 38,004 |   |

 

Depreciation expense was$9,690, $8,689, and $7,037 for the years ended December 31, 2007, 2006 and2005, respectively.

 

**8**.             **Goodwill and Other IntangibleAssets**

 

Other intangible assets subject to amortization,including the intangible assets from our acquisitions detailed in Note 3, areas follows:

 
| ** **                                | ** ** | **December 31, 2007** | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **Gross  Carrying  Amounts**    | ** ** | **Accumulated  Amortization**   | ** ** | **Gross  Carrying  Amounts** | ** ** | **Accumulated  Amortization** | ** ** |
| Developed  technology                     |       | $                               | 56,840     |                            | $          | 17,292 |   | $ | 68,720 |   | $ | 17,741 |   |
| Internally  developed software for resale |       | 21,900                          |       | 4,867                           |       | 21,900 |   | 1,217 |   |
| Patents and  trademarks                   |       | 30,670                          |       | 6,590                           |       | 35,520 |   | 7,753 |   |
| Customer base  and certification          |       | 99,878                          |       | 25,496                          |       | 100,120 |   | 9,449 |   |
| Maintenance  contracts                    |       | 9,600                           |       | 2,560                           |       | 9,600 |   | 640 |   |
| Non-compete  agreements                   |       | 10,624                          |       | 5,432                           |       | 12,720 |   | 3,775 |   |
| Other assets                              |       | 2,310                           |       | 1,603                           |       | 4,228 |   | 2,559 |   |
|                                      |       | $                               | 231,822    |                            | $          | 63,840 |   | $ | 252,808 |   | $ | 43,134 |   |

 

For the years ended December 31, 2007, 2006 and2005, amortization expense for other intangible assets was $43,629, $26,626 and$18,509, respectively.  The approximatefuture annual amortization for other intangible assets is as follows:

 
| **Years ending December 31:** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|
| 2008                                         |       | $          | 42,372     |   |
| 2009                                         |       | 37,757     |       |
| 2010                                         |       | 34,724     |       |
| 2011                                         |       | 26,272     |       |
| 2012                                         |       | 17,112     |       |
| Thereafter                                   |       | 9,745      |       |
| Total                                        |       | $          | 167,982    |   |

 

70

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The changes in the carryingamount of goodwill for the year ended December 31, 2007, are as follows:

 
| ** **                            | ** ** | **Management  Systems  Division** | ** ** | **LANDesk  Division** | ** ** | **Embedded  Software  and  Solutions  Divisions** | ** ** | **Other  Business  Units** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|-----------------------|------------|---------------------------------------------------|------------|----------------------------|------------|-----------|------------|
|                                  |       |                              |       |                  |       |                                              |       |                       |       |      |       |
| Balance as of  January 1, 2007   |       | $                                 | 316,430    |                  | $          | 274,613                                           |       | $                          | 11,862     |      | $          | 4,583 |   | $ | 607,488 |   |
|                                  |       |                              |       |                  |       |                                              |       |                       |       |      |       |
| Reallocation  from segment changes    |       | 11,862                            |       | —                |       | (11,862                                           | )          | —                     |       | —    |       |
|                                  |       |                              |       |                  |       |                                              |       |                       |       |      |       |
| Adjustments  during the year          |       | (281                              | )          | (22,258               | )          | —                                            |       | —                     |       | (22,539   | )          |
|                                  |       |                              |       |                  |       |                                              |       |                       |       |      |       |
| Balance as of  December 31, 2007 |       | $                                 | 328,011    |                  | $          | 252,355                                           |       | $                          | —     |      | $          | 4,583 |   | $ | 584,949 |   |
|                                       |            |                                   |            |                       |            |                                                   |            |                            |            |           |            |  |  |  |  |  |  |

 

The adjustments to LANDesk goodwill are the primarilythe result of the finalization of the purchase price allocation and theelections made under Internal Revenue Code Section 338(g) during 2007(*see note 10*).We performed an annualimpairment test of goodwill in the fourth quarter of 2007, 2006 and 2005.  The test in the fourth quarter of each yearconcluded that there had been no impairment of goodwill and that no adjustmentswere required.  See Note 16 fordiscussion on reallocation of goodwill among reporting units.

 

**9.****            ****Product Warranties**

 

The activity within theliability for warranty returns in 2007 and 2006 is as follows:

 
| ** **                                                | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                      |       |     |       |     |       |
| Balance,  beginning of year                               |       | $        | 2,486      |     | $          | 2,536 |   |
|                                                      |       |     |       |     |       |
| Accruals for  product warranties issued during the period |       | 5,973    |       | 155      |       |
| Assumed on the  acquisition of Cyclades                   |       | —   |       | 158      |       |
| Settlements made  during the period                       |       | (6,605   | )          | (363     | )          |
|                                                      |       |     |       |     |       |
| Balance, end of  year                                     |       | $        | 1,854      |     | $          | 2,486 |   |

 

Deferred revenue related to our extended warranty forhardware products program was $5,388 at December 31, 2007 and $4,545 at December 31,2006.  We recorded earned revenue fromthe amortization of deferred revenue related to extended warranties of $3,754during 2007, $2,649 during 2006, and $912 during 2005.  In addition, we recorded new extendedwarranties of $4,597 during 2007, $3,661 during 2006, and $1,168 during 2005.

 

We defer revenue for subscription, service andmaintenance contracts until earned, which is generally over the term of thecontract or when services are performed. As of December 31, 2007, deferred revenue was $60,647, of whichapproximately $59,078 related to LANDesk. As of December 31, 2006,deferred revenue was $53,514, of which approximately $47,858 related toLANDesk.

 

71

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**10.****                              ****Income Taxes**

 

The income before income tax (benefit) and provisionfor (benefit from) income taxes for the years ended December 31, 2007,2006 and 2005 are comprised of the following:

 
| ** **                                        | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                              |       |     |       |     |       |     |       |
| Income before  income tax (benefit) expense:      |       |     |       |     |       |     |       |
| U.S.                                              |       | $        | 1,267      |     | $          | 41,595   |       | $ | 30,881 |   |
| Foreign                                           |       | 44,514   |       | 24,097   |       | 36,205   |       |
|                                              |       |     |       |     |       |     |       |
| Total income  before income tax (benefit) expense |       | $        | 45,781     |     | $          | 65,692   |       | $ | 67,086 |   |
|                                              |       |     |       |     |       |     |       |
| Current:                                          |       |     |       |     |       |     |       |
| U.S. Federal                                      |       | $        | 5,771      |     | $          | 19,574   |       | $ | 17,667 |   |
| U.S. State                                        |       | 802      |       | 1,745    |       | 273      |       |
| Foreign                                           |       | 8,095    |       | 7,102    |       | 4,422    |       |
|                                              |       |     |       |     |       |     |       |
|                                              |       | 14,668   |       | 28,421   |       | 22,362   |       |
| Deferred:                                         |       |     |       |     |       |     |       |
| U.S. Federal                                      |       | (13,995  | )          | (5,647   | )          | (2,914   | )          |
| U.S. State                                        |       | (338     | )          | (919     | )          | (345     | )          |
| Foreign                                           |       | (483     | )          | (1,695   | )          | (366     | )          |
|                                              |       |     |       |     |       |     |       |
|                                              |       | (14,816) |       | (8,261   | )          | (3,625   | )          |
|                                              |       |     |       |     |       |     |       |
| Total provision  for (benefit from) income taxes  |       | $        | (148       | )        | $          | 20,160   |       | $ | 18,737 |   |

 

The provision for(benefit from) federal income taxes differs from the amount computed byapplying the statutory rate of 35% to taxable income as follows:

 
| ** **                                                         | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                               |       |     |       |     |       |     |       |
| Expected federal  income tax provision                             |       | $        | 16,023     |     | $          | 22,993   |       | $ | 23,480 |   |
| Add (deduct):                                                      |       |     |       |     |       |     |       |
| Extraterritorial  income exclusion benefit                         |       | 0        |       | (89      | )          | (64      | )          |
| State income tax  (benefit), net of federal tax                    |       | 302      |       | 541      |       | (47      | )          |
| Tax effect  resulting from foreign operations taxed at lower rates |       | (8,787   | )          | (5,789   | )          | (7,450   | )          |
| Acquired  in-process research and development                      |       | (6,510   | )          | 3,060    |       | —   |       |
| Compensation  expense                                              |       | (287     | )          | (1,126   | )          | 705      |       |
| Municipal bond  interest income                                    |       | (57      | )          | (739     | )          | (1,074   | )          |
| Subpart F income                                                   |       | 1,543    |       | 923      |       | 1,447    |       |
| Foreign tax  credit                                                |       | (860     | )          | (258     | )          | (526     | )          |
| Research credit                                                    |       | (2,386   | )          | (930     | )          | (833     | )          |
| Repatriation  dividend                                             | * *   | *—* |       | —   |       | 3,809    |       |
| Valuation  allowance                                               |       | 429      |       | 1,135    |       | —   |       |
| Other                                                              |       | 442      |       | 439      |       | (710     | )          |
|                                                               |       | $        | (148)      |     | $          | 20,160   |       | $ | 18,737 |   |

 

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** **

The components of the net deferred income tax assetsand liabilities at December 31, 2007 and 2006, are as follows:

 
| ** **                                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net current  deferred income tax assets:                        |       |     |       |     |       |
| Allowance for  doubtful accounts                                |       | $        | 533        |     | $          | 386 |   |
| Allowance for  sales returns and liability for warranty returns |       | 1,289    |       | 1,067    |       |
| Inventory  reserves                                             |       | 2,841    |       | 3,205    |       |
| Operating loss  carryforwards                                   |       | 847      |       | 931      |       |
| Other                                                           |       | 1,570    |       | 1,766    |       |
|                                                            |       |     |       |     |       |
|                                                            |       | $        | 7,080      |     | $          | 7,355 |   |
|                                                            |       |     |       |     |       |
| Net noncurrent  deferred income tax assets (liabilities):       |       |     |       |     |       |
| Accumulated  depreciation                                       |       | $        | (1,289     | )        | $          | (1,750 | ) |
| Acquired  intangible assets                                     |       | 3,083    |       | (36,849  | )          |
| Operating loss  carryforwards                                   |       | 4,895    |       | 3,115    |       |
| Capital loss  carryforward                                      |       | 489      |       | 506      |       |
| Research credit  carryforward                                   |       | 1,262    |       | 1,985    |       |
| Allowance for impairment  on investments                        |       | 1,461    |       | 1,560    |       |
| Stock-based  compensation expense                               |       | 6,173    |       | 4,558    |       |
| Other                                                           |       | 57       |       | 673      |       |
|                                                            |       | 16,131   |       | (26,202  | )          |
|                                                            |       |     |       |     |       |
| Less valuation  allowances                                      |       | (3,986   | )          | (4,175   | )          |
|                                                            |       |     |       |     |       |
|                                                            |       | $        | 12,145     |     | $          | (30,377 | ) |
|                                                            |       |     |       |     |       |
| Net deferred  income tax asset (liability)                      |       | $        | 19,225     |     | $          | (23,022 | ) |

 

During2006, we wrote off a deferred tax asset of $1,040 arising from an acquiredresearch credit carryforward. The acquired company had a full valuationallowance recorded against the deferred tax asset resulting in no impact onreported goodwill.

 

Thenet change in the valuation allowance for deferred tax assets was a decrease of($189) in 2007 primarily due to allowances recorded against deferred tax assetsattributable to operating loss and state research credit carryforwards.

 

Weintend to permanently reinvest our undistributed earnings of approximately$120,752 as of December 31, 2007 of our foreign subsidiaries ininternational operations. Should our intent change, additional income taxexpense would likely be recorded due to the differential in tax rates betweenthe U.S. and the international jurisdictions. In 2005, we repatriated $90,000of foreign earnings in accordance with the provisions of the American JobsCreation Act of 2004 (the “Act”). Additional income tax expense of $3,809resulted from this transaction. The Act created a temporary incentive for U.S.corporations to repatriate accumulated income earned abroad by providing an 85percent dividends received deduction for certain dividends from controlledforeign corporations.

 

Forstate income tax purposes, at December 31, 2007 we have approximately$12,209 of net operating loss carry forwards available to offset future taxableincome in certain states. These state net operating loss carryforwards are subjectto certain limitations. If not utilized, the state net operating losscarryforwards will expire from 2013 to 2026. For foreign income tax purposes,we have approximately $28,305 of net operating loss carryforwards available tooffset future taxable income in certain jurisdictions. The carryforward periodfor a significant portion is unlimited.

 

Theprovision for income taxes includes a tax benefit of $6,510 attributable to theLANDesk acquisition for previously expensed in-process research and developmentexpense of $18,600 recorded in 2006. The tax benefit results from the taxelections made in the second quarter of 2007 discussed below. Prior to thosedeductions the in-process research and development expense was non-deductiblefor U.S. tax purposes.

 

73

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During the second quarterof 2007, we made elections under Internal Revenue Code Section 338(g) relatedto the August 2006 acquisition of LANDesk. As a result of the election theacquisition is now treated for U.S. tax purposes as an asset acquisition wherewe stepped up the tax basis in assets and liabilities previously recorded inthe initial purchase accounting. We previously accounted for this acquisitionas a qualified stock purchase, with carryover tax basis in the assets andliabilities recorded. Our preliminary purchase price allocation was based uponthe initial structure of the transaction and did not take into considerationthe tax impacts should these elections be made within the required time period,including the tax impacts associated with the amount assigned to acquiredin-process research and development that was charged to expense at acquisition.

 

Wehave re-measured the deferred taxes related to this business combination totake into consideration the tax impacts of the elections made. As a result, weadjusted the deferred tax accounts with the offsetting reduction to goodwillpreviously recorded from this transaction. We have indemnified former LANDeskshareholders for any incremental personal tax consequences should this electioncreate incremental tax obligations for these former shareholders. As a result,we recorded an accrued liability of $6,246 with the offsetting increase togoodwill previously recorded from this transaction.

 

Weadopted FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes, an interpretation of FASB Statement No. 109” on January 1,2007. As a result of adopting this FASB Interpretation, we recorded an increaseto reserves for uncertain tax positions of $2,900.  This increase wasrecorded as an increase to the January 1, 2007 accumulated deficitbalance.  As of December 31, 2007 we had total reserves for uncertaintax positions related to gross unrecognized tax benefits of $10,707 of which$8,945, if recognized, would affect the effective tax rate.  We recognizepotential accrued interest and penalties related to unrecognized tax benefitsfrom our global operations within income tax expense. We recorded $896 of suchexpenses within our 2007 income tax expense. As of December 31, 2007, wehad accrued interest payable related to the unrecognized tax benefits of$3,055. A reconciliation of the beginning and ending amount of unrecognized taxbenefits is as follows:

 
| ** **                                                | ** ** | **2007** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|
| Balance at  January 1,                               |       | $        | 11,400     |   |
|                                                      |       |     |       |
| Additions based  on tax positions related to current year |       | 234      |       |
| Additions for  tax positions of prior years               |       | 729      |       |
| Reductions for  tax positions of prior years              |       | (1,380   | )          |
| Settlements                                               |       | (276     | )          |
|                                                      |       |     |       |
| Balance at  December 31,                             |       | $        | 10,707     |   |

 

We conduct businessglobally, and as a result our subsidiaries file income tax returns in the U.S.federal jurisdiction and various state and foreign jurisdictions.  In thenormal course of business we are subject to examinations by taxing authoritiesthroughout the world including the U.S.  With few exceptions, we are nolonger subject to U.S. federal, state, and local, or non-U.S. income taxexaminations for periods before 2004.

 

The Internal RevenueService (IRS) commenced an examination in 2006 of our U.S. income tax returnsfor 2004 and 2005. As of December 31, 2007 the IRS had not issued anyproposed adjustments for those periods. During the first quarter of 2008 theIRS proposed certain adjustments increasing our tax liabilities relatingprimarily to transfer pricing for those periods. We have reached a negotiatedsettlement with the IRS concerning those adjustments. We anticipate that apayment for additional tax including interest will be made in the range of $6.5to $8.5 million by the end of the first quarter of 2008. We do not anticipatethat this payment would result in a material change to our financial position.

 

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**11.**                               Treasury Stock

** **

As of December 31,2007, we may repurchase a total of 15,000 shares under the share repurchaseprogram approved by our Board of Directors (*see Note 20*). Wepurchased 2,887 shares in 2007 and 7,038 shares in 2006 under the sharerepurchase program. We have purchased 12,700 shares through December 31,2007, under the share repurchase program (*see Note 20*). In August 2006, we reissued 7,073 sharesof treasury stock in conjunction with the acquisition of LANDesk (*see Note 3*).

 

**12.**                               Earnings Per Share

** **

Asummary of the calculation of basic and diluted earnings per share (EPS) forthe years ended December 31, 2007, 2006 and 2005, is as follows:

 
| ** **                                      | ** ** | **Income   (Numerator)** | ** ** | **Shares   (Denominator)** | ** ** | **Earnings   Per-Share** | ** ** |
|-------------------------------------------------|------------|-------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **For the  Year Ended December 31, 2007**  |       |                          |       |                            |       |                          |       |
| **Basic  EPS**                                  |       |                          |       |                            |       |                          |       |
| Net income                                      |       | $                             | 45,929     |                            | 50,207     |                          | $          | 0.91 |   |
| **Effect  of Dilutive Securities**              |       |                          |       |                            |       |                          |       |
| Stock options  and restricted stock units (RSU) |       |                          |       | 882                             |       |                          |       |
| **Diluted  EPS**                                |       |                          |       |                            |       |                          |       |
| Net income and  assumed conversions             |       | $                             | 45,929     |                            | 51,089     |                          | $          | 0.90 |   |
|                                            |       |                          |       |                            |       |                          |       |
| **For the  Year Ended December 31, 2006**  |       |                          |       |                            |       |                          |       |
| **Basic  EPS**                                  |       |                          |       |                            |       |                          |       |
| Net income                                      |       | $                             | 45,532     |                            | 48,549     |                          | $          | 0.94 |   |
| **Effect  of Dilutive Securities**              |       |                          |       |                            |       |                          |       |
| Stock options  and restricted stock units (RSU) |       |                          |       | 926                             |       |                          |       |
| **Diluted  EPS**                                |       |                          |       |                            |       |                          |       |
| Net income and  assumed conversions             |       | $                             | 45,532     |                            | 49,475     |                          | $          | 0.92 |   |
|                                            |       |                          |       |                            |       |                          |       |
| **For the  Year Ended December 31, 2005**  |       |                          |       |                            |       |                          |       |
| **Basic  EPS**                                  |       |                          |       |                            |       |                          |       |
| Net income                                      |       | $                             | 48,349     |                            | 49,318     |                          | $          | 0.98 |   |
| **Effect  of Dilutive Securities**              |       |                          |       |                            |       |                          |       |
| Stock options                                   |       |                          |       | 936                             |       |                          |       |
| **Diluted  EPS**                                |       |                          |       |                            |       |                          |       |
| Net income and  assumed conversions             |       | $                             | 48,349     |                            | 50,254     |                          | $          | 0.96 |   |

 

Anti-dilutiveoptions to purchase common stock outstanding and anti-diluted RSUs wereexcluded from the calculations above. At December 31, 2007, 2006 and 2005,RSUs and options purchase 2,279, 2,242 and 2,375 shares of common stock,respectively, were outstanding but were not included in the computation ofdiluted earnings per share because inclusion of such options would have beenanti-dilutive.

 

**13.**                               Commitments and Contingencies

** **

Welease buildings and certain equipment under various operating leases. Rentexpense under these leases totaled approximately $7,269, $4,868 and $3,578 forthe years ended December 31, 2007, 2006 and 2005, respectively. Futureminimum rental payments under non-cancelable operating leases are approximatelyas follows:

 
| **Years ending December 31:** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|
| 2007                                         |       | $          | 6,370      |   |
| 2008                                         |       | 5,195      |       |
| 2009                                         |       | 4,149      |       |
| 2010                                         |       | 1,423      |       |
| 2011                                         |       | 1,367      |       |
| Thereafter                                   |       | 1,366      |       |
|                                         |       | $          | 19,870     |   |

 

75

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In the ordinary course of our business, we may at any pointin time have a significant amount of contractual commitments not yet recognizedin our financial statements. These commitments totaled $27,338 as of December 31,2007 and are all due within twelve months of year end. These commitments relateprimarily to our need to schedule the purchase of inventories in advanceof the related forecasted sales to customers. We also have at any point in timea variety of short-term contractual commitments for services such asadvertising, marketing, accounting, legal, and research and developmentactivities. The liabilities for these services and the related expenses aretypically recognized upon the receipt of the related services.

 

We have been involved from time to time in litigation in thenormal course of business. (*See Note 19*).

 

**14.**                               Equity Compensation and Stock PurchasePlans

** **

Wehave equity compensation plans covering substantially all of our employees anddirectors. Purchase prices for common stock subject to options issued under theassumed plans generally approximate the fair market value of the related sharesat the date of grant. Generally, options vest over three to four years andtypically expire 10 years from the grant date.

 

Wegrant equity incentive awards under the 2005 Avocent Corporation EquityIncentive Plan (the 2005 Plan). As approved by the stockholders, the 2005 Planauthorizes a total of 4,750 shares of common stock for issuance, plus (i) anyshares remaining available for issuance under previous stock option plans up toa maximum of 1,187 shares and (ii) any shares subject to any outstandingoptions under our stock option plans that subsequently expireunexercised.  New options may no longer be granted under any former plans.The 2005 Plan allows for options, restricted stock, restricted stock units, stockappreciation rights, performance shares, performance units, deferred stockunits, and dividend equivalents, and options granted under the 2005 Plan may beeither incentive stock options or nonqualified stock options. Nonqualified stock options, restricted stock, restricted stock units,performance shares, performance units, stock appreciation rights, deferredstock units, and dividend equivalents may be granted under the 2005 Plan to ourdirectors, employees, or consultants, but incentive stock options may begranted only to our employees.  Options may not be granted at less thanthe fair market value on date of grant and may not have a term of greater than10 years. We issue new shares tosatisfy stock options exercised. During 2007, we granted both stockoptions and restricted stock units under the 2005 Plan.

 

The following schedulesummarizes the stock option activity in our stock-based compensation plans asfollows:

 
| ** **                                   | ** ** | **Number of   Options** | ** ** | **Range of   Exercise   Prices** | ** ** | **Weighted   Average   Exercise   Price** | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------------|------------|
| Options  outstanding, December 31, 2006 |       | 4,929                             |       | $ 1.31 — $70.94                       |       | $                                                        | 33.45      |   |
| Options granted                              |       | 7                                 |       | $ 25.64 — $35.05                      |       | $                                                        | 28.90      |   |
| Options  forfeited and cancelled             |       | (121                              | )          | $ 1.31 — $56.06                       |       | $                                                        | 29.68      |   |
| Options  exercised                           |       | (277                              | )          | $ 1.31 — $32.66                       |       | $                                                        | 18.83      |   |
|                                         |       |                              |       |                                            |       |                                                     |       |
| Options  outstanding, December 31, 2007 |       | 4,538                             |       | $ 1.31 — $70.94                       |       | $                                                        | 34.44      |   |

 

On April 29,2005, our Board of Directors approved a plan to accelerate vesting of all thenoutstanding stock options with an exercise price of greater than $25.00 andunvested on December 25, 2005. Under the provisions of APB 25, there wasno compensation expense related to accelerating these options as the optionsaffected by the acceleration had exercise prices higher than the closing priceof our common stock as of the modification date. As a result of the Board’saction, stock options to purchase approximately 1,100 shares of our commonstock became exercisable effective December 25, 2005. The exercise pricesof the affected stock options ranged from $25.17 to $41.57 per share. Theclosing price of our common stock on April 29, 2005 was $25.14. There wereno such accelerations during 2007 or 2006.

 

The total pretaxintrinsic value of options exercised during the years ended December 31,2007, 2006 and 2005 was $3,431, $22,074 and $15,289, respectively.

 

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The following tablesummarizes information about stock options outstanding at December 31,2007:

 
| **Range of   Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted Avg.  Remaining  Contractual    Life** | ** ** | **Intrinsic  Value** | ** ** | **Weighted  Avg.  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Avg.  Exercise  Price** | ** ** | **Intrinsic  Value** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|------------------------------------------------------------------|------------|----------------------|------------|-------------------------------------|------------|-------------------------|------------|-------------------------------------|------------|----------------------|------------|
| $ 1.31 – $21.77                     |       | 939                     |       | 4.55                                                             |       | $                    | 6,201      |                                | $          | 16.70                   |       | 846                                 |       | $                    | 16.88      |   | $ | 5,443 |   |
| $ 21.80 – $27.25                    |       | 1,340                   |       | 5.21                                                             |       | 137                  |       | 26.14                               |       | 1,337                   |       | 26.14                               |       | 137                  |       |
| $ 27.30 – $46.94                    |       | 826                     |       | 6.03                                                             |       | —               |       | 36.77                               |       | 751                     |       | 37.24                               |       | —               |       |
| $ 52.44                                  |       | 1,423                   |       | 2.40                                                             |       | —               |       | 52.44                               |       | 1,423                   |       | 52.44                               |       | —               |       |
| $ 53.00 – $70.94                    |       | 10                      |       | 2.84                                                             |       | —               |       | 57.01                               |       | 10                      |       | 57.01                               |       | —               |       |
|                                          |       | 4,538                   |       | 4.33                                                             |       | $                    | 6,338      |                                | $          | 34.44                   |       | 4,367                               |       | $                    | 34.90      |   | $ | 5,580 |   |

 

Theoptions above were issued with exercise prices that approximated fair value atthe date of grant.

 

The aggregate intrinsicvalue in the preceding table represents the total pretax intrinsic value, basedon our closing price of $23.31 as of December 31, 2007, which would havebeen received by option holders had all option holders exercised their optionson that date. The weighted average remaining contractual term for exercisableoptions was 4.21 at December 31, 2007. The total number of in-the-moneyoptions exercisable as of December 31, 2007 was 1,086. At December 31,2007, 2,906 options or 1,453 RSUs are available for grant under our 2005 plan.

 

*RestrictedStock Units*

 

Our2005 Plan permits the granting of restricted stock units to eligible employeesand directors. Awards granted during 2007 typically become fully vested overtwo or three year periods. Restricted stock units are payable in shares of ourcommon stock upon vesting.

 

Thefollowing table presents a summary of the activity in our nonvested restrictedstock units during the year ended December 31, 2007:

 
| **Nonvested stock units**              | ** ** | **Number of    Stock Units** | ** ** | **Weighted-   Average    Grant-Date    Fair Value** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| Nonvested stock  units at December 31, 2006 |       | 967                                              |       | $                                                                                 | 28.67      |   |
| Granted                                          |       | 755                                              |       | 27.73                                                                             |       |
| Vested                                           |       | (355                                             | )          | 26.74                                                                             |       |
| Forfeited                                        |       | (60                                              | )          | 26.81                                                                             |       |
| Nonvested stock  units at December 31, 2007 |       | 1,307                                            |       | $                                                                                 | 27.20      |   |

 

Asof December 31, 2007, there was approximately $17,300 of totalunrecognized compensation cost related to nonvested share-based compensationarrangements granted under the 2005 Plan. That cost is expected to berecognized over an estimated weighted average amortization period ofapproximately 1.3 years. In the first quarter of 2008, a total of 544 sharesvested. At the release of these shares, 159 shares were withheld for taxes,resulting in a net issuance of 385 shares.

 

*Performance– Based Restricted Stock Units*

 

Certainrestricted stock units contain both service and performance conditions thataffect the quantity of awards that will vest. Performance-based restrictedstock units begin vesting upon the completion of a specified service period andthe achievement of certain performance targets (which can include individualand company measures) and are converted into shares of our common stock uponvesting, typically over a three year period. The fair value is based on themarket price of our common stock on the grant date and assumes that the targetpayout level will be achieved. Compensation cost is adjusted in future periodsfor subsequent changes in the expected outcome of the performance relatedconditions until the vesting date. All performance-based restricted stock unitactivity is included in the nonvested stock unit table of activity above.

 

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*Valuationand Expense Information*

 

The following tablesummarizes stock-based compensation expense related to employee stock optionsand restricted stock units under SFAS 123R for the years ended December 31,2007 and 2006, which was allocated as follows:

 
| ** **                                                       | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                       | ** ** | **2007**                                    | ** ** | **2006** | ** ** |
|                                                             |       |                                        |       |   |   |
| Cost of sales                                                    |       | $                                           | 1,134      |   | $ | 978 |   |
|                                                             |       |                                        |       |   |   |
| Research and  development                                        |       | 5,825                                       |       | 4,302 |   |
| Selling, general  and administrative                             |       | 12,682                                      |       | 9,307 |   |
|                                                             |       |                                        |       |   |   |
| Stock-based  compensation expense included in operating expenses |       | 18,507                                      |       | 13,609 |   |
|                                                             |       |                                        |       |   |   |
| Total  stock-based compensation expense                          |       | 19,641                                      |       | 14,587 |   |
| Tax benefit                                                      |       | (3,673                                      | )          | (4,862 | ) |
|                                                             |       |                                        |       |   |   |
| Total  stock-based compensation expense, net of tax              |       | $                                           | 15,968     |   | $ | 9,725 |   |

 

For the year ended December 31,2005, we recorded stock compensation expense of $2,014 related to theamortization of deferred compensation recorded as a result of assumed optionsfrom acquisitions. For 2005, $1,138 was recorded in research and developmentexpense and $876 was recorded in selling, general and administrative expense.

 

Thetable below illustrates the effect on net income and earnings per share as ifwe had applied the fair-value recognition provisions of SFAS 123 to all of ouremployee stock-based compensation awards for periods prior to the adoption ofSFAS 123R.

 
| ** **                                                                                                                              | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Net income — as  reported                                                                                                          |       | $        | 48,349     |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                            |       | 2,014    |       |
| Deduct: Total  stock based employee compensation expense determined under fair value method  for all awards, net of related tax effects |       | (28,684  | )          |
| Net income — pro  forma                                                                                                            |       | $        | 21,679     |   |
|                                                                                                                                    |       |     |       |
| Basic earnings  per share — as reported                                                                                            |       | $        | 0.98       |   |
| Basic earnings  per share — pro forma                                                                                              |       | $        | 0.44       |   |
| Diluted earnings  per share — as reported                                                                                          |       | $        | 0.96       |   |
| Diluted earnings  per share — pro forma                                                                                            |       | $        | 0.43       |   |

 

We estimate the fairvalue of options using the Black-Scholes Model. This model requires the inputof assumptions regarding a number of complex and subjective variables that willusually have a significant impact on the fair value estimate. These variablesinclude, but are not limited to, the volatility of our stock price and employeeexercise behaviors. The assumptions and variables used for the current periodgrants were developed based on SFAS 123R and SEC guidance contained in SAB 107.The weighted-average estimated fair value of stock options granted to employeesduring the years ended December 31, 2007 and 2006 was $9.23 and $13.07 pershare, respectively, using the Black-Scholes Model with the followingweighted-average assumptions:

 
| ** **                | ** ** | **2007** | ** ** | **2006** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| Expected  volatility      |       | 42.04    | %          | 44.23    | %          |
| Risk-free  interest rate  |       | 4.72     | %          | 4.85     | %          |
| Expected  dividend yield  |       | —   |       | —   |       |
| Expected life  (in years) |       | 3.2      |       | 4.31     |       |

 

78

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We based our estimate ofexpected volatility for the years ended December 31, 2007 and 2006 on thesequential historical daily trading data of our common stock for a period equalto the expected life of the options granted. The selection of the historical volatility approach was based onavailable data indicating our historical volatility is as equallyrepresentative of our future stock price trends as is implied volatility. Therisk-free interest rate assumption is based upon implied yields of U.S. Treasuryzero-coupon bonds on the date of grant having a remaining term equal to theexpected life of the options granted. The dividend yield is based on our historical and expected dividendpayouts. The expected life of our employee stock options is based uponhistorical exercise and cancellation activity of previously stock-based grantswith a ten-year contractual term. Stock-based compensation expense recognizedin our consolidated statements of income for the years ended December 31,2007 and 2006 is based on options and restricted stock units ultimatelyexpected to vest, and has been reduced for estimated forfeitures.  These estimates were based upon historicalforfeiture experience.

 

We have used third-partyanalyses to assist in developing some of the assumptions used in ourBlack-Scholes Model.  We will continue toassess the assumptions and methodologies used to calculate estimated fair valueof stock-based compensation.  If circumstanceschange, and additional data becomes available over time, we may change ourassumptions and methodologies, which may materially impact our fair valuedetermination.

 

*Pro Forma Information Under SFAS 123 for Periods Prior to January 1,2006*

 

The pro forma amountsreflected above are not representative of the effects on reported net income infuture years because, in general, options granted typically do not vest forseveral years and additional awards are made each year.  However, on April 29, 2005, our Board ofDirectors approved a plan to accelerate vesting of certain options resulting inadditional pro-forma expense of approximately $13,000, before tax, in2005.  The weighted-average estimatedvalue of stock options granted to employees and directors during the year endedDecember 31, 2005 was $7.00 per share, using the Black-Scholes Model withthe following weighted-average assumptions:

 

| ** **               | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|
| Dividend yield           |       | —   |       |
| Expected life  (years)   |       | 1.8      |       |
| Expected  volatility     |       | 45.3     | %          |
| Risk-free  interest rate |       | 3.60     | %          |

 

*EmployeeStock Purchase Plan*

 

On December 6,2000, our stockholders approved an employee stock purchase plan for all of ouremployees (the AESPP), through which qualified employees may participate incommon stock ownership. The AESPP qualifies as a non-compensatory plan under Section 423of the Internal Revenue Code. We have reserved 1,500 shares of common stock forissuance under the AESPP. The price of stock purchased under the AESPP isgenerally 85% of the lower of the fair market value of our common stock (i) atthe beginning of the offering period or (ii) at the end of the purchaseperiod. In the event the fair market value at the end of a purchase period isless than the fair market value at the beginning of the offering period, theparticipants will be withdrawn from the current offering period followingexercise and automatically re-enrolled in a new offering period. The newoffering period will use the lower fair market value as of the first date ofthe new offering period to determine the purchase price for future purchaseperiods. The AESPP administrator interprets and administers all rules andregulations applicable to the AESPP. Pursuant to the AESPP, 247 shares were issued at a weighted averageprice of $24.42 per share for the year ended December 31, 2005.  Our Board of Directors has indefinitelysuspended participation in the AESPP following the 2005 purchase periods.

 

**15.**                              Retirement Plans

** **

We sponsor a 401(k) savingsplan covering substantially all U.S. employees and a profit-sharing plancovering substantially all international employees.  Under the 401(k) savings plan, we makediscretionary contributions to match 50% of an employee’s contributions up to6% of the employee’s compensation. We may also elect to make additionaldiscretionary contributions as determined by our Board of Directors.  We made only discretionary matchingcontributions, during the years ended December 31, 2007, 2006 or 2005under the 401(k) savings plan. Our expense for contributions under theseplans totaled approximately $3,245, $2,022 and $1,658 for the years ended December 31,2007, 2006 and 2005, respectively.

 

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**16.**                              Segment Reporting

** **

In thefirst quarter of 2007, we merged the Mobile Technologies Division into theLANDesk Division as their products consist primarily of software sold tosimilar customer groups.  Also in thefirst quarter of 2007, we merged the Embedded Software and Solutions Divisioninto the Management Systems Division as they are serving similar customers andmarket segments. As a result of merging these two divisions we re-evaluated oursegment disclosures and identified two reportable segments.  Accordingly, we have provided revenue andoperating income (loss) below under the new segment structure and haveretroactively adjusted the segment information previously disclosed for theyears ended December 31, 2006 and 2005 to conform to the current segmentdisclosures.  In addition, as a result ofthe merger of divisions, we reallocated goodwill among our reporting units (*see Note 8*).

 

We evaluate the performanceof our segments based on revenue and operating profit, which is calculatedbefore corporate and unallocated costs, stock-based compensation costs,amortization of intangibles and other purchase accounting adjustments, andacquired in-process research and development expense.  We do not track or use assets by segment as ameasure of performance and, therefore, have not presented assets by segment.The other business units do not qualify for individual presentation nor do theyqualify for aggregation into another business unit.  The following is a presentation ofinformation for our two reportable segments (Management Systems and LANDesk):

 
| ** **                                                         | ** ** | **For the years ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2007**                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net revenues:                                                      |       |                                                          |       |   |   |   |   |
| Management  Systems                                                |       | $                                                             | 463,609    |   | $ | 460,178 |   | $ | 352,095 |   |
| LANDesk                                                            |       | 111,906                                                       |       | 40,368 |   | — |   |
| Other business  units                                              |       | 22,633                                                        |       | 16,658 |   | 14,532 |   |
| Corporate and  unallocated                                         |       | 4,601                                                         |       | 3,677 |   | 3,261 |   |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | (1,874                                                        | )          | (1,686 | ) | — |   |
| Total net  revenues                                                |       | $                                                             | 600,875    |   | $ | 519,195 |   | $ | 369,888 |   |

 
| ** **                                                         | ** ** | **For the years ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2007**                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Operating income  (loss):                                          |       |                                                          |       |   |   |   |   |
| Management  Systems                                                |       | $                                                             | 133,355    |   | $ | 142,722 |   | $ | 96,422 |   |
| LANDesk                                                            |       | 3,983                                                         |       | 5,270 |   | — |   |
| Other business  units                                              |       | (8,285                                                        | )          | (10,606 | ) | (11,340 | ) |
| Corporate and  unallocated costs                                   |       | (14,178                                                       | )          | (11,276 | ) | (10,845 | ) |
| Stock-based  compensation                                          |       | (19,641                                                       | )          | (14,587 | ) | (2,014 | ) |
| Amortization of  intangibles and other expenses                    |       | (43,173                                                       | )          | (27,229 | ) | (19,126 | ) |
| Acquired  in-process research and development expense              |       | —                                                        |       | (20,700 | ) | — |   |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | (1,874                                                        | )          | (1,686 | ) | — |   |
| Total income  from operations                                      |       | $                                                             | 50,187     |   | $ | 61,908 |   | $ | 53,097 |   |

 

**Revenue and operating income for our Management SystemsDivision includes the operating results of Cyclades from the date of theacquisition (*See Note 3*).**

** **

**80**

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** **

Sales by product line forour Management Systems Division and LANDesk Division for the years ended December 31,  2007, 2006 and 2005 are as follows:

 
| ** **                                      | ** ** | **For the years ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Management  Systems Division (MSD) net revenue: |       |                                                          |       |   |   |   |   |
| KVM                                             |       | $                                                             | 354,876    |   | $ | 352,402 |   | $ | 311,734 |   |
| Serial  management                              |       | 49,603                                                        |       | 46,534 |   | 4,124 |   |
| Embedded software  and solutions                |       | 32,983                                                        |       | 33,766 |   | 21,882 |   |
| Other                                           |       | 26,147                                                        |       | 27,476 |   | 14,355 |   |
| Total MSD net  revenue                          |       | $                                                             | 463,609    |   | $ | 460,178 |   | $ | 352,095 |   |

 
| ** **                     | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|
| ** **                     | ** ** | **2007**                                    | ** ** | **2006** | ** ** |
| LANDesk Division  net revenue: |       |                                        |       |   |   |
| Licenses and  royalties        |       | $                                           | 42,514     |   | $ | 20,545 |   |
| Maintenance and  services      |       | 45,911                                      |       | 13,319 |   |
| Subscription  revenue          |       | 23,481                                      |       | 6,504 |   |
| Total LANDesk  net revenue     |       | $                                           | 111,906    |   | $ | 40,368 |   |

 

Following is apresentation of sales by geographic region for the years ended December 31,2007, 2006 and 2005:

 
| ** **               | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net sales:               |       |     |       |     |       |     |       |
| United States            |       | $        | 333,915    |     | $          | 295,825  |       | $ | 210,844 |   |
| International            |       | 266,960  |       | 223,370  |       | 159,044  |       |
|                     |       |     |       |     |       |     |       |
| Total geographic  region |       | $        | 600,875    |     | $          | 519,195  |       | $ | 369,888 |   |

** **

**We sell our products internationally to customers inseveral countries.  Outside of the UnitedStates, no other country accounted for more than 10% of sales in 2007, 2006 or2005.**

** **

Following is apresentation of sales by customer type for the years ended December 31,2007, 2006 and 2005:

 
| ** **           | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------|------------|----------|------------|----------|------------|----------|------------|
| Net sales:           |       |     |       |     |       |     |       |
| Branded              |       | $        | 393,799    |     | $          | 311,885  |       | $ | 191,901 |   |
| OEM                  |       | 207,076  |       | 207,310  |       | 177,987  |       |
|                 |       |     |       |     |       |     |       |
| Total customer  type |       | $        | 600,875    |     | $          | 519,195  |       | $ | 369,888 |   |

 

Following is apresentation of long-lived assets as of December 31, 2007 and 2006:

 
| ** **          | ** ** | **As of December 31,** | ** ** |
|---------------------|------------|---------------------------------------|------------|
| ** **          | ** ** | **2007**                              | ** ** | **2006** | ** ** |
| Long-lived  assets: |       |                                  |       |   |   |
| United States       |       | $                                     | 26,266     |   | $ | 25,585 |   |
| International       |       | 11,032                                |       | 12,419 |   |
| Total               |       | $                                     | 37,298     |   | $ | 38,004 |   |

** **

**17.**                               Line of Credit and Interest Rate Swap

** **

On June 16,2006, we entered into a $250,000 unsecured, five-year revolving bank line ofcredit (the Credit Agreement).  We used$150,000 under the line of credit to fund a portion of the LANDesk acquisition(*See Note 3*).  Further, we have and plan to continue to useborrowings for the purchase of shares under our stock repurchase program (*See Note 11*) and other business purposes.  The line of credit bears an interest rate ofLIBOR plus a credit spread and carries no set principal repayment schedule,other than any outstanding amount being due at the end of the five yearterm.  The credit spread is based on aleverage ratio computation. Currently, the credit spread is 70 basis points.Direct costs incurred from obtaining the line of credit were capitalized andare being amortized over 

 

81

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theterm of the agreement.  There was $95,000outstanding under the line of credit as of December 31, 2007.  The line of credit carries certain customaryevents of default and covenants, including covenants that (without the consentof the Administrative Agent) restrict the ability of Avocent and oursubsidiaries to pay dividends, create or permit liens on assets or engage inmergers and acquisitions. There also exist certain financial covenantsincluding a minimum interest coverage ratio and a maximum total leverage ratio.We pay a commitment fee on the unused portion of the line of credit based onthe results of a leverage ratio computation. Currently, the commitment fee rateis 12.5 basis points.

 

InAugust 2006, we entered into an interest rate swap agreement with anotional amount of $125,000. The notional amount of the interest rate swap was$80,000 as of December 31, 2007. The objective of the rate swap agreement is to provide a hedge againstrising LIBOR interest rates that would have a negative effect on our cash flowsdue to changes in interest rates on the line of credit.  The swap was effective on August 31,2006 and terminates on December 31, 2008. The swap calls for us to make fixed rate payments of 5.42% (plus thecredit spread) over the term of the hedge and to receive floating rate paymentsbased on LIBOR (matching the LIBOR rate in the line of credit above) from thecounter-party.  We anticipate that thehedge will be settled upon maturity and it is being accounted for as a cashflow hedge. The interest rate swap is recorded at fair value each reportingperiod with the changes in the fair value of the hedge that take place throughthe date of maturity recorded in accumulated other comprehensive income (OCI).

 

AtDecember 31, 2007, we recorded an unrealized loss on the swap, net of tax,of $390 in accumulated other comprehensive income (OCI). There was no materialineffectiveness in the year and we anticipate no reclassification of OCI intoearnings in the next 12 months.

 

**18.**                               Summarized QuarterlyFinancial Data (Unaudited)

** **

The following tablepresents unaudited quarterly consolidated operating results for each of ourlast eight fiscal quarters. This information has been prepared on a basisconsistent with our audited consolidated financial statements and includes alladjustments, consisting only of normal recurring adjustments that we considernecessary for a fair presentation of the data.

 
| ** **                 | ** ** | **Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **March 30,  2007**         | ** ** | **June 29,  2007** | ** ** | **September 28,  2007** | ** ** | **December 31,  2007** | ** ** |
| Net sales                  |       | $                                | 133,151    |   | $ | 150,225 |   | $ | 162,072 |   | $ | 155,427 |   |
| Gross profit               |       | $                                | 81,015     |   | $ | 95,082 |   | $ | 103,590 |   | $ | 99,333 |   |
| Income from  operations    |       | $                                | 2,512      |   | $ | 13,870 |   | $ | 20,438 |   | $ | 13,367 |   |
| Net income (2)             |       | $                                | 746        |   | $ | 15,000 |   | $ | 16,117 |   | $ | 14,066 |   |
| Net income per  share (1): |       |                             |       |   |   |   |   |   |   |
| Basic                      |       | $                                | 0.01       |   | $ | 0.30 |   | $ | 0.32 |   | $ | 0.29 |   |
| Diluted                    |       | $                                | 0.01       |   | $ | 0.29 |   | $ | 0.32 |   | $ | 0.28 |   |

 
| ** **                 | ** ** | **Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **March 31,  2006**         | ** ** | **June 30,  2006** | ** ** | **September 29,  2006** | ** ** | **December 31,  2006** | ** ** |
| Net sales                  |       | $                                | 94,512     |   | $ | 118,005 |   | $ | 141,814 |   | $ | 164,864 |   |
| Gross profit               |       | $                                | 55,957     |   | $ | 71,410 |   | $ | 88,991 |   | $ | 105,414 |   |
| Income from  operations    |       | $                                | 14,913     |   | $ | 17,201 |   | $ | 8,180 |   | $ | 21,614 |   |
| Net income (2)             |       | $                                | 12,933     |   | $ | 13,581 |   | $ | 2,550 |   | $ | 16,468 |   |
| Net income per  share (1): |       |                             |       |   |   |   |   |   |   |
| Basic                      |       | $                                | 0.26       |   | $ | 0.28 |   | $ | 0.06 |   | $ | 0.32 |   |
| Diluted                    |       | $                                | 0.26       |   | $ | 0.28 |   | $ | 0.05 |   | $ | 0.32 |   |

 

----

(1)       The net income per share for each quarter within afiscal year does not equal the total net income per share for the particularfiscal year due to variations in the price of our common stock during the yearand the effect these variations had on the weighted average shares outstandingfrom common equivalents calculation.

 

(2)       The income from operations and net income for thequarter ended March 31, 2006 include a non-recurring charge of $2,100 foracquired in-process research and development related to the Cycladesacquisition.  

 

Similar chargeswere incurred in the quarter ended September 29, 2006, for LANDesktotaling $18,600.  A tax benefit of$6,510 is included in the second quarter of 2007 as a result of certain taxelections related to the LANDesk in-process research and development expense (*see note 10*).

 

82

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**19.****                               Litigation**

 

In March 2006,TFS Electronic Manufacturing Services, Inc. (“TFS”) filed a Third-PartyComplaint and an Objection to Claim of Avocent Corporation with the UnitedStates Bankruptcy Court, District of Arizona. As a result of the complaint, an adversary proceeding wascommenced against us in the TFS bankruptcy case in an effort to disallow ourbankruptcy claim against TFS in its entirety. TFS also seeks damages in an undetermined amount for our alleged breachof contract, negligence, negligent misrepresentations, breaches of warranty,unjust enrichment, disparagement of TFS’ business, and quantum merit.  TFS is seeking recovery of actual damages,punitive damages, attorneys’ fees, pre- and post-judgment interest, costs fromus.  For purposes of discovery, thematter was consolidated with a separate matter between TFS and TopSearchPrinted Circuits (HK), Ltd., pending in the United States District Court forthe District of Arizona. A mediation session was held in October 2007 andconcluded without resolution, and the District Court subsequently severed thetwo matters.  TFS’ claim against Avocentis now back in the Bankruptcy Court and discovery is currently underway.

 

In January 2007, we filed a complaint forpatent infringement in the United States District Court for the WesternDistrict of Washington against Aten Technology, Inc., Aten InternationalCo., Ltd, Belkin Corporation, Rose Electronics and its general partners, andTrippe Manufacturing Company.  Thedefendants filed counterclaims alleging non-infringement, unenforceability, andinvalidity.  In May 2007, we enteredinto a Settlement and License Agreement with Trippe Manufacturing, anddismissed Trippe from the lawsuit.  In October 2007,the District Court stayed the action pending a re-examination of our patents bythe Patent and Trademark Office (the “PTO”). That re-examination is currently underway.

 

In March 2007,KBM Enterprises, formerly a contract manufacturer forAvocent, filed a complaint against Avocent in the Circuit Court of MadisonCounty, Alabama, seeking $9,500 for costs allegedly incurred by KBMin its manufacturing efforts on behalf of Avocent.  We have filed an answer and counterclaimsagainst KBM and one of its principals, and we intend to vigorously defend ourpositions.  Discovery is currentlyunderway.

 

In April 2007,we filed a complaint for declaratory judgment against Aten International Co.,Ltd. in the United States District Court for the Northern District ofAlabama.  We are seeking a declaratoryjudgment that two patents owned by Aten and asserted against Avocent areinvalid and that certain of products alleged by Aten to infringe do notinfringe these patents.  In August 2007,Aten’s motion to dismiss for lack of personal jurisdiction was granted, and wehave appealed that ruling to the Federal Circuit Court of Appeals.  Oral arguments were held in February 2008.

 

In November 2007,Gemini IP, LLC filed a complaint for patent infringement in the United StatesDistrict Court for the Eastern District of Texas, Sherman Division, againstAvocent Corporation and our subsidiary LANDesk Software, Inc.  The complaint alleges infringement of aGemini patent through the sales of a LANDesk product.  The complaint seeks injunctive relief,damages, attorneys’ fees, and costs. Avocent Corporation was dismissed from the lawsuit in January 2008,and we have made a claim for indemnification against the LANDesk escrowaccount.

 

The outcome of anyclaim or litigation is inherently uncertain, however our current view based onthe facts and circumstances known to us is that resolution of theforegoing matters will not materially affect our operations, financialcondition, or cash flows.

 

**20.****                              SubsequentEvents**

 

In January 2008, ourBoard approved an additional 4,000 shares for our share re-purchaseprogram.  During the period from January 1,2008 through February 15, 2008, we purchased 2,978 additional shares ofour common stock for a total cost of $47,747. As of February 15, 2008 there were 3,323 shares available forrepurchase under the program.

 

In January of 2008John R. Cooper, our Chief Executive Officer and Chairman of the Board ofDirectors, announced his resignation, effective March 31, 2008.  Additionally, we undertook certainorganizational realignment activities during the first quarter of 2008 toadjust headcount in targeted areas.  Weexpect to record approximately $4,000 to $4,500 of expense, including $600 to$800 of stock-based compensation, related to Mr. Coopers retirement and the realignment activities inthe first quarter of 2008.

 

83

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**Item 9.  Changes in and Disagreements With Accountantson Accounting and Financial Disclosure.**

 

None.

 

**Item 9A. Controls and Procedures.**

 

(a) *Evaluation of disclosure controls and procedures.*  Based on their evaluation as of December 31,2007, our Chief Executive Officer and Chief Financial Officer have concludedthat our disclosure controls and procedures (as defined in Rules 13a-14(c) and15d-14(c) under the Securities Exchange Act of 1934) are effective.

 

(b) *Changes in internal controls*.  There were no changes in our internalcontrols or in other factors that significantly affected these controlssubsequent to the date of their evaluation, including any corrective actionswith regard to significant deficiencies and material weaknesses.  We completed the integration of LANDesk,acquired in August 2006, into Avocent standard processes and controlsduring 2007 including extending our ERP system LANDesk.  This has enhanced our internal control overfinancial reporting through the automation and standardization of certaincontrols and processes, as all of our financially significant locations are nowoperating under the same ERP system.

 

Management’s Report onInternal Control over Financial Reporting and the Report of IndependentRegistered Public Accounting Firm is included in Part II, Item 8 ofthis Annual Report on Form 10-K.

 

**Item 9B. Other.**

 

None.

 

**PART III**

 

Information with respectto Items 10 through 14 of this Part III may be found in the definitiveproxy statement to be delivered to stockholders in connection with the 2008Annual Meeting of Stockholders. Such information is incorporated herein byreference.

 

84

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**PART IV**

 

**Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.**

 

**(a) FinancialStatement Schedule**

 

**Schedule of Valuation and Qualifying Accounts**

*For theyears ended December 31, 2007, 2006 and 2005 (in thousands)*

 
| ** **                            | ** ** | **Beginning Balance** | ** ** | **Assumed on  Acquisitions(1)** | ** ** | **Charged to  Income** | ** ** | **Deductions from  Reserves** | ** ** | **Ending Balance** | ** ** |
|---------------------------------------|------------|----------------------------|------------|--------------------------------------|------------|-----------------------------|------------|------------------------------------|------------|-------------------------|------------|
|                                  |       |                       |       |                                 |       |                        |       |                               |       |                    |       |
| Year ended  December 31, 2005:   |       |                       |       |                                 |       |                        |       |                               |       |                    |       |
| Allowance for  doubtful accounts      |       | $                          | 1,740      |                                 | —     |                        | (585       | )                                  | (26        | )                       | $          | 1,129 |   |
| Allowance for  inventory obsolescence |       | $                          | 3,785      |                                 | —     |                        | 3,308      |                               | (2,535     | )                       | $          | 4,558 |   |
| Allowance for  sales returns          |       | $                          | 3,174      |                                 | —     |                        | 7,923      |                               | (8,220     | )                       | $          | 2,877 |   |
| Liability for  warranty returns       |       | $                          | 2,760      |                                 | —     |                        | 252        |                               | (476       | )                       | $          | 2,536 |   |
| Valuation  allowance for income taxes |       | $                          | 2,853      |                                 | —     |                        | 167        |                               | (2,466     | )                       | $          | 554 |   |
|                                  |       |                       |       |                                 |       |                        |       |                               |       |                    |       |
| Year ended  December 31, 2006:   |       |                       |       |                                 |       |                        |       |                               |       |                    |       |
| Allowance for  doubtful accounts      |       | $                          | 1,129      |                                 | 840        |                        | 480        |                               | —     |                    | $          | 2,449 |   |
| Allowance for  inventory obsolescence |       | $                          | 4,558      |                                 | 1,131      |                        | 6,151      |                               | (6,262     | )                       | $          | 5,578 |   |
| Allowance for  sales returns          |       | $                          | 2,877      |                                 | 3,140      |                        | 9,061      |                               | (9,040     | )                       | $          | 6,038 |   |
| Liability for  warranty returns       |       | $                          | 2,536      |                                 | 158        |                        | 155        |                               | (363       | )                       | $          | 2,486 |   |
| Valuation  allowance for income taxes |       | $                          | 554        |                                 | 2,486      |                        | 1,135      |                               | —     |                    | $          | 4,175 |   |
| Year ended  December 31, 2007:   |       |                       |       |                                 |       |                        |       |                               |       |                    |       |
| Allowance for  doubtful accounts      |       | $                          | 2,449      |                                 | —     |                        | 1,234      |                               | (1,202     | )                       | $          | 2,481 |   |
| Allowance for  inventory obsolescence |       | $                          | 5,578      |                                 | —     |                        | 7,209      |                               | (5,459     | )                       | $          | 7,328 |   |
| Allowance for  sales returns          |       | $                          | 6,038      |                                 | —     |                        | 14,368     |                               | (15,390    | )                       | $          | 5,016 |   |
| Liability for  warranty returns       |       | $                          | 2,486      |                                 | —     |                        | 5,974      |                               | (6,606     | )                       | $          | 1,854 |   |
| Valuation  allowance for income taxes |       | $                          | 4,175      |                                 |       |                        | 429        |                               | (618       | )                       | $          | 3,986 |   |

 

----

(1)                                  Amountsrepresent balances assumed from the acquisition of Cyclades and LANDesk in2006.

 

85

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**(b) Exhibits**

 
|                     | ** ** | ** **                                                                                                                                                                    | ** ** | **Incorporated by Reference** | ** ** |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                                                                                  | ** ** | **Form**                      | ** ** | **Entity(1)** | ** ** | **Date** | ** ** | **Number** | ** ** | **Included** | ** ** |
| 3.1                 |       | Certificate of Incorporation of Aegean Sea Inc.                                                                                                                          |       | S-4                           |       | AGI |   | 3/31/00 |   | Ex. 3.1 |   |   |   |
| 3.1.1               |       | Certificate of Amendment of Certificate of  Incorporation (changing name from Aegean Sea Inc. to Avocent  Corporation)                                                   |       | 10-K                          |       | AVCT |   | 3/27/01 |   | Ex 3.1.1 |   |   |   |
| 3.2                 |       | Amended and Restated Bylaws of Avocent Corporation                                                                                                                            |       | 10-Q                          |       | AVCT |   | 11/5/07 |   | Ex. 99.14 |   |   |   |
| 10.1                |       | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Huntsville Corp., the  Company, and Edward H. Blankenship |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.1 |   |   |   |
| 10.2                |       | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Huntsville Corp., the  Company, and John R. Cooper        |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.2 |   |   |   |
| 10.2.2              |       | Retirement and General Release Agreement dated  January 23, 2008, among Avocent Huntsville Corp., the Company, and  John R. Cooper                             |       |                          |       |   |   |   |   |   |   | X |   |
| 10.3                |       | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Huntsville Corp., the  Company, and Stephen M. Daly       |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.3 |   |   |   |
| 10.4                |       | Employment and Noncompetition Agreement dated  December 13, 2006, among Avocent Huntsville Corp., the Company, and  Kay E. Kienast                             |       |                          |       |   |   |   |   |   |   | X |   |
| 10.5                |       | Amended and Restated Employment and Noncompetition  Agreement dated December 12, 2006, among Avocent International Ltd., the  Company, and Kieran MacSweeney        |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.4 |   |   |   |
| 10.6                |       | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Huntsville Corp., the  Company, and Eugene F. Mulligan    |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.5 |   |   |   |
| 10.7                |       | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Texas, L.P., the  Company, and C. David Perry             |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.6 |   |   |   |
| 10.8                |       | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Huntsville Corp., the  Company, and Douglas E. Pritchett            |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.7 |   |   |   |
| 10.9                |       | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Redmond Corp., the  Company, and Samuel F. Saracino       |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.8 |   |   |   |
| 10.10               |       | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Huntsville Corp., the  Company, and Christopher Thomas              |       | 10-K                          |       | AVCT |   | 3/1/07 |   | Ex. 10.9 |   |   |   |

 

86

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| 10.11 |   | Amended and Restated Employment and Noncompetition  Agreement dated December 13, 2006, among Avocent Huntsville Corp., the  Company, and Doyle C. Weeks                            |   | 10-K   |   | AVCT   |   | 3/1/07  |   | Ex. 10.10   |   |   |   |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|---------|--------|-------------|--------|--------|--------|
| 10.12 |   | Amended and Restated Amendment Agreement among the  Company, Avocent Employment Services Company, Cybex Computer Products  Corporation and Stephen F. Thornton                                    |   | 10-Q   |   | AVCT   |   | 8/9/02  |   | Ex. 10.30.1 |   |   |   |
| 10.13 |   | Form of Avocent Corporation Indemnification  Agreement for Officers and Directors                                                                                                            |   | 10-Q   |   | AVCT   |   | 9/29/00 |   | Ex. 10.11   |   |   |   |
| 10.14 |   | Form of Amendment to Option Agreement for  Directors regarding Change of Control of the Company                                                                                              |   | 10-K   |   | AVCT   |   | 3/12/04 |   | Ex. 10.31   |   |   |   |
| 10.15 |   | Transaction Agreement dated April 26, 2006,  among the Company, Crimson Acquisition Corp, LANDesk Group Limited, and the  Shareholder Representative                                         |   | 10-Q   |   | AVCT   |   | 5/10/06 |   | Ex. 99.14   |   |   |   |
| 10.16 |   | Avocent Corporation 2005 Equity Incentive Plan, as  amended, and Form of Agreements                                                                                                          |   | 8-K    |   | AVCT   |   | 6/15/06 |   | Ex. 99.16   |   |   |   |
| 10.17 |   | $250,000,000 Credit Agreement dated June 16,  2006, among Avocent Corporation, the Guarantors Party thereto, the Lenders  Party thereto, and Regions Bank                                    |   | 8-K    |   | AVCT   |   | 6/20/06 |   | Ex. 99.18   |   |   |   |
| 10.18 |   | Summary of Avocent Corporation 2007 Executive Bonus  Program                                                                                                                                      |   | 10-Q   |   | AVCT   |   | 5/7/07  |   | Ex. 99.10   |   |   |   |
| 21.1  |   | Subsidiaries of Avocent Corporation                                                                                                                                                               |   |   |   |   |   |    |   |        |   | X      |   |
| 23.1  |   | Consent of PricewaterhouseCoopers LLP, Independent  Registered Public Accounting Firm                                                                                                             |   |   |   |   |   |    |   |        |   | X      |   |
| 24.1  |   | Power of Attorney(2)                                                                                                                                                                              |   |   |   |   |   |    |   |        |   | X      |   |
| 31.1  |   | Sarbanes-Oxley Act of 2002  Section 302(a) Certification of the Chief Executive Officer                                                                                                 |   |   |   |   |   |    |   |        |   | X      |   |
| 31.2  |   | Sarbanes-Oxley Act of 2002  Section 302(a) Certification of the Chief Financial Officer                                                                                                 |   |   |   |   |   |    |   |        |   | X      |   |
| 32.1  |   | Certification of the Chief Executive Officer and the  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |   |   |   |   |   |    |   |        |   | X      |   |

 

----

 

(1)                                  Thefollowing abbreviations are used to identify corporate entities:

 

AVCT – AvocentCorporation and AGI = Aegean Sea Inc. (now known as AvocentCorporation)

 

(2)                                  Setforth on the signature page and incorporated herein by reference.

 

**(c)  Reports on Form 8-K**

 

None

 

87

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
|            | **AVOCENT CORPORATION**                 | ** **         |
|------------|-----------------------------------------|--------------------|
| ** ** | ** **                              | ** **         |
| ** ** | ** **                              |
|       | By:                                     | /s/ John R. Cooper |
|       | John R. Cooper, Chief Executive Officer |
|       | Date: February 21, 2008            |               |
|            |                                         |                    |  |

 

**POWER OFATTORNEY**

 

KNOW ALL PERSONS BY THESEPRESENTS:

 

That the undersignedofficers and directors of Avocent Corporation do hereby constitute and appointEdward H. Blankenship, Samuel F. Saracino, and Doyle C. Weeks, andeach of them, the lawful attorney and agent with power and authority to do anyand all acts and things and to execute any and all instruments which saidattorneys and agents, or either of them, determine may be necessary oradvisable or required to enable Avocent Corporation to comply with theSecurities Exchange Act of 1934, as amended, and any rules or regulationsor requirements of the Securities Exchange Act of 1934, as amended, and any rules orregulations or requirements of the Securities and Exchange Commission inconnection with this Form 10-K Report. Without limiting the generality ofthe foregoing power and authority, the powers granted include the power andauthority to sign the names of the undersigned officers and directors in thecapacities indicated below to this Form 10-K Report of amendments orsupplements thereto, and each of the undersigned hereby ratifies and confirmsall that said attorneys and agents or either of them, shall do or cause to bedone by virtue hereof. This Power of Attorney may be signed in severalcounterparts.

 

IN WITNESS WHEREOF, eachof the undersigned has executed this Power of Attorney as of the date indicatedopposite his name.

 

In accordance with theExchange Act, this report has been signed below by the following persons onbehalf of the registrant and in the capacities and on the dates indicated.

 
| **Signature**                   | ** ** | **Title**                                                                           | ** ** | **Date**                |
|---------------------------------|------------|-------------------------------------------------------------------------------------|------------|-------------------------|
|                            |       |                                                                                |       |                    |
| /s/ John R.  Cooper             |       | Chief Executive Officer                                                             |       | February 21,  2008 |
| John R. Cooper                  |       | (Principal Executive Officer)                                                       |       |                    |
|                            |       |                                                                                |       |                    |
| /s/ Edward H.  Blankenship      |       | Senior Vice President of Finance, Chief Financial  Officer, and Assistant Secretary |       |                    |
| Edward H.  Blankenship          |       | (Principal Financial and Accounting Officer)                                        |       | February 21,  2008 |
|                            |       |                                                                                |       |                    |
| /s/ Harold D.  Copperman        |       | Director                                                                            |       | February 21,  2008 |
| Harold D.  Copperman            |       |                                                                                |       |                    |
|                            |       |                                                                                |       |                    |
| /s/ Francis A. Dramis, Jr. |       | Director                                                                            |       | February 21,  2008 |
| Francis A.  Dramis, Jr.    |       |                                                                                |       |                    |
|                            |       |                                                                                |       |                    |
| /s/ Edwin L.  Harper            |       | Chairman of the Board of Directors                                                  |       | February 21,  2008 |
| Edwin L. Harper                 |       |                                                                                |       |                    |
|                            |       |                                                                                |       |                    |
| /s/ William H. McAleer          |       | Director                                                                            |       | February 21, 2008  |
| William H. McAleer              |       |                                                                                |       |                    |
|                            |       |                                                                                |       |                    |
| /s/ Stephen F.  Thornton        |       | Director                                                                            |       | February 21,  2008 |
| Stephen F.  Thornton            |       |                                                                                |       |                    |
|                            |       |                                                                                |       |                    |
| /s/ David P.  Vieau             |       | Director                                                                            |       | February 21,  2008 |
| David P. Vieau                  |       |                                                                                |       |                    |
|                            |       |                                                                                |       |                    |
| /s/ Doyle C.  Weeks             |       | President and Director                                                              |       | February 21,  2008 |
| Doyle C. Weeks                  |       |                                                                                |       |                    |

 

88

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