** **

**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM 10-K**

 

**(Mark One)**

 
| **ý** | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                  |
|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** **                                                                                                                                                                                                                 |
| ** ** | **FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004.**                                                                                                                                                                           |
| ** ** | ** **                                                                                                                                                                                                                 |
| **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**

 

----

 

**AVOCENT CORPORATION**

(Exact name of registrantas 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’s telephone  number, including area code)               |
|                                                                     |       |                                  |
| Securities registered  under Section 12(b) of the Exchange Act: **None** |
|                                                                     |       |                                  |
| Securities registered  under Section 12(g) of the Exchange Act:     |
| **Common  Stock, $0.001 par value per share**                            |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days.  Yes  ý     No  o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, anddisclosure will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference inPart III of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined by Rule 12b-2 of theAct).  Yes  ý     No  o

 

The aggregate market value of the voting common stockheld by non-affiliates of the registrant on June 27, 2003 was approximately$1,364,588,525.

 

The number of shares outstanding of the registrant’scommon stock as of March 7, 2005 was 50,181,809

 

**DOCUMENTS INCORPORATED BYREFERENCE**

 

Information with respect to items 10 to 14 ofPart III of this Form 10-K may be found in the definitive proxystatement to be delivered to stockholders in connection with the 2005 AnnualMeeting of Stockholders. Such information is incorporated herein by reference.

 

 

----

 

**PART I**

 

**Item 1. Business.**

 

*THIS ANNUALREPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS ANDUNCERTAINTIES. THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT THAT ARE NOTPURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THESECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE FORWARD-LOOKING STATEMENTSINCLUDE, WITHOUT LIMITATION, STATEMENTS RELATING TO FUTURE ECONOMIC CONDITIONSIN GENERAL AND STATEMENTS ABOUT OUR FUTURE:*

 

•                                          *STRATEGY AND BUSINESSPROSPECTS;*

 

•                                          *ENGINEERING AND DESIGNACTIVITIES, DEVELOPMENT AND INTRODUCTION OF NEW PRODUCTS AND TECHNOLOGIES, ANDTHE SIZE AND GROWTH OF THE POTENTIAL MARKETS FOR THESE PRODUCTS ANDTECHNOLOGIES IN THE FUTURE;*

 

•                                          *DEVELOPMENT OF NEW OEM,DISTRIBUTOR, RESELLER, AND SUPPLIER RELATIONSHIPS;*

 

•                                          *SALES, EARNINGS, INCOME,EXPENSES, OPERATING RESULTS, TAX RATES, OPERATING AND GROSS PROFIT AND PROFITMARGINS, INVENTORY LEVELS AND VALUATIONS, RECEIVABLES, RESERVES, LIQUIDITY,INVESTMENT INCOME, CURRENCY RATES, EMPLOYEE STOCK OPTION EXERCISES, CAPITALRESOURCE NEEDS, CUSTOMERS, AND COMPETITION;*

 

•                                             *ABILITY TO OBTAIN AND PROTECTOUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS;*

 

•                                             *EXPANSION OF INTERNATIONALSALES; AND*

 

•                                          *ACQUISITIONS AND TRANSACTIONCOSTS AND ADJUSTMENTS.*

 

*ALL OF THESEFORWARD-LOOKING STATEMENTS ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATEOF THIS ANNUAL REPORT. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSEDISCUSSED IN THIS ANNUAL REPORT. THE FORWARD-LOOKING STATEMENTS CONTAINED INTHIS ANNUAL REPORT, AND OTHER WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS MADEBY US FROM TIME TO TIME, ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THATCOULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THEFORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE,BUT ARE NOT LIMITED TO, THOSE DISCUSSED UNDER THE CAPTION “FACTORS THAT MAYAFFECT FUTURE RESULTS.”*

 

**Overview**

 

Avocent Corporation designs,manufactures, licenses, and sells solutions that provide connectivity andcentralized management of IT infrastructure. We (meaning Avocent and its wholly-owned subsidiaries) provide connectivityand management products and technologies that centralize control of servers,mobile devices, and network appliances, increasing the efficiency of ITpersonnel. Server manufacturers resell private-labeled Avocent KVM (keyboard,video, and mouse) switches and embedded technology in their systems, andcompanies large and small depend on our products and technologies for managingtheir growing IT infrastructure.

 

Our technological innovations include internetprotocol (IP) based switching, centralized management, and intuitive softwareinterfaces. Our products and technologies manage servers, serial devices,wireless devices, mobile devices, and embedded infrastructure. With more thantwo decades of experience, we have grown through product innovations, globalexpansion, and strategic acquisitions. Formed as a result of the merger in 2000 between Apex Inc. and CybexComputer Products Corporation, we subsequently acquired Equinox Systems Inc. in2001, 2C Computing, Inc. in 2002, Soronti, Inc. in 2003, and Crystal LinkTechnologies, OSA Technologies, Inc., and Sonic Mobility, Inc. in 2004.

 

Our KVM switching systems eliminate the need for extrakeyboards, monitors, and mice and allow businesses to save critical space intheir data centers.  Our KVM over IPswitching systems eliminate distance limitations and provide 24/7 access andcontrol of thousands of servers, even when the servers are dispersed indifferent physical locations.  Our DSViewsoftware management and KVM over IP switching systems allow IT managers to usea single console to gain secure, local and remote access and control of serversand other network data center devices from any location.

 

1

----

 

Our innovative advances for the data center includemulti-platform switching, analog matrix switching, KVM extension over CAT 5,PCI bus extension, our proprietary on-screen menu switching system, remote KVMover IP connectivity, digital serial over IP, digital-analog integrated accessto multiple servers, the intelligent platform management interface (IPMI)solutions, wireless KVM, PDA, and hand-held management solutions, andcentralized management software for access and control of networkinfrastructure.

 

Our *DSR SeriesTM*switches combine analog and digital connections, serial connectivity, andexternal modem support in one switch. These appliances integrate our KVM overIP switching technology and CAT 5 connectivity. IT managers and network administrators gain worldwide access and controlof their servers and serial devices and can monitor and manage them all from asingle computer screen.  In addition, weprovide plug and play switching systems for the many network administration,management, and storage problems faced by corporate customers, data centers,and mid-sized businesses. Our connectivity solutions include products andtechnologies sold or licensed under the Avocent, Cybex, and Equinox brands,including our *AMX*TM,***AutoView*TM*, Cstation*TM,*DSView®, DS Series, LongView*TM*,**OutLook®, SuperSerial*,*SwitchView**®*, *Emerge*TM, *SonicAdmin*TM,and *SonicSentinel*TM products.

 

We market our products around the world to adiversified group of original equipment manufacturers (OEMs), dealers,distributors, resellers, and end users, primarily through our sales andcustomer 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 Internet address 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, and anyamendments to these reports, as soon as reasonably practicable after weelectronically file them with, or furnish them to, the Securities and ExchangeCommission.  Also available at thiswebsite are our Code of Business Conduct and Ethics, our Corporate GovernanceGuidelines, our Whistleblower Policy, the Nominating and Governance Committee’sPolicies and Procedures for Director Candidates, and the Charters for ourAudit, Compensation, and Nominating and Governance Committees.  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 principalaccounting officer or controller (or any persons performing similar functions)and relates to the code of ethics definition enumerated in the SEC’sregulations, we will disclose such amendment or waiver at this website withinfive (5) business days after the date of such amendment or waiver.  The information found on our website is notpart of this Form 10-K.  In addition toour website, the SEC maintains an Internet site at *www.sec.gov* that contains reports, proxy and informationstatements, and other information regarding us and other issuers that fileelectronically with the SEC.

 

Apex, AMWorks, AMX, Avocent, the Avocent logo,AutoView, Cybex, DSR, DSView, Equinox, LongView, OutLook, The Power of BeingThere, SwitchView, and XP are trademarks or registered trademarks owned by us. ** **This annual reportalso includes trademarks of other companies.

 

**Industry Background**

 

Information technology is critical to most businessoperations as computers perform multiple and diverse functions throughout manydifferent types of organizations. Many corporations have decentralizedcomputing power while sharing technology resources and providing broad accessto enterprise data. This has resulted in the widespread adoption of distributednetwork computing environments using a network-based architecture ofinterconnected computers. The typical data center installation consists of alocal area network, or LAN, with a large number of  computers operating as servers dedicated toperforming specific functions for the many client computers connected to theLAN and, in many cases, may include a wide-area network, or WAN.

 

In addition, with the shift of software applicationsto a web services model, the demand for servers and storage is growing. Usersare accessing more data and resources using intranets and the internet. Thisgrowth causes a proliferation of servers and increases the need to manage thisgrowing network of servers and network devices.

 

Corporate LANs, WANs, internet service providers(ISPs), application service providers (ASPs), server farms, and data centersface significant network administration, environmental, and spacelimitations.  Facilities managers andnetwork administrators, who may manage hundreds or thousands of servers andother networked devices, must identify and access relevant servers and devices,add or delete users, add, change, or upgrade applications, tune systems forbetter performance, and diagnose and correct network failures. These serversare generally designed to operate as stand-alone systems, each with its ownconsole, and facilities managers and network administrators must therefore dealwith a large number of consoles, whether centrally located or dispersedthroughout the organization, when performing administration and management tasks.

 

Information technology resources are critical toorganizations. Accordingly, constant availability is crucial to the operationof many businesses. The time that an ISP, an ASP, a data center, a server farm,or corporate network is down or degraded can cause significant inconvenience,loss of productivity, and financial loss. Because the diagnosis and thecorrection of abnormal server or network behavior often require supportpersonnel to physically access each affected server through its own console, quickand efficient fault management can be difficult, especially when there are alarge number of dispersed servers involved. In addition, when 

 

2

----

 

a network fails, the ability of a facilities manager or networkadministrator to quickly and efficiently diagnose and correct the problem isoften hampered by the inability to access the software tools that reside on thenetwork and that are normally used to manage network failures.

 

In addition to these administration and managementproblems, as organizations grow and their computing needs increase, the numberof servers, consoles, peripherals, and cables grows. Without efficient storageand configuration, networked hardware consumes substantial and often expensive floorspace, creates clutter that hampers network administration and management, andincreases the risk of physical damage to expensive hardware. The spacemanagement solutions available to facilities managers and networkadministrators have generally consisted of racks or cabinets designed to houseonly one type of server, and most have not been technically designed for easeof access. Organizations with distributed, heterogeneous client/server networkshave often been left with no customized solution.

 

**Products, Technologies, and Solutions**

 

We provide a variety of solutions to many of thenetwork administration, management, and storage problems faced by facilitiesmanagers and network administrators responsible for monitoring and servicingservers and network installations.  Ourprincipal products and technologies are:

 

•                                          Our*DS Series*TM products allow users tocontrol servers from remote locations using an Internet or network connectionwithout the necessity of remote access hardware or software on the computers orservers being accessed.  The *DS Series*KVM products digitize keyboard, video, and mouseinformation and compress and transport that information in packets overtraditional network connections using only a portion of the bandwidth requiredby other products and optimizing 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*TMcentralized 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 devices and gain “point-and-click” access andcontrol over these devices using a browser interface.

 

•                                          Our*OutLook®* switches are designed forsmall-to-medium network configurations and provide ease-of-use, reliability,and enhanced server density.  Our *OutLook* switches allow one, two, or four users to accessheterogeneous server populations that use different platforms, such as Intel,Macintosh, IBM RS 6000, and Sun Sparc, and different operating systems, such asWindows, Unix, NetWare, and Linux, and allow information technologyprofessionals to organize, access, maintain, and control banks of servers froma single console or multiple consoles. Multiple *OutLook* switches can be integratedto provide centralized control of up to 256 servers.  *OutLook*switches offer extensive functionality, including programmable naming,scanning, security, and system broadcast features. With our proprietary *OSCAR*® interface, *OutLook*switches allow users to select and manage servers using an intuitive,information-rich on-screen menu.

 

**•****                                         **Our *AutoView*®**switch family offersusers a variety of analog and digital switching solutions.  Our *AutoView*TM**2000 switch is an analog switch thatfeatures end-to-end CAT 5 connectivity, while our *Autoview*1000R and *AutoView*2000Rswitches combine an analog port for local access and an Ethernet port forextended and remote IP-based digital access using our digital *KVM over IP* server management tool.  With end-to-end CAT 5 connectivity,convenient on-screen management, and flexible access, the *AutoView*1000R and 2000R provide local andremote users with access to servers from any location in the world that has aninternet or dial-up connection.  Forcontrol of multi-platform servers, our *AVWorks*TMadministration software is bundled with each switch.  Our *AutoView® Wireless*switch provides wireless connectivity between computers and monitors,keyboards, mice, and audio devices.

 

•                                          Our*AMX*TM analog matrix switchingsystems address the continued market opportunity for analog switches andprovide simpler access and easier manageability of servers in multi-rack,multi-platform environments.  Our *AMX*switches increase the number of userswith simultaneous access and offer efficient scalability with an architecturethat makes it easy to add and support additional servers. Our advanced *AMWorks*TMsoftware is also included with our *AMX*switches for central administration.

 

•                                          Ourextension product lines include CAT5 extension products, fiber and copperextension products, as well as 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 Category 5 UTP cable.   Our *LongView Wireless*is a KVM extender, which can wirelesslyconnect monitors (VGA, SVGA, and XGA), keyboards, mice, and audio devices to acomputer up to 1,000 feet away.

 

3

----

 

•                                          Ourdigital extension product lines feature our bus extension technology that letsadministrators centralize all PCI-based computers for ease of maintenance whileproviding users with full PC functionality at the desktop.  These fiber or CAT5 extension products enablea distributed computing environment that can provide access to centralized PCassets from up to 2,400 feet away*.*

 

•                                          OurAvocent Equinox branded products add high-performance, reliable, and affordableserver-based products for serial and dial access applications.  The *SuperSerial*product line includes network-based appliances and bus-based adapters. TheAvocent Equinox serial product lines provide serial connectivity for security,commercial point-of-sale, process control, industrial automation, datacollection, remote access, fax servers, Internet access, and customapplications.

 

•                                          Ourdesktop solutions include *SwitchView*®switches and remote access products, which are designed for the small office orhome office market and include USB and multimedia support in a variety of twoand four port models.  Our *SwitchView**OSD* product isan eight port switch designed for small and medium-sized businesses with anon-screen display. Our *SwitchViewMP*isa four port switch that provides connectivity to Intel-based, Sun, and USBmachines without the need for expensive adapters or converters.  Our *SwitchViewSC*switch is the only KVM switch certified to the U.S. Government’s NAIP CommonCriteria, and is designed to provide secure access for up to four computers butmake it impossible to transfer data between the connected computers, animportant factor for governmental agencies, corporate headquarters, or militaryoffices that need access to both secure and unsecure networks.  Our *SwitchView IP*adds economical remote access capability to existing KVM switches and offerssecure, browser-based access, BIOS-level access to multiple servers anywhere,anytime.

 

•                                          OurCPS and CCM appliances deliver secure, serial over IP access to console portsof servers and serially managed devices such as power management systems,network hubs and routers.  These serialappliance and attached devices can be centrally managed using our managementsoftware.

 

•                                          Inaddition to our “appliance” products, we develop embedded applications,solutions, and systems for our OEM and other strategic customers.  Our embedded solutions team has incorporatedour proprietary KVM switching technologies, our Dambrackas video compression(DVC) algorithms, and the IPMI management solutions technology we acquired inour acquisition of OSA Technologies into servers, desktops, laptops, and otherdevices, and we have licensed these technologies to some of our customers.  We are also pursuing additional embeddedopportunities directly with our OEM and other****customers,and we are continuing to integrate our embedded KVM and IPMI technologies withour current appliance platforms such as our *DSI5100*.

 

•                                          Ouracquisition of Sonic Mobility gave us two new software products for securewireless systems administration and mobile device management on multipleplatforms, including BlackBerry, Pocket PC, and Palm.  Our *SonicAdmin* software provides IT administrators with theability to manage network and data center infrastructure from mobile handhelddevices.  An administrator can, among other things, reboot servers,unlock/change passwords, restart services not functioning properly, view eventlogs, move files, and send messages to logged-in users.  Our *SonicSentinel* software offers the remote control andadministration of PDAs and smart phones that connect to a computernetwork.  IT administrators can, among other things, monitor all mobiledevices for current status, apply passwords to unprotected devices, and formobile devices that are lost or stolen, wipe out sensitive data.

 

The products and technologies described above are allpart of our connectivity solutions, and we have no other class of products thataccounts for 10% or more of our net sales.

 

**Sales and Marketing**

 

We market and sell our products through our own salesforce and various distribution channels, including OEMs and a variety ofdistributor and reseller arrangements. We market our products primarily throughdirect customer sales calls, advertisements in trade publications, onlinesponsorships, participation in major industry trade shows, promotions withdistributors and resellers, direct marketing, telemarketing, publicity programs,and through our website. We also devote a substantial portion of our marketingefforts to developing, monitoring, and enhancing our relationships with ournetwork of OEMs, independent dealers, distributors, resellers, and end users.Our sales personnel are supported by our engineers and our customer servicerepresentatives who provide technical support and advice to customers. As ofDecember 31, 2004, we employed 283 people in sales, marketing, andcustomer support.

 

We currently sell or license various switchingproducts and technologies to Dell, Hewlett-Packard, IBM, and other OEMspursuant to private-label, branded, and licensing arrangements. These OEMcustomers integrate and sell our products and technologies with or within theirown products, including network servers. We devote significant sales,engineering, operations, and customer service resources to our OEM accounts. Wehave significant experience in working with our OEM and other servermanufacturers, and we 

 

4

----

 

intend to use that experience to enter into new relationships withother computer manufacturers in the United States, Europe, and Asia. We believethat the architecture, quality, and reliability of our products andtechnologies, together with our commitment to customer service, are attractiveto server manufacturers.

 

We have relationships with a variety of distributorsand resellers, value added resellers, or VARs, and systems integrators, for thedistribution and sale of Avocent, Cybex, and Equinox branded products in theUnited States, Europe, Asia, and elsewhere. We devote resources to educatingour distributors and resellers about the benefits of our products and trainingthem in the proper installation and support of our products. We will continueto devote additional resources to increase these branded sales, and we willpursue additional relationships with distributors and resellers, bothdomestically and internationally, who have the technical capability and marketpresence to assist end-user customers in developing network space management,access, and control solutions to meet their particular needs. Our futuresuccess will depend in part on our ability to attract, train, and motivateadditional distributors and resellers.

 

We provide discounts, other special pricingarrangements, and certain return privileges to our OEMs and ourdistributors and resellers. Our agreements with our distributors and resellersare generally nonexclusive and may be terminated on short notice by eitherparty without cause. Our distributors and resellers are not within our control,are not obligated to purchase products from us, and frequently offer productsof several different manufacturers, including products that compete with ours.

 

International sales accounted for approximately 41% ofnet sales in 2004, 40% of net sales in 2003, and 40% of net sales in 2002, andwere made primarily to OEMs, distributors, and resellers located in Europe,Canada, Asia, and other foreign countries. Sales to customers in theNetherlands, including the European distribution facility for one of our OEMcustomers, accounted for 10% of sales in 2004. Sales to customers in the UnitedKingdom, including the European distribution facility for one of our OEMcustomers, accounted for 10% of 2003 sales and 15% of 2002 sales.  No other country accounted for more than 10%of 2004, 2003, or 2002 sales. We are expanding our international sales effortswithin Europe, Asia, and the Pacific Rim through the utilization of our salesoffices in Beijing, Guangzhou, and Shanghai, China; London, England; Paris,France; Rotterdam, Holland; Shannon, Ireland; Steinhagen, Germany; Tokyo,Japan; Hong Kong; and Singapore.

 

**Customers**

 

To date, a substantial portion of our net sales hasbeen generated from sales of switching solutions and products to OEMs forintegration with their product offerings. Sales to OEM customers represented45% of net sales in 2004 and 46% of net sales in each of 2003 and  2002. While we have contracts with some ofour OEM customers, none of them is obligated to purchase products from usexcept pursuant to binding purchase orders. Consequently, any OEM customercould cease doing business with us at any time. The loss of, or materialdecline in orders from, certain of our current OEM customers would have amaterial adverse effect on our business, financial condition, results ofoperations, or cash flow.

 

In addition to our OEM customers, our principalcustomers include a diversified group of dealers, major distributors, VARs. anddirect end users who purchase our branded products (55% of net sales in 2004and 54% of net sales in each of 2003 and 2002). We believe that our broad rangeof products sold at different price points offers us the opportunity to marketour products to customers of all sizes, in different industries, and withvarying degrees of technical sophistication.

 

Sales to Hewlett-Packard and Dell representedapproximately 23% and 12%, respectively, of net sales in 2004.  Sales to Tech Data and Ingram Micro representedapproximately 11% each of net sales in 2004. Sales to Hewlett-Packard represented approximately 23% of net sales in2003 and 25% of net sales in 2002 (including sales to Compaq before and afterits merger with Hewlett-Packard in 2002). Sales to Dell represented approximately 14% of net sales in 2003 and 11%of net sales in 2002.  Sales to Tech Datarepresented approximately 12% of net sales in 2003 and 11% of net sales in2002. No other customer accounted for more than 10% of our net sales in 2004,2003, or 2002.

 

**Seasonality**

 

Our operating results are affected by seasonal trendsand by general conditions in the server market. We have experienced, and expectto continue to experience, some degree of seasonality due to customer buyingcycles. We believe that the third and fourth quarters will generally havehigher net sales levels due to customer budgeting and procurement cycles, whichmay depress net sales in other quarters. In the past, revenue in ourfourth quarter of each year has typically been higher than revenue in priorquarters for the year.  In addition, wetypically see a sequential decline in revenue from the fourth quarter of a yearto the first quarter of the following year. While it is difficult to predict revenue in any quarter, we expect thatthis pattern will continue in the future.

 

**Customer Service**

 

We emphasize customer service by developing highquality products, encouraging customer feedback through contact with our keycustomers, providing technical support and information on our website, andproviding a customer hotline that offers technical support for the life of ourproducts. We strive to respond quickly to our customers’ requests for technicalsupport and service, and our 

 

5

----

 

engineering department often works with individual customers totroubleshoot problems and develop custom solutions. We offer warranties forparts and service on all of our products, ranging from one to three years. Wealso offer a 30-day money-back guarantee for all of our appliance products soldin North America. To date, we have not experienced any significant productreturns. We may, as a result of competitive pressures, change our warrantypolicies in the future to provide coverage that is greater in scope andduration than the coverage we currently offer. If we were to increase ourwarranty coverage, our risk of warranty claims, and therefore our warrantyexpense and reserves, would likely increase.

 

**Development of New Products and Technologies**

 

We believe that the timely development of enhancementsto our existing products and technologies and of new products and technologiesis essential to building our competitive position. The market for our productshas experienced rapid technological advances, frequent new productintroductions and enhancements, and significant price competition. Theintroduction of products incorporating superior or alternative technologies(such as switching software), the creation or adoption of new technologies, 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. Ourproducts generally combine components, such as printed circuit boards,semiconductors, memory, connectors, cable assemblies, power supplies andenclosures, that are manufactured by other companies and are generallyavailable to our competitors and potential competitors. Our future success willdepend in large part upon continued innovative application of commerciallyavailable components, together with continued enhancements to our proprietarysoftware, firmware, and other technologies, the expansion and enhancement ofour existing products, and the development and introduction of new technologiesand products that address changing customer needs on a cost-effective andtimely basis. By emphasizing customer-driven research and development, we havebeen able to develop innovative, practical, and marketable products that havehad immediate application and acceptance. Our failure to respond on a timelybasis to technological changes or customer requirements could have a materialadverse effect on our business, financial condition, results of operations, andcash flow.

 

Due to our significant reliance on OEM relationships,some of our product development efforts are focused on developing new productsor enhancements for OEM customers. At times, these new products or enhancementsmay not be available to, or readily marketable to, other customers withoutsignificant modifications or delay.

 

Our engineering and product development efforts focuson anticipating the needs of our customers by providing innovative, practical,and marketable products and technologies that have immediate applications intheir markets. By maintaining contact with customers throughout theinstallation and technical support process, we are able to identify and testpotential design modifications and improvements as well as new applications andextensions for existing products and technologies. We expect this process willenable us to develop new product categories and applications based on existingtechnology developed to meet specific customer needs. 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.

 

Our engineering and product development expenses wereapproximately $45.4 million in 2004 (excluding $29.3 in expensed in-processresearch and development expenses related to our acquisitions of Crystal LinkTechnologies, OSA Technologies, Inc., and Sonic Mobility, Inc.), $29.8 millionin 2003 (excluding $3.9 million in expensed in-process research and developmentexpenses related to our acquisition of Soronti), and $26.5 million in 2002(excluding $6.0 million in expensed in-process research and developmentexpenses related to our acquisition of 2C Computing). As of December 31,2004, we employed 353 people in our engineering department. In addition, we useindependent contractors from time to time. As of December 31, 2004, wewere working with approximately 28 independent contractors on various developmentprojects.

 

To meet the challenges of the rapidly changingtechnology in the computer industry, we expect to make substantial investmentsin product development in the future. There can be no assurance that these newor enhanced versions or any other of our product development efforts will leadto commercially viable products or technologies, will be completed on a timelybasis, or will include the features required to achieve market acceptance.

 

A key component of our engineering and productdevelopment strategy is the acquisition of new technologies and companies.  We acquired Equinox Systems Inc. in2001, 2C Computing, Inc. in 2002, Soronti, Inc. in 2003, and Crystal LinkTechnologies, OSA Technologies, Inc., and Sonic Mobility, Inc. in 2004.  We intend to continue to evaluateopportunities to acquire technologies and companies, and it is likely that wewill complete additional acquisitions in the future.  There can be no assurance that theseacquisitions will result in the timely development of commercially viableproducts or technologies that achieve market acceptance.

 

**Manufacturing**

 

We do not manufacture any of our products in theirentirety. Instead, we manage product planning, purchasing, and shipping, and weperform final assembly, quality assurance, and testing on some of our productswhile we outsource some or all of these functions on other products. In orderto avoid the capital investment required to establish and maintain in-housemanufacturing capabilities, we rely on subcontractors throughout the world forthe assembly of printed circuit board assemblies, subassemblies, 

 

6

----

 

chassis and equipment enclosures. 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. Outsourcingour manufacturing functions allows us to concentrate our resources on researchand development, product design, quality assurance, sales and marketing, andcustomer service. We (or our subcontractors) subject our most criticalcomponents and products to automated testing, equipment burn-in procedures,comprehensive quality audits, functional testing, and regulatory screening toassure quality and reliability. As of December 31, 2004, we employed 155 peoplein our manufacturing and logistics department.

 

We currently rely on several third partymanufacturers, including Elcoteq Network Corporation, Likom Computer Products,MC Assembly, and Three-Five Systems, Inc., for subassembly of our products.These outsourcing arrangements, and any future outsourcing arrangements,involve numerous risks, including reduced control over product quality,delivery schedules, manufacturing yields, and costs. In addition, while thesethird-party manufacturers have arrangements for warranty obligations, we remainprimarily responsible to our customers for warranty obligations. We attempt todiversify our outsourced manufacturing operations and believe we have anadequate supply of alternative subcontractors.

 

We generally purchase industry-standard parts andcomponents, including power supplies, semiconductors, memory, cable assemblies,line filters, enclosures, and printed circuit boards for the assembly of ourproducts from multiple vendors and suppliers through a worldwide sourcingprogram. Custom molded cables and certain turn-key products procured fromoutside sources have significant delivery times (10 to 12 weeks), and failureto obtain adequate supplies could adversely affect our product deliveries. Webuy components under purchase orders and generally do not have long-termagreements with our suppliers. Circuit board assemblies are currently obtainedfrom a number of sources, including Elcoteq Network Corporation, Likom ComputerProducts, MC Assembly, and Three-Five Systems. We believe that there areadequate alternative sources for our product components. Any termination of, orsignificant disruption in, the business or affairs of our suppliers or ourthird-party manufacturers or in our relationship with them may prevent us fromfilling customer orders in a timely manner since we generally do not maintainlarge inventories of our components.

 

In the past, we have experienced delays in the receiptof certain components, which have resulted in delays in related productdeliveries. We attempt to manage these risks through developing alternativesources, committing internal resources to supply chain management, andmaintaining relationships and close personal contact with each of our contractmanufacturers and suppliers. There can be no assurance, however, that delays incomponent and product deliveries will not occur in the future, and theinability to obtain sufficient components or to develop alternative sources ifand as required in the future, could result in delays or reductions in productshipments, which, in turn, could have a material adverse effect on ourbusiness, financial condition, results of operations, or cash flow. Some of thecomponents for our products are available from a single supplier or a limitednumber of suppliers. We attempt to maintain quality relationships and closecontact with each of our suppliers.

 

**Competition**

 

The market for our products is highly fragmented andcompetitive, and we expect competition to increase in the future. In the marketfor switching systems, we compete with companies such as Raritan Computer, RoseElectronics, Minicom Advanced Systems, Agilent, Aten International, Belkin,Cyclades Corporation, Lantronix, Inc., and Digi International, some of whichmay have substantially greater financial, marketing, and technical resourcesthan we have. We also compete with other companies (such as Intel andMicrosoft) that offer alternative technologies or products (such as software)that compete with our switching systems. In addition, certain of our OEM customers, such as Dell,Hewlett-Packard, and IBM, offer technologies and products that are competitivewith our products, and we expect these technologies and products to remaincompetitive in the features they offer. Our products and technologies are also in competition with the productsand technologies offered by hardware manufacturers and network managementcompanies such as Intel, Microsoft, and Cisco.

 

In the market for our products, we compete primarilyon the basis of technological capabilities, performance in relation to price,product features, quality, reliability, development capabilities, productavailability, and customer service and support. Our future success will behighly dependent upon timely completion, introduction, and distribution of newproducts, technologies and features at competitive price and performance levelsthat address the evolving needs of our customers. We continually experienceprice competition and expect that pricing pressures could increase in thefuture.

 

**Proprietary Technology**

 

Our future success is dependent in part upon ourability to protect our intellectual property and our proprietary rights in ourproducts and technologies. We seek to protect our intellectual property rightsby invoking the benefits of the patent, trademark, copyright, trade secret, andunfair competition laws of the United States, which provide only limitedprotection. We have been issued 48 U.S. patents and have 34 U.S. patentapplications pending. We have various corresponding patent applications pendingunder the provisions of the Patent Cooperation Treaty, which permits the filingof corresponding foreign patent applications in numerous foreign countrieswithin a limited time period. We also have other foreign patent applicationspending. There can be no assurance that any additional patents will be issuedfrom any of our pending applications, that any patents will be issued in anyadditional countries where our products or technologies can be sold orlicensed, or that any claims allowed in our patents or in any pending patentapplications will be of sufficient scope or strength for, or provide anymeaningful protection or any commercial advantage to, us. 

 

7

----

 

Moreover, our competitors may challenge the validity of, or be able todesign around, these patents or any other patents 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.

 

We believe that certain products of certaincompetitors infringe one or more of our U.S. patents. In May 2001, we filed acomplaint for patent infringement in the United States District Court for theSouthern District of New York against Raritan Computer Inc. The Raritancomplaint sought injunctive relief, damages, attorneys’ fees and costs underthree of our patents.  After a seven daybench trial in New York in January 2002, U.S. District Judge Milton Pollackfound that there was no infringement of our patents by Raritan and ordered thatjudgment be entered in favor of Raritan. We appealed that judgment, and in April 2003, the United States Court ofAppeals for the Federal Circuit issued its ruling on our appeal in this patentlitigation.  The Court of Appeals ruledin our favor by vacating the non-infringement decision of the District Courtfor the Southern District of New York and remanding the case for furtherproceedings consistent with the Court of Appeals’ opinion.  InSeptember 2003, Raritan petitioned the United States Supreme Court for a Writof Certiorari to review the Court of Appeals decision, and we filed ouropposition to the petition in November 2003. Raritan’s petition was denied by the Supreme Court in December 2003, andthe case was sent back to the United States District Court for the SouthernDistrict of New York.  With the death in2004 of Judge Pollack, the case was assigned to U.S. District Court Judge KevinCastel, and a Markman hearing on claims construction was held in February 2005.

 

In October 2003, we filed acomplaint for patent infringement in the United States District Court for theNorthern District of Alabama against ClearCube Technology, Inc.  The ClearCube complaint seeks injunctive relief,damages, attorneys’ fees, and costs under three Avocent patents. ClearCube hasfiled counterclaims alleging non-infringement, unenforceability, invalidity,and misuse of the Avocent patents. A Markman hearing on claims construction was originally set for February2005, but in response to an inquiry from the Court, we recently agreed that thehearing should be postponed until the United States Court of Appeals for theFederal Circuit issues its ruling on the issues raised in an unrelated patentcase.

 

In the future, we may file additional lawsuits againstother companies regarding the alleged infringement. Patent litigation, and anyother litigation relating to our intellectual property to which we become aparty, is subject to numerous risks and uncertainties, and there can be noassurance that we will be successful in any such litigation. There can be noassurance that the steps we take to protect our intellectual property rightswill be adequate to prevent misappropriation of our technologies or that we canuse our intellectual property rights to successfully prevent competitors fromcommercializing technologies that are substantially equivalent or superior toour products and technologies. Additionally, current or future competitorscould develop their own proprietary technologies or obtain patents that mayprevent us from developing or selling our products and technologies.

 

**Employees**

 

As of December 31, 2004, we had 599 full-timeemployees working in the United States. Of our domestic full-time employees, 181were in marketing, sales, and customer support, 221 were in engineering,research, and development, 114 were in manufacturing and logistical operations,and 83 were in administration. As of December 31, 2004, we had 313full-time employees working at our facilities outside of the United States. Ofour international full-time employees, 102 were in marketing, sales, andcustomer support, 132 were in engineering, research, and development, 41 werein manufacturing and logistical operations, and 38 were in administration. Ouremployees are not covered by any collective bargaining agreements relating totheir employment by us. We believe that we have good relations with ouremployees.

 

**Backlog**

 

Backlog consists of purchase orders with deliverydates scheduled within the next six months. None of our customers is obligatedto purchase products from us except pursuant to binding purchase orders.Because of the timing of orders and the possibility of customer changes todelivery schedules, our backlog as of any particular date is not representativeof 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.

 

8

----

 

**FACTORS THAT MAY AFFECT FUTURERESULTS**

 

*THIS ANNUAL REPORT CONTAINS FORWARD-LOOKINGSTATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE OUR ACTUALRESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN THIS ANNUAL REPORT.  THESE RISKS AND UNCERTAINTIES INCLUDING THEFOLLOWING:*

 

**Intense competition from new and existingcompetitors could impair our ability to grow our business and sell our productsand technologies.**

 

The markets for our products and technologies are highlyfragmented and intensely competitive. Aggressive competition from both hardwareand software products and technologies could result in price reductions andloss of sales, which would materially harm our business. Our business isbecoming increasingly sensitive to the introduction of new products andtechnologies, price changes, and marketing efforts by numerous and variedcompetitors. Accordingly, our future success will be highly dependent upon ourtimely completion and introduction of new products and technologies and featuresat competitive prices and performance levels that address the evolving needs ofour customers. We continue to experience aggressive price competition andincreased customer sensitivity to product prices, and pricing and margin pressuresare likely to increase in the future. Because of this competition, we may haveto continue to lower the prices of many of our products and technologies tostay competitive, while at the same time trying to maintain or improve ourrevenue and gross margin. Because our business model is based on providinginnovative and high quality products, we may spend a proportionately greateramount on research and development than some of our competitors. If we cannotproportionately decrease our cost structure on a timely basis in response tocompetitive price pressures, our gross margin and profitability could beadversely affected. In addition, if our pricing and other factors are notsufficiently competitive, or if there is an adverse reaction to our productdecisions, we may lose market share in certain areas, which could adverselyaffect our revenue and prospects.

 

We compete for sales of switching systems andextension products with companies such as Raritan Computer, Rose Electronics,Minicom Advanced Systems, Agilent, Aten International, CompuCable Mfg. Group,Belkin, Cyclades Corporation, Lantronix, Inc., and Digital V6. We also facecompetition from software providers (such as Microsoft), who may be able tooffer software solutions at a much lower cost or even bundled for free, andfrom server manufacturers (including our OEM customers), who are able to offertheir competitive technologies or products at the time of the server sale.These software and hardware solutions address many of the problems ourswitching systems and technologies, extension products, and remote accessproducts are designed to address.

 

Current and potential competitors may be able torespond more quickly to new or emerging technologies or products and to changesin customer requirements or to devote greater resources to the research,development, promotion, and sale of their products and technologies than we do.In addition, current and potential competitors have established or mayestablish cooperative relationships among themselves or with third parties thatenhance the ability of their products and technologies to address the needs ofour current and prospective customers. We may not be able to competesuccessfully against current and future competitors and competitive pressuremay materially harm our business.

 

Certain of our customers, such as Dell,Hewlett-Packard, IBM, and Microsoft, presently offer competitive hardwareand/or software products, technologies, and solutions that address many of theproblems our products and technologies address. These customers could decide tomanufacture their own switching or remote access products, enhance their owninternally-developed switching solutions or technologies, or offer products ortechnologies supplied by competitors. Companies with hardware manufacturingexperience or network management products, many of which are substantiallylarger than we are and have significantly more financial resources than we do,also offer products or technologies that compete with us. Established companieswith hardware manufacturing or network management experience (such as Intel orCisco) could also offer new products, new technologies, or new solutions thatcompete with our products and technologies.

 

**Our failure to respond to rapid technologicalchange or to introduce successful new products and technologies may result inreduced revenue or revenue growth.**

 

The process of developing or acquiring new productsand technologies and enhancing existing products and technologies is complex,costly, and uncertain, and any failure by us to anticipate customers’ changingneeds and emerging technological trends accurately could significantly harm ourmarket share and results of operations. We must make long-term investments,develop or obtain appropriate intellectual property, and commit significantresources before knowing whether our predictions will accurately reflectcustomer demand for our products and services. After we develop a product, wemust then accurately forecast volumes and configurations that meet customerrequirements, manufacture appropriate volumes quickly and at low cost, andtrain our sales force and resellers. Any delay in the development, production, marketingof, or training for new products or technologies could result in our not beingamong the first to market, which could further harm our competitive position.

 

Sales of switching, extension, and remote accessproducts and technologies are characterized by rapid technological advances,frequent new product and technological introductions and enhancements, andsignificant price competition. If we do not 

 

9

----

 

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 could competewith our existing products at a lower price, which would reduce our revenue.

 

Our products combine components, such as printedcircuit boards, connectors, semiconductors, memory, cable assemblies, powersupplies and enclosures, that are manufactured by other companies and aregenerally available to competitors and potential competitors. Our futuresuccess will depend in large part upon continued innovative application of suchcommercially available components, together with continued enhancements to ourproprietary software, firmware, and other technologies, the expansion andenhancement of existing products and technologies, and the development and introductionof new products and technologies that address changing customer needs on acost-effective and timely basis. If we fail to respond on a timely basis totechnological developments, changes in industry standards, customerrequirements, or software innovations, we will lose customers, and our businesswill be greatly harmed. Similar results could occur if we experiencesignificant delays in the development or introduction of new products ortechnologies.

 

Due to our significant reliance on OEM relationships,our development efforts may often be focused on developing new products,technologies, or enhancements for OEM customers. As a result, our OEMrelationships may negatively affect our ability to develop new and enhancedproducts and technologies for our non-OEM customers. Moreover, these newproducts, technologies, or enhancements for OEM customers may not be availableto, or readily marketable to, other customers without significant modificationand delay. The termination or significant disruption of our relationship withcertain OEMs or other customers for whom we devote significant productdevelopment resources is likely to result in lost opportunities with respect tothe development of products, technologies, or enhancements for our other customers.

 

**We are likely to experience fluctuations inoperating results.**

 

We have in the past experienced substantialfluctuations in operating results, on a quarterly and an annual basis, and weexpect these fluctuations will continue in the future. Our operating resultswill be affected by a number of factors, including, but not limited to:

 

•                                          Thevolume and timing of orders, particularly from OEM and other large customers;

 

•                                          Thetiming of shipments;

 

•                                          Thetiming of new product introductions, new technologies, and enhancements by usand by our competitors;

 

•                                          Changesin product or distribution channel mixes;

 

•                                          Changesin pricing policies or price reductions;

 

•                                          Competitionfrom new products and technologies and price reductions by competitors;

 

•                                          Theavailability and cost of supplies and components;

 

•                                          Salesand marketing expenses related to entering into new markets, introducing newproducts, new technologies, and retaining current OEM and other largecustomers; and

 

•                                          Fluctuationsin sales of servers due to changes in economic conditions or capital spendinglevels.

 

Our operating results will continue to be affected byseasonal trends, by general conditions in the server market, and by generaleconomic conditions. We have experienced, and we expect to continue toexperience, some degree of seasonality due to customer buying cycles. Webelieve that the third and fourth quarters will generally have higher net saleslevels due to customer budgeting and procurement cycles, which may depress netsales in other quarters.  In addition,European sales are often weaker during the summer months.  Inthe past, revenue in our fourth quarter of each year has typically been higherthan revenue in prior quarters for the year. 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.Many of the factors that create and affect seasonal trends are beyond ourcontrol.

 

Our quarterly sales have also reflected a pattern inwhich a disproportionate percentage of such quarters’ total sales occur towardthe end of such quarter, and this trend has become more pronounced in recentperiods. This uneven sales pattern makes 

 

10

----

 

prediction of revenue, earnings and working capital for each financialperiod difficult, increases the risk of unanticipated variations in quarterlyresults and financial condition, and places pressure on our inventorymanagement and logistics systems. If predicted demand is substantially greaterthan orders, there will be excess inventory. Alternatively, if orderssubstantially exceed predicted demand, we may not be able to fulfill all of theorders received in the last few weeks of each quarter. Other developments latein a quarter, such as a systems failure, component pricing movements, or globallogistics disruptions, could adversely impact inventory levels and results ofoperations in a manner that is disproportionate to the number of days in thequarter affected.

 

We believe that quarter-to-quarter comparisons of ourhistorical financial results are not meaningful indicators of our futureoperating results, and you should not rely on them as an indication of ourfuture performance. If our quarterly operating results fail to meet theexpectations of equity research analysts, the price of our common stock couldbe negatively affected.

** **

**Due to the maturity of our business and uncertainglobal economic and political conditions, our revenue may decline or our costsmay increase.**

** **

As our business matures, it is possible that ourrevenue will not grow at the pace that it grew in 2003 and 2004.  Our future growth rates depend in part on ourability to expand sales of our existing products and technologies and todevelop and market new products and technologies.  With uncertain global economic and politicalconditions, we may not have sufficient resources to cover the significant costsinvolved in such an expansion.  If ourrevenue does not increase at or above the rate that equity research analystsexpect, the trading price of our common stock may decline.

 

Our revenue may also suffer as a result of generaleconomic and political conditions and instability both in the United States andin the rest of the world.  Prior to 2003,there was a rapid and severe downturn in the U.S. market and global economy,and whether that trend has reversed is uncertain.  In addition, there is substantial uncertaintydue to recent terrorist activity, such as the terrorist attacks in the UnitedStates on September 11, 2001, and the recent and current military activity inAfghanistan, Iraq, and the Middle East. Additional terrorist acts or acts of war could cause damage ordisruption to us or to our suppliers and our customers.  Fears of global recession, war, and acts ofterrorism could dampen consumer confidence and cause our customers to slow orcease spending for our products and technologies.  This global economic and politicalinstability could cause our revenue to decline or our costs to increase andhave a material adverse effect on our business.

 

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

 

Sales outside the United States make up almost half ofour revenue, and over half of our manufacturing takes place outside the UnitedStates. Accordingly, our future revenue, gross margin, expenses, and financialcondition could suffer due to a variety of international factors, including:

 

•                                          Ongoinginstability or changes in a country’s or region’s economic or politicalconditions, including inflation, recession, interest rate fluctuations, andactual or anticipated military or political conflicts;

 

•                                          Currencyfluctuations, which could contribute to variations in sales of products andtechnologies and could also affect our reported results expressed in U.S.dollars;

 

•                                          Longeraccounts receivable cycles and financial instability among customers;

 

•                                          Taxor trade regulations and procedures and actions affecting production, pricing,and marketing of or payments for products;

 

•                                          Locallabor conditions and other regulations;

 

•                                          Differingtechnology standards or customer requirements;

 

•                                          Fluctuationsin freight costs and disruptions at important geographic points of exit andentry;

 

•                                          Naturalor manmade disasters, such as earthquakes, tsunamis, hurricanes, and typhoons,fires, power shortages, blackouts, or telecommunications failures; and

 

•                                          Medicalepidemics, such as Severe Acute Respiratory Syndrome.

 

The factors described above also could disrupt ourproduct manufacturing and key suppliers located outside of the United States.For example, we rely on manufacturers in Asia and Europe for the assembly andmanufacture of many of our products.

 

11

----

 

**Our gross margins are expected to vary and maydecline.**

 

Gross margins may vary or decline fromperiod-to-period depending on a number of factors, including:

 

•                                          Theratio of OEM sales to branded sales, since OEM sales typically have lower grossmargins than branded sales;

 

•                                          Productmix, because sales of some of our products and technologies will have lowergross margins than sales of other products or technologies;

 

•                                          Rawmaterials, freight, and labor costs;

 

•                                          Introductionof new products and technologies by us and by our competitors; and

 

•                                          Thelevel of outsourcing of our manufacturing and assembly services.

 

We expect that our gross margins may vary and maydecline in the future primarily due to the factors listed above and toincreased competition and the introduction of new products and technologiesthat may affect product prices.

 

**A substantial portion of our businessconsists of sales to a limited number of OEM customers that are not obligatedto continue doing business with us, and these sales vary considerably fromquarter to quarter.**

 

A substantial portion of our sales is concentratedamong a limited number of OEM customers. Sales to these OEMs representedapproximately 45% of net sales in 2004 and 46% of net sales in each of 2003 and2002.  In 2004, sales to Hewlett-Packardrepresented approximately 23% of our net sales, and sales to Dell representapproximately 12% of our net sales. Sales to Hewlett-Packard represented approximately 23% of our net salesin 2003 and 25% of our net sales in 2002 (including sales to Compaq before andafter its merger with Hewlett-Packard in 2002). Sales to Dell represented approximately 14% of net sales in 2003 and 11%of net sales in 2002.

 

We have experienced, and we expect to continue toexperience, period-to-period variability in sales to these OEM customers. Anycancellation, rescheduling, or reduction of orders by OEM customers in thefuture could materially adversely affect our operating results. Although ourOEM customers typically place orders for products up to several months prior toscheduled shipment dates, these orders are subject to cancellation.

 

Our OEM business is subject to many risks, including:

 

•                                          Contracttermination or reduced or delayed orders;

 

•                                          Shortorder cycles and difficulty in predicting sales because our OEM customers donot have long-term commitments to purchase from us;

 

•                                          Changesin the OEMs’ internal product life cycles including the delay of planned newproduct introductions and uncertainty over product end-of-life decisions;

 

•                                          Adoptionof competing products or technologies developed by third parties for the OEMsor by the OEMs’ internal development teams; and

 

•                                          Changesin corporate ownership, financial condition, business direction, or product mixby the OEMs.

 

Any of these risks could have a material adverseeffect on our business, financial condition, and results of operations. We haveexperienced, and expect to continue to experience, pricing pressures andsignificant variability in orders from our OEM customers, which may in thefuture have a material adverse effect on our quarterly sales and operating results.

 

The loss of one or more large OEM customers wouldmaterially harm our business. While we have contracts with some of our existingOEM customers, none of our OEM customers is obligated to purchase products fromus except pursuant to binding purchase orders. Consequently, any OEM customercould cease doing business with us at any time. Our dependence upon a fewOEMs also results in a significant concentration of credit risk, thus asubstantial portion of our trade receivables outstanding from time to time maybe concentrated among a limited number of customers. In addition, OEM customershave longer payment cycles that increase the likelihood of aged or problemaccounts receivable.

 

We use multiple warehouses for many of our OEMcustomers to fulfill their orders under a just-in-time inventory managementsystem, which requires us to maintain sufficient inventory levels of ourproducts at each of these warehouses to satisfy our OEMs anticipated customerdemand, and we generally recognize revenue only when these OEM customers takepossession of our 

 

12

----

 

products. 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 customers haverequested, and are likely to continue to request from time to time, that wedelay shipment dates or cancel orders for products that are subject to firmorders. As a result, at any time we may be holding a significant amount ofOEM-branded products in inventory, and our sales to OEMs for futurequarters are difficult to predict. The inability to accurately predict thetiming and volume of orders for our OEM customers during any given quarter couldadversely affect operating results for that quarter and, potentially, forfuture quarters. If we underestimate sales, we may not be able to fill orderson a timely basis. This could cause customer dissatisfaction and loss of futurebusiness. If we overestimate sales, we may experience increased costs frominventory storage, waste, and obsolescence.

 

**A substantial portion of our business consists ofsales of branded products, and these sales are difficult to forecast. Failureto accurately forecast these sales could lead to costly overproduction orproduct shortages.**

 

A substantial portion of our sales consists of salesof branded products. We expect these sales to increase in the future, and if weare successful in increasing branded sales as a percentage of net sales, ourquarterly sales and operating results will become more dependent upon thevolume and timing of branded product orders received during the quarter.Because many customers of our branded products typically place orders shortlybefore their requested shipment date, revenues from branded sales are difficultto forecast. With continued industry-wide initiatives by distributors andresellers to reduce their inventories and to shorten their lead times, ourmajor distributor and reseller customers are reducing early commitments to firmorders. Furthermore, many purchasers typically require prompt delivery ofproducts. This results in a limited backlog of orders for these products andrequires us to maintain sufficient inventory levels to satisfy anticipatedcustomer demand. The inability to accurately forecast the timing and volume oforders for branded products during any given quarter could adversely affectoperating results for such quarter and, potentially, for future periods. If weunderestimate sales, we will not be able to fill orders on a timely basis. Thiscould cause customer dissatisfaction and loss of future business. If weoverestimate sales, we will experience increased costs from inventory storage,waste, and obsolescence.

 

**We will need to expand sales through distributors andresellers in order to develop our business and increase revenue.**

 

We expect to rely increasingly on distributors andresellers, VARs, and systems integrators for the distribution and sale of ourbranded products. Our strategy contemplates the expansion of our distributorand reseller network both domestically and internationally, particularly inAsia. Our future success will depend in part on our ability to attract, train,and motivate new distributors and resellers and expand our relationships withcurrent distributors and resellers. We may not be successful in expanding ourdistributor and reseller relationships. We will be required to investsignificant additional resources in order to expand these relationships, andthe cost of this investment may exceed the margins generated from thisinvestment.

 

In addition, distributors and resellers often haverights of return, and in the future, these returns from our existing or any newdistributors and resellers may have a material adverse effect on our business,financial condition, and results of operations. Our agreements with our currentdistributors and resellers are generally nonexclusive and may be terminated onshort notice by either party without cause, and any new distributor or reselleragreements are likely to contain similar provisions. Distributors and resellersare not obligated to purchase products from us and frequently offer products ofseveral different manufacturers, including competitors’ products, and distributorsand resellers may give higher priority to the sale of our competitors’products. A reduction in sales efforts by our distributors or resellers couldlead to a reduction in our sales and could materially adversely affect ourbusiness, financial condition, and results of operations.

 

**If we are unable to successfully develop ourinternational distribution networks and international sales efforts, results ofoperations may suffer.**

 

We are working to develop, integrate, and expand ourinternational distribution networks in an effort to increase internationalsales of switching, extension, remote access, and other products. We may not besuccessful in developing or expanding the international distribution network orin marketing and selling products in foreign markets, particularly Asia. If therevenues generated by our international sales are not adequate to recover theexpense of establishing, expanding, and maintaining an internationaldistribution network, our business, financial condition, and results ofoperations could be materially adversely affected. If international salesbecome a more significant component of net sales, our business could becomemore vulnerable to the risks inherent in doing business on an internationallevel, including:

 

•                                          Difficultiesin managing foreign resellers;

 

•                                          Longerpayment cycles and problems in collecting accounts receivable;

 

•                                          Theeffects of seasonal customer demand;

 

•                                          Changesin regulatory requirements;

 

13

----

 

•                                          Difficultiesin meeting the requirements of different international product regulations;

 

•                                          Risksrelating to the protection of our intellectual property rights;

 

•                                          Theimpact on our marketing expenses and our research and development resources aswe localize our product offerings to meet local user requirements such aslanguage translations and hardware compatibility issues;

 

•                                          Exportrestrictions, tariffs, and other trade barriers;

 

•                                          Fluctuationsin currency exchange rates; and

 

•                                          Potentiallyadverse tax consequences and political instability.

 

The existence or occurrence of any one of thesefactors could have a material adverse effect on our business, financialcondition, and results of operations.

 

**We are dependent upon third-party suppliers andoutsourced manufacturing. Disruption of our access to these supplies andservices, or problems with the quality of supplies or services, could preventus from filling customer orders and harm our business.**

 

The principal components of our products areelectronic components, power supplies, semiconductors, memory, cableassemblies, line filters, enclosures, and printed circuit boards, all of whichare purchased from outside vendors. We generally buy components under purchaseorders and generally do not have long-term agreements with our suppliers. Also,we generally do not maintain large inventories of components. Any terminationof, or significant disruption of, our relationships with the suppliers of ourproduct components may prevent us from filling customer orders in a timelymanner which could result in customer dissatisfaction and lost sales.

 

We have occasionally experienced, and we may in thefuture experience, shortages or delays in delivery of components. Althoughalternate suppliers are available for most of the components and servicesneeded to produce our products, the number of suppliers of some components islimited, and qualifying a replacement supplier and receiving components fromalternate suppliers could take several months.

 

We have limited ability to control quality issues(particularly with respect to faulty components manufactured by thirdparities), and we depend upon suppliers to deliver components that are freefrom defects, competitive in functionality and cost, and in compliance withspecifications and delivery schedules. Disruption in supply, a significantincrease in the cost of one or more components, failure of a third partysupplier to remain competitive in functionality or price, or the failure of asupplier to comply with any of our procurement needs could delay or interruptour ability to manufacture and deliver our products to customers on a timelybasis, thereby delaying our revenue recognition and adversely affecting ourbusiness, financial condition, and results of operations.

 

We rely on third party manufacturers for subassemblyof products and for final assembly, quality assurance, and testing of some ofour products. These outsourcing arrangements and any future outsourcingarrangements involve numerous risks, including the economic and financialviability of these manufacturers, reduced control over product quality,delivery schedules, manufacturing yields, and costs.  Moreover, although arrangements with suchmanufacturers may contain provisions for warranty obligations on the part ofsuch manufacturers, we are primarily responsible to our customers for warrantyobligations.

 

**Our products are subject to warranty claims andreturns. Increased warranty claims or returns could harm our business.**

 

We typically offer a 30-day unconditional money-backguarantee on our appliance products sold in North America. We also offerwarranties for parts and service on all our products, ranging from one to threeyears (and, in the case of some of our Equinox branded products, five years).Although our historical return experience has not been significant, our returnsmay increase in the future. An increase in returns would have an adverse effecton our sales and could negatively affect our financial results. We may, as aresult of competitive pressures or customer demands, change our warrantypolicies in the future to provide coverage that is greater in scope andduration than the coverage we currently offer. If we were to increase ourwarranty coverage, our risk of warranty claims, and therefore our warrantyexpense and reserves, would likely increase.

 

**We must meet the increased demands on customer serviceoperations or customer satisfaction and sales could suffer.**

 

Continued growth of our sales is likely to beaccompanied by increasing demands on customer service operations. As a resultof our commitment to a high level of customer service, we will need to investsignificant resources in the maintenance and improvement of our customerservice resources. Any failure to maintain adequate customer service couldcause customer dissatisfaction, result in reduced sales of products and,accordingly, materially adversely affect our business, financial condition, and

 

14

----

 

results of operations.

 

**Executive officers and other key personnel maydepart, which could adversely affect our results of operations and harm ourability to grow the business.**

 

We are greatly dependent on the ability to retain keymanagement, sales, and technical personnel, and our future success is highlydependent upon the personal efforts of our management, sales, and technicalpersonnel. The loss of services of key personnel could have a material adverseeffect on our business, financial condition, and results of operations. We havehistorically used stock options as a key component in our executive andemployee compensation programs in order to align employees’ interests with theinterests of our stockholders, encourage employee retention, and providecompetitive compensation packages. Many of our employee stock options haveexercise prices in excess of our stock price, which reduces the value of thestock options to employees and could affect our ability to retain or attractpresent and prospective employees. In addition, the Financial AccountingStandards Board and other agencies have finalized changes to U.S. generallyaccepted accounting principles that will require us to record a charge toearnings for employee stock option grants and other equity incentives.Moreover, applicable stock exchange listing standards relating to obtainingstockholder approval of equity compensation plans could make it more difficultor expensive for us to grant options to employees in the future. As a result,we may incur increased compensation costs, change our equity compensationstrategy, or find it difficult to attract, retain, and motivate employees, anyof which could materially adversely affect our business. Competition foremployees with the skills required, particularly 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 to offer additional compensationor incentives to attract and retain these and other employees.

 

**Difficulties encountered during changing economicconditions could adversely affect our results of operations.**

 

For the last several years, we have experienced rapidrevenue and customer growth and expansion in the number of employees, productofferings, customers, operating locations, and suppliers. In addition, we haveacquired a number of companies in the same time period. This growth and theseacquisitions have placed significant strain on our managerial, operational, andfinancial resources and resulted in new and increased responsibilities formanagement personnel. There can be no assurance that our management, personnel,systems, procedures, and controls are, or will be, adequate to support our existingand future operations or that we will continue to grow.

 

Our ability to effectively manage during changingeconomic conditions will require us to continue to implement and improve ouroperational, financial, and information systems and internal controls and willlikely require additional management personnel. In addition, we believe that wemust continue to develop greater engineering, marketing, sales, and customerservice capabilities in order to develop new products and technologies, securenew customers, and effectively serve the evolving needs of present and futurecustomers. We may not be successful in strengthening these capabilities.Without adequate management, engineering, 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 during changingeconomic conditions, our business, financial condition, and results ofoperations could be materially adversely affected.

 

Because our business and operating results depend to asignificant extent on the general conditions in the server market, any adversechange in the server market due to adverse economic conditions, decliningcapital spending levels, or other factors could have a material adverse effecton our business, financial condition, and results of operations. In addition,we continue to see industry-wide initiatives by OEMs and by distributors andresellers to reduce their inventories and to shorten their lead times, therebyreducing early commitments to firm orders by our major OEM and our distributorand reseller customers.

 

**We have limited protection of proprietary rightsand face risks of third party infringements.**

 

Our future success depends in part upon our ability toprotect proprietary rights in our products. We seek to protect our intellectualproperty rights by invoking the benefits of the patent, trademark, copyright,trade secret, and unfair competition laws of the United States and othercountries. These laws, however, afford only limited protection. There can be noassurance that the steps we have taken to protect our intellectual propertyrights, or that the steps we take in the future, will be adequate to preventmisappropriation of our intellectual property or technologies or that ourcompetitors will not independently develop proprietary or other technologiesthat are substantially equivalent or superior to our products or technologies.

 

The U.S. Patent and Trademark Office has issuedseveral patents to us for various aspects of our products. We have variouscorresponding patent applications pending under the provisions of the PatentCooperation Treaty, which permits the filing of corresponding foreign patentapplications in numerous foreign countries within a limited time period. Wealso have other United States and foreign patent applications pending. Therecan be no assurance that any additional patents will be issued from any ofthose pending applications or that any patents will be issued in any additionalcountries where our products can be sold. Claims allowed in our patents or inany pending patent applications may not be of sufficient scope or strength for,or provide meaningful protection or any commercial advantage to us. Also,competitors may develop their own intellectual property or technologies, obtain

 

15

----

 

their own patents, or challenge the validity of, or be able to designaround, our patents. The laws of certain foreign countries in which ourproducts are or may be developed, manufactured, or sold (particularly certaincountries in Asia) may not protect our products or intellectual property rightsto the same extent as do the laws of the United States and thus increase thelikelihood of piracy of our technologies and products.

 

In May 2001, we filed a complaint for patentinfringement in the United States District Court for the Southern District ofNew York against Raritan Computer Inc. The Raritan complaint sought injunctiverelief, damages, attorney’s fees and costs under three of our patents. After aseven-day bench trial in New York in January 2002, U.S. District Judge MiltonPollack found that there was no infringement of our patents by Raritan andordered that judgment be entered in favor of Raritan.   We appealed that judgment, and in April2003, the United States Court of Appeals for the Federal Circuit issued itsruling on our appeal in this patent litigation. The Court of Appeals ruled in our favor by vacating the non-infringementdecision of the District Court for the Southern District of New York andremanding the case for further proceedings consistent with the Court of Appeals’opinion.  In September 2003, Raritan petitioned the United States Supreme Court fora Writ of Certiorari to review the Court of Appeals decision, and we filed ouropposition to the petition in November 2003. Raritan’s petition was denied by the Supreme Court in December 2003, andthe case was sent back to the United States District Court for the SouthernDistrict of New York.  With the death in2004 of Judge Pollack, the case was assigned to U.S. District Court Judge KevinCastel, and a Markman hearing on claims construction was held in February 2005.

 

In October 2003, we filed acomplaint for patent infringement in the United States District Court for theNorthern District of Alabama against ClearCube Technology, Inc.  The ClearCube complaint seeks injunctiverelief, damages, attorneys’ fees, and costs under three Avocent patents.ClearCube has filed counterclaims alleging non-infringement, unenforceability,invalidity, and misuse of the Avocent patents. A Markman hearing on claims construction was originally set for February2005, but in response to an inquiry from the court, we recently agreed that thehearing should be postponed until the United States Court of Appeals for theFederal Circuit issues its ruling on the issues raised in an unrelated patentcase.

 

We may initiate claims or litigation against otherthird parties for infringement of proprietary rights or to establish thevalidity of proprietary rights. Similarly, our competitors may initiate claimsor litigation against us alleging infringement of their proprietary rights orimproper use of their intellectual property. Existing litigation, and any other litigation relating to intellectualproperty to which we become a party, is subject to numerous risks and uncertainties,including the risk of counterclaims or other litigation against us, and we maynot be successful in any such litigation. Litigation is expensive, and theexisting litigation or any other litigation by or against us could result insignificant additional expense and divert the efforts of technical andmanagement personnel, whether or not such litigation results in a favorabledetermination. In the event of an adverse result in any such litigation, wecould be required to pay substantial damages, suspend or cease the manufacture,use, and sale of any infringing products, expend significant resources toredesign products or develop non-infringing technology, discontinue the use ofcertain processes, or obtain licenses to the infringing technology. There canbe no 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 claim againstus, or our customers, and a license is not made available on commerciallyreasonable terms, our business, financial condition, and results of operationscould be adversely affected.

 

The network server, electronics, and relatedindustries are characterized by vigorous pursuit and protection of intellectualproperty rights or positions, which has resulted in significant and oftenprotracted and expensive litigation. We have in the past been, and we may fromtime to time in the future be, a party in proceedings alleging infringement ofintellectual property rights owned by third parties. If necessary or desirable,we may seek licenses under such intellectual property rights. However, licensesmay not be offered on terms acceptable to us, or at all. The failure to obtaina license from a third party for technology used by us could cause us to incursubstantial liabilities and to suspend or cease the manufacture of productsrequiring such technology. Additionally, current or future competitors couldobtain patents that may prevent us from developing or selling our products.

 

**We have acquired, and expect to continue toacquire, technologies and companies that could disrupt our business or exposeus to other risks.**

 

A key component of our engineering and productdevelopment strategy is the acquisition of technologies and companies.  We acquired Equinox Systems Inc. in2001, 2C Computing, Inc. in 2002, Soronti, Inc. in 2003, and Crystal LinkTechnologies, OSA Technologies, Inc., and Sonic Mobility, Inc. in 2004.  We intend to continue to execute our strategythrough the acquisition of technologies or companies or through investments incomplementary companies, products, or technologies, and it is likely we willcomplete such acquisitions or investments in the future.  These acquisitions and investments involvemany risks, including the following:

 

•                                          Difficultyintegrating the acquired company’s personnel, products, technologies, andoperations;

 

•                                          Diversionof management’s attention;

 

•                                          Difficultyin combining product and technology offerings and entering into new markets orgeographical areas in which we have no or limited direct experience and whereour competitors may have stronger market positions;

 

16

----

 

•                                          Lossof key personnel;

 

•                                          Delaysor difficulties in coordinating and combining administrative, manufacturing,research and development and other operations, facilities, and relationshipswith third parties in accordance with local laws and other obligations whilemaintaining adequate standards, controls and procedures;

 

•                                          Difficultyin completing projects associated with acquired in-process research anddevelopment;

 

•                                          Incurringamortization expense related to certain intangible assets and recordinggoodwill and non-amortizable assets that will be subject to impairment testingand possible impairment charges;

 

•                                          Dilutionof existing stockholders as a result of issuing equity securities, includingthe assumption of any stock options issued by the acquired company;

 

•                                          Overpaymentfor any acquisition or investment;

 

•                                          Assumptionof liabilities of the acquired company, including any potential intellectualproperty infringement claims; and

 

•                                          Incurringsubstantial write-offs, restructuring charges, and transactional expenses.

 

**Our failure to manage these risksand challenges could materially harm our business, financial condition, andresults of operations.  Further, if we donot successfully 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 from expectations of marketanalysts or investors for any given quarter.**

 

**Unanticipated changesin our tax rates or exposure to additional income tax liabilities could affectour profitability.**

 

We are subject to income taxes in both the UnitedStates and various foreign jurisdictions, and our domestic and internationaltax liabilities are subject to the allocation of expenses in differentjurisdictions. Our effective tax rates could be adversely affected by changesin the mix of earnings in countries with differing statutory tax rates, in thevaluation of deferred tax assets and liabilities, in tax laws, or by materialaudit assessments, which could affect our profitability. In addition, theamount of income taxes we pay is subject to audit in various jurisdictions, anda material assessment by a governing tax authority could affect ourprofitability. Further, if we elect to repatriate cash held outside the UnitedStates pursuant to The American Jobs Creation Act of 2004, our tax rate mayincrease.

 

**Fluctuations in the value of foreign currenciescould result in currency exchange losses.**

 

Currently, a majority of our international business isconducted in U.S. dollars. However, as we expand our international operations,it is likely that international business will increasingly be conducted inforeign currencies. In particular, the introduction of the euro has led many ofour European customers to request or insist that our sales to them bedenominated in euros instead of U.S. dollars. Fluctuations in the value offoreign currencies relative to the U.S. dollar have caused, and are expected toincreasingly cause, currency translation gains and losses. While we attempt tohedge our foreign currency exposure, we cannot predict the effect of exchangerate fluctuations upon future quarterly and annual operating results, and wemay experience currency losses in the future.

 

**Unforeseenenvironmental costs could impact our future earnings.**

 

Some of our operations use substances regulated undervarious federal, state, and international laws governing the environment,including those governing the discharge of pollutants into the air and water,the management and disposal of hazardous substances and wastes, and the cleanupof contaminated sites. Many of our products are subject to various federal,state, and international laws governing chemical substances in products,including those regulating the manufacture and distribution of chemicalsubstances and those restricting the presence of certain substances inelectronics products. We could incur substantial costs, including cleanup costs,fines, civil or criminal sanctions, third-party property damage, or personalinjury claims if we were to violate or become liable under environmental lawsor if our products become non-compliant with environmental laws. We also faceincreasing complexity in our product design and procurement operations as weadjust to new and future requirements relating to the materials composition ofour products, including the restrictions on lead and certain other substancesthat will apply to specified electronics products put on the market in theEuropean Union as of July 1, 2006 (Restriction of Hazardous SubstancesDirective) and similar legislation currently proposed in China and othercountries. The ultimate costs under environmental laws and the timing of thesecosts are difficult to predict, and liability under some environmental lawsrelating to contaminated sites can be imposed retroactively and on a joint andseveral basis.

 

17

----

 

We could also face significant costs and liabilitiesin connection with product take-back legislation. The European Union hasfinalized the Waste Electrical and Electronic Equipment Directive, which makesproducers of electrical goods, including computers and peripherals, financiallyresponsible for specified collection, recycling, treatment, and disposal ofpast and future covered products. This deadline to enact and implement thedirective by individual European Union governments generally wasAugust 13, 2004, although extensions were granted to some countries (suchlegislation, together with the directive, the “WEEE Legislation”), andproducers are financially responsible under the WEEE Legislation beginning inAugust 2005. Similar legislation has been or may be enacted in othergeographies, including in the United States and Japan, the cumulative impact ofwhich could be significant for us.

 

**Provisions in our charter documents and inDelaware law may discourage potential acquisition bids for us and may preventchanges in management that stockholders may favor.**

 

Provisions in our charter documents could discouragepotential acquisition proposals and could delay or prevent a change in controltransaction that stockholders may favor. These provisions could have the effectof discouraging others from making tender offers for shares, and as a result,these provisions may prevent the market price of our common stock fromreflecting the effects of actual or rumored takeover attempts and may preventstockholders from reselling their shares at or above the price at which theypurchased their shares. These provisions may also prevent changes in managementthat stockholders may favor. Our charter documents do not permit stockholdersto act by written consent, limit the ability of stockholders to call astockholders meeting, and provide for a classified board of directors, whichmeans stockholders can only elect, or remove, a limited number of directors inany given year. Furthermore, the board of directors has the authority to issueup to five million shares of preferred stock in one or more series. The boardof directors can fix the price, rights, preferences, privileges, andrestrictions of such preferred stock without any further vote or action by ourstockholders. The issuance of shares of preferred stock may delay or prevent achange in control transaction without further action by our stockholders.

 

In addition, Delaware law may inhibit potentialacquisition bids for us. Delaware law prevents certain Delaware corporations,including Avocent, from engaging, under certain circumstances, in a businesscombination with any interested stockholder for three years following the datethat such stockholder became an interested stockholder.

 

**Our stock will likely be subject to substantialprice and volume fluctuations which may prevent stockholders from resellingtheir shares at or above the price at which they purchased their shares.**

 

Fluctuations in the price and trading volume of ourcommon stock may prevent stockholders from reselling their shares above theprice at which they purchased their shares. Stock prices and trading volumesfor many technology companies fluctuate widely for a number of reasons,including some reasons which may be unrelated to their businesses or results ofoperations. This market volatility, as well as general domestic orinternational economic, market and political conditions, could materiallyadversely affect the market price of our common stock without regard tooperating performance. In addition, if our operating results were to be belowthe expectations of public market analysts and investors, the market price ofour common stock would likely decrease significantly.

 

**Item 2. Properties.**

 

Our world-wide headquarters, occupying approximately181,000 square feet and containing administrative, sales, marketing, researchand development, engineering, manufacturing, and distribution facilities, arelocated in Huntsville, Alabama, on an 18-acre tract of land owned by us inCummings Research Park.

 

Our Redmond, Washington facility, which consists ofapproximately 82,000 square feet in an industrial office building, containsadministrative, sales, marketing, research and development, engineering,manufacturing, and distribution operations. In 2002, we renegotiated the leasefor this space for occupancy through March 2009, and the current base rentunder the amended lease is approximately $816,000 per year, plus taxes,insurance, and maintenance of approximately $192,000 per year.

 

Our international administrative, sales, marketing,research and development, engineering, manufacturing, and distributionoperations are located in a 129,000 square foot building owned by us in thefree trade zone in Shannon, Ireland.

 

We also own a 45,000 square foot building on 6.5 acresof land in Sunrise, Florida. Our Sunrise facility contains sales, marketing,research and development, and engineering personnel.

 

In addition, we lease office space in San, JoseCalifornia (OSA Technology’s administrative, sales, marketing, research anddevelopment, and engineering operations), Austin, Texas (sales and marketingpersonnel to support our OEM operations), Chelmsford, Massachusetts (sales andengineering personnel), Draper, Utah (sales, marketing, and engineeringpersonnel), San Diego, California (sales, marketing, and engineeringpersonnel), Calgary, Canada (administrative, sales, marketing, and engineeringoperations for our Sonic Mobility operations), Steinhagen, Germany(administrative, sales, and engineering personnel), Taipei, Taiwan (administrative,sales, marketing, and engineering personnel), and Shanghai, China (engineeringpersonnel).

18

----

 

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 May 2001, we filed a complaint for patentinfringement in the United States District Court for the Southern District ofNew York against Raritan Computer Inc. The Raritan complaint sought injunctiverelief, damages, attorneys’ fees and costs under three of our patents.  After a seven day bench trial in New York inJanuary 2002, U.S. District Judge Milton Pollack found that there was noinfringement of our patents by Raritan and ordered that judgment be entered infavor of Raritan.  We appealed thatjudgment, and in April 2003, the United States Court of Appeals for the FederalCircuit issued its ruling on our appeal in this patent litigation.  The Court of Appeals ruled in our favor byvacating the non-infringement decision of the District Court for the SouthernDistrict of New York and remanding the case for further proceedings consistentwith the Court of Appeals’ opinion.  In September 2003, Raritan petitioned theUnited States Supreme Court for a Writ of Certiorari to review the Court ofAppeals decision, and we filed our opposition to the petition in November2003.  Raritan’s petition was denied bythe Supreme Court in December, 2003, and the case was sent back to the UnitedStates District Court for the Southern District of New York.  With the death in 2004 of Judge Pollack, thecase was assigned to U.S. District Court Judge Kevin Castel, and a Markmanhearing on claims construction was held in February 2005.

 

In October 2003, we filed acomplaint for patent infringement in the United States District Court for theNorthern District of Alabama against ClearCube Technology, Inc.  The ClearCube complaint seeks injunctiverelief, damages, attorneys’ fees, and costs under three Avocent patents.ClearCube has filed counterclaims alleging non-infringement, unenforceability,invalidity, and misuse of the Avocent patents.  A Markman hearing on claims construction wasoriginally set for February 2005, but in response to an inquiry from the Court,we recently agreed that the hearing should be postponed until the United StatesCourt of Appeals for the Federal Circuit issues its ruling on the issues raisedin an unrelated patent case.

 

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

 

None.

 

19

----

 

**PART II**

 

**Item 5. Market For Registrant’s Common Equity andRelated Stockholder Matters.**

 

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

 

Our common stock is quoted on The Nasdaq NationalMarket System under the symbol “AVCT.” The following table shows the high andlow sales prices of our common stock for each quarterly period within the lasttwo fiscal years as reported by the Nasdaq National Market System.

 
| ** **                        | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------------------|------------|----------|------------|---------|------------|
| Quarter ended  December 31, 2004  |       | $        | 40.69      |    | $          | 26.53 |   |
| Quarter ended  October 1, 2004    |       | $        | 35.69      |    | $          | 25.59 |   |
| Quarter ended  July 2, 2004       |       | $        | 38.24      |    | $          | 30.86 |   |
| Quarter ended  April 2, 2004      |       | $        | 42.20      |    | $          | 35.64 |   |
| Quarter ended  December 31, 2003  |       | $        | 39.53      |    | $          | 29.50 |   |
| Quarter ended  September 26, 2003 |       | $        | 33.38      |    | $          | 24.11 |   |
| Quarter ended  June 27, 2003      |       | $        | 33.85      |    | $          | 22.33 |   |
| Quarter ended  March 28, 2003     |       | $        | 29.80      |    | $          | 21.68 |   |

 

As of March 7, 2005, there were 282 holders of recordof our common stock.

 

**Dividend Policy**

 

We have not declared or paid any cash dividends in thepast and, for the foreseeable future, we expect to retain earnings to financethe expansion and development of our business. The payment of dividends iswithin the discretion of our Board of Directors and will depend on ourearnings, capital requirements and operating and financial condition, amongother factors.

 

**Equity Compensation Plan Information**

 

Please see Item 12 of this Annual Report on form 10-Kfor disclosures relating to our equity compensation plans.  Such information is incorporated by referencefrom our 2004 proxy statement.

 

**Recent Purchases of Treasury Stock**

 

In the fourth quarter of 2004 our Board of Directorsapproved a stock repurchase program whereby we may, from time to time, purchaseup to 2 million shares of our common stock in the open market, in privatelynegotiated transactions or otherwise, at prices that we deem appropriate. Theplan has no expiration date. Details of these purchases are as follows:

 
| **Period:**                                | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price Paid  Per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announce Plan** | ** ** | **Maximum Number of  Shares Remaining to  Purchase Under the  Plan** | ** ** |
|--------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|---------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
|                                       |       |                                  |       |                              |       |                                                                      |       |                                                                 |       |
| November 1, 2004  – November 30, 2004 |       | —                                |       | —                            |       | —                                                                    |       | 2,000,000                                                            |       |
| December 1, 2004  – December 31, 2004 |       | 100,000                               |       | $                                 | 39.78      |                                                                      | 100,000    |                                                                 | 1,900,000  |   |
|                                       |       |                                  |       |                              |       |                                                                      |       |                                                                 |       |
| Totals                                     |       | 100,000                               |       | $                                 | 39.78      |                                                                      | 100,000    |                                                                 | 1,900,000  |   |

 

20

----

 

**Item 6. Selected Financial Data.**

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

 
| ** **                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Net sales                        |       | $        | 365,255    |     | $          | 304,238  |       | $        | 260,600    |     | $          | 255,911 |   | $ | 222,372 |   |
| Net income  (loss) (1)           |       | $        | 18,040     |     | $          | 38,547   |       | $        | 10,738     |     | $          | (320,466 | ) | $ | (130,556 | ) |
| Basic per share  income (loss)   |       | $        | 0.37       |     | $          | 0.83     |       | $        | 0.24       |     | $          | (7.22 | ) | $ | (3.92 | ) |
| Diluted per  share income (loss) |       | $        | 0.36       |     | $          | 0.81     |       | $        | 0.24       |     | $          | (7.22 | ) | $ | (3.92 | ) |
| Total assets                     |       | $        | 770,781    |     | $          | 660,763  |       | $        | 568,607    |     | $          | 547,198 |   | $ | 815,246 |   |

 

----

(1) For the periods presented, we recognizedcharges for acquired in-process research and development expenses for thefollowing mergers and acquisitions: $94.0 million for Apex Inc. and CybexComputer Products Corp. in 2000, $4.6 million for Equinox Systems Inc. in 2001,$6.0 million for 2C Computing, Inc. in 2002, $3.9 million for Soronti, Inc. in2003, and $6.5 million for Crystal Link Technologies,  $21.7 million for OSA Technologies, Inc. and$1.1 million for Sonic Mobility Inc. in 2004, (*see note 3 to the financial statements*).  Additionally, we recorded an impairmentcharge of $195.4 million in 2001 as a reduction in the remaining carrying valueof goodwill arising from the merger of Apex and Cybex.  EffectiveJanuary 1, 2002, we adopted SFAS No. 142 and ceased amortizing goodwill createdfrom mergers and acquisitions. However, prior to the adoption of FASB 142, werecorded $52.8 million of goodwill amortization during the year ended December31, 2000 and $111.0 million during the year ended December 31, 2001.

 

21

----

 

**Item 7.****           Management’s Discussionand Analysis of Financial Condition and Results of Operations.**

 

THE INFORMATION IN THIS ITEM 7—”MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”CONTAINS FORWARD-LOOKING STATEMENTS, INCLUDING, WITHOUT LIMITATION, STATEMENTSRELATING TO OUR REVENUES, EXPENSES, MARGINS, LIQUIDITY, CAPITAL NEEDS,INVESTMENTS, ACQUISITON ACCOUNTING, ACQUISITION AND TRANSACTION COSTS ANDADJUSTMENTS INCLUDING, AMONG OTHER THINGS, WRITE OFF OF IN-PROCESS RESEARCH ANDDEVELOPMENT COSTS AND AMORTIZATION OF INTANGIBLE ASSETS. THESE FORWARD-LOOKINGSTATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSEACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THEFORWARD-LOOKING STATEMENTS. FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE,BUT ARE NOT LIMITED TO, THOSE DISCUSSED UNDER THE CAPTION “FACTORS THAT MAYAFFECT FUTURE RESULTS.”

 

**Overview**

 

Avocent designs,manufactures, licenses and sells solutions that provide connectivity andcentralized management of IT infrastructure. We provide connectivity and management products and technologiesthat centralize control of servers, mobile devices, and network appliances,increasing the efficiency of IT personnel. Server manufacturers rely onembedded Avocent technology in their systems and companies large and smalldepend on our products and technologies for managing their growing ITinfrastructure.

 

Our innovations include IP-based switching,centralized management, and intuitive software interfaces. Our products andtechnologies manage servers, serial devices, wireless devices, mobile devices,and embedded infrastructure. With more than two decades of experience, we havegrown through product innovations, global expansion, and strategicacquisitions.  Formed as a result of themerger in 2000 between Apex Inc. and Cybex Computer Products Corporation, wesubsequently acquired Equinox Systems Inc. in 2001, 2C Computing, Inc. in 2002,and Soronti, Inc. in 2003, Crystal Link Technologies, OSA Technologies, Inc.,and Sonic Mobility, Inc. in 2004.

 

Our KVM switching systems eliminate the need for extrakeyboards, monitors, and mice and allow businesses to save critical space intheir data centers.  Our KVM over IPswitching systems eliminate distance limitations and provide 24/7 access andcontrol to an almost unlimited number of servers, even when the servers aredispersed in different physical locations. Our *DSView* software management and KVM overIP switching systems allow IT managers to use a single console to gain secure,local and remote access and control of servers and other network data centerdevices from any location.

 

Our innovative advances for the data center includemulti-platform switching, analog matrix switching, KVM extension over CAT 5,PCI bus extension, a proprietary on-screen menu switching system, remote KVMover IP connectivity, digital serial over IP, digital-analog integrated accessto multiple servers, intelligent platform management interface (IPMI)solutions, wireless KVM, PDA, and hand-held management solutions, and centralizedmanagement software for access and control of network infrastructure.

 

Our DSR switches are revolutionary in theindustry.  They combine powerful analogand digital connections, serial connectivity, and external modem support in oneswitch. These appliances integrate our KVM over IP switching technology and CAT5 connectivity.  IT managers and networkadministrators gain worldwide access and control of their servers and serialdevices and can track them all from a single computer screen.  In addition, we provide plug and playswitching systems for the many network administration, management, and storageproblems faced by corporate customers, data centers, and mid-size businesses.Our connectivity solutions include products and technologies sold or licensedunder the Avocent, Cybex, and Equinox brands, including our *AMX*TM,***AutoView*TM*, Cstation*TM,*DSView®, DS Series, LongView*TM*,**OutLook®, SuperSerial*, *SwitchView®, Emerge*TM, *SonicAdmin*TM,and *SonicSentinel*TM products.

 

We market and sell our products around the world to adiversified group of original equipment manufacturers (OEMs) dealers,distributors, resellers, and end users, primarily through our sales andcustomer support staff, advertisements in trade publications, and participationin major industry trade shows.

A substantial portion of our revenue is derived fromsales to a limited number of OEMs who purchase our switching systems 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 for45% of sales in 2004 and 46% in both 2003 and 2002.  Sales to our branded customers accounted for55% of sales in 2004 and 54% of sales in both 2003 and 2002. We do not havecontracts with many of our branded customers, and in general, our OEM andbranded business customers are obligated to purchase products from us onlypursuant to binding purchase orders.  Theloss of, or material decline in orders from, these customers would have amaterial adverse effect on our business, financial condition, results ofoperations, and cash flows.  Our top fivecustomers include both OEM and branded customers, and accounted for 64% ofsales in both 2004 and 2003 and 65% of sales in 2002.

 

22

----

 

We sell products to dealers, end-users, and OEMs inthe United States, Canada, Europe, and Asia as well as in other foreignmarkets.  Sales within the United Statesaccounted for approximately 59% of 2004 sales and 60% of 2003 and 2002sales.  Sales outside of the UnitedStates accounted for 41% of 2004 sales and 40% of 2003 and 2002 sales.  Sales to customers in the Netherlands,including the European distribution facility for one of our OEM customers,accounted for 10% of sales in 2004. Sales to customers in the United Kingdom,including the European distribution facility for one of our OEM customers,accounted for 10% of 2003 sales and 15% of 2002 sales.  No other country accounted for more than 10%of 2004, 2003, or 2002 sales.

 

With continued industry-wide initiatives to reduce allchannel inventories and to shorten lead times, trends with our major customersare, generally, to reduce the number of weeks of forward-committed firm orders.This trend 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 continue to experiencesignificant price competition in the market for all of our products, and weexpect that pricing pressures will continue in the future.  In addition, general economic conditions arenot as predictable as they were in prior years and we expect our revenue growthrate to fluctuate in relation to economic conditions and IT related spendingtrends.  Depending on future generaleconomic conditions and other factors, our revenue could decline in the future.

 

Many of our executiveofficers and directors are vested in significant amounts of options to purchaseshares of our common stock and continue to vest in additional shares on aregular basis.  These officers anddirectors have informed us that they have sold, and may sell additional, sharesof our common stock to provide liquidity and diversify their portfolios.

 

**Results of Operations**

 

Our consolidated statements of operations,stockholders’ equity, and cash flows reflect the results of acquired companiesfrom the respective dates of acquisition. Certain reclassifications have been made to the prior year financialstatements to conform to the current year presentation.

 

The following table sets forth, for the periodsindicated, selected statement of operations data expressed as a percentage ofnet sales:

 
| ** **                                            | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|
| ** **                                            | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net sales                                             |       | 100.0                        | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                         |       | 41.7                         |       | 43.5 |   | 49.5 |   |
| Gross profit                                          |       | 58.3                         |       | 56.5 |   | 50.5 |   |
| Operating  expenses:                                  |       |                         |       |   |   |   |   |
| Research and  development expenses                    |       | 12.4                         |       | 9.8 |   | 10.2 |   |
| Acquired  in-process research and development expense |       | 8.0                          |       | 1.3 |   | 2.3 |   |
| Selling, general  and administrative expenses         |       | 23.2                         |       | 23.1 |   | 25.7 |   |
| Amortization of  intangible assets                    |       | 6.7                          |       | 7.2 |   | 8.5 |   |
| Total operating  expenses                             |       | 50.3                         |       | 41.4 |   | 46.7 |   |
| Income from  operations                               |       | 8.0                          |       | 15.1 |   | 3.8 |   |
| Net investment  income                                |       | 1.4                          |       | 1.6 |   | 2.2 |   |
| Net realized  investment gains (losses)               |       | (1.1                         | )          | 0.9 |   | (0.1 | ) |
| Other income  (expense), net                          |       | —                       |       | (0.1 | ) | (0.1 | ) |
| Income before  provision for income taxes             |       | 8.3                          |       | 17.5 |   | 5.8 |   |
| Provision for  income taxes                           |       | 3.4                          |       | 4.8 |   | 1.7 |   |
| Net income                                            |       | 4.9                          | %          | 12.7 | % | 4.1 | % |

 

*Years Ended December 31,2004 and 2003*

 

*Net sales.*  Our net sales consist of sales of keyboard,video, and mouse console switching systems, digital connectivity solutions,serial connectivity devices, wireless extension products, and IPMI, extension,remote access and management solutions. In 2004, net sales increased 20% to$365.3 million from $304.2 million in 2003. This increase in salesresulted from increased demand from our branded and OEM customers across allgeographic regions.  Branded sales in 2004increased 22% over 2003, while OEM sales in 2004 increased 18% over 2003.  Branded sales accounted for 55% of sales in2004 and 54% of sales in 2003.  OEM saleswere 45% of sales in 2004 and 46% of sales in 2003.  Continued strong demand for our digitalproduct line contributed to our sales growth. Contributions from IPMI andembedded KVM royalty revenues also increased our net sales.  The primary contributor to the growth of ourdigital product revenue was the increased sales of the OEM versions of ourdigital product line, which was introduced in mid-2002.  Sales of our digital

 

23

----

 

solutions accounted for$175.0 million or 48% of sales in 2004 compared with $114.8 million or 38% ofsales for 2003.  Our IPMI and embeddedKVM royalty revenues totaled $3.7 million in 2004, the first year we recognizedrevenues from these technologies.

 

Sales in 2004 were strong internationally and in theUnited States.  International salesaccounted for 41% of sales in 2004 and 40% of sales in 2003, while sales withinthe United States were 59% of sales in 2004 and 60% of sales in 2003.  Sales in the U.S. increased 19% from $182.1million in 2003 to $216.7 million in 2004, while international sales increased21.7% from $122.1 million in 2003 to $148.6 million in 2004.  This increase in sales in the U.S. can beattributed to the continued strength of our branded sales, the strong sales ofour digital solutions, and the contributions from our IPMI and embedded KVMroyalty revenues.  The strength in ourinternational sales was most evident in the European and the Asia Pacificregions, where both branded and OEM sales were strong. We believe the overallstrength in these regions is the result of our continued investments in internationalsales and marketing programs over the past three years.

 

We expect the new digital hardware and softwaresolutions we announced in January 2005 will allow us to continue to grow ourdigital revenues as a percentage of sales. We expect the design wins in ourembedded KVM and IPMI business during the second half of 2004 will positivelyaffect our revenue in 2005.  We alsoexpect to see revenues from our new family of serial connectivity managementproducts announced in January 2005.  Weexpect a two to three month transition period for some of our new productintroductions to gain traction in the market place as we train our resellernetwork and allow end-user customers to re-evaluate our solutionofferings.  We believe that this producttransition period combined with the seasonal decline in OEM sales we typicallyexperience from the fourth quarter to the first quarter will cause our revenuesto be down sequentially in the first quarter of 2005 from the fourth quarter of2004.  In addition, an order for a largecustomer that we had anticipated to occur in the first quarter has beendeferred, and we have experienced greater than expected seasonal softness in theOEM market, with a substantial portion being attributable to one customer.  These factors, when combined with increasedcompetition in the marketplace, are all contributing to the expected shortfallin revenue in the first quarter of 2005. For our first quarter ending April 1,2005, we expect our revenue to be in the range of $73 to $77 million, our grossmargin percentage to be in the mid 50’s due to lower revenue coverage of fixedcosts, and our operational earnings per share, before the effects of intangibleamortization and merger related costs, to be in the range of $0.14 to $0.17.  We are withdrawing our prior guidance andre-evaluating our expectations for the balance of 2005.

 

*Gross profit.*  Gross profit is affected by a variety offactors, including: the ratio of sales among our distribution channels, as OEMsales have lower gross margins than our branded sales; absorption of fixedcosts as sales levels fluctuate; product mix, raw materials, and labor costs;new product introductions by us and by our competitors; and the level of ouroutsourcing of manufacturing and assembly services.  Gross margins continued to improvesignificantly, as they grew to 58.3% in 2004 from 56.5% in 2003.  Gross margin in 2004 benefited from highersales of our digital solutions, which typically have a higher margin than our analogproducts, and accounted for almost 48% of sales in 2004 compared to 38% ofsales in 2003.  Gross margins alsobenefited from our IPMI and KVM embedded royalty revenues, which have grossmargins of 80% to 90%.  Margins werepositively affected by our efforts both to lower product costs through productredesigns that eliminated costly components and to reduce costs in our supplychain.

 

We expect that the contributions from our newcost-reduced family of digital products and higher revenues from our IPMI andembedded KVM solutions will continue to improve our gross margins throughout2005. Overall, we believe the combination of these two factors will besufficient to offset 2005 price declines and the additional costs expected fromcomplying with the new environmental regulations and will contribute toimproved gross margins for 2005.

 

*Researchand development expenses.* Research and development expenses include compensation for engineers,support personnel, outside contracted services and materials costs, and areexpensed as they are incurred. Research and development expenses were$45.4 million, or 12.4% of net sales in 2004, compared to$29.8 million, or 9.8% of net sales in 2003. The increased research anddevelopment expense can be attributed to an increase in the number of engineers,and an increase in materials, certification, and testing of products currentlyin development. The increase in headcount was the result of the addition ofengineers through our four most recent acquisitions and the hiring of softwareengineers to support the software development efforts for our IPMI and embeddedKVM solutions.  We invested in expandingour test lab facilities during 2004, which were completed in the fourthquarter.  During the second half of 2004,we expanded our use of contracted services in order to meet our aggressiveproduct development goals for the year. The development goals included the completely refreshed versions of ourdigital product family that were announced in January 2005 and the release ofDSView3, our management software that was also recently released.  Other efforts included the release of AvocentIntegrated Access Module (iRAM), an embedded product for remote servermanagement and the DSI5100 appliance released in January 2005, which integratesour IPMI management software into our DS Series product line.  These recent product introductions representthe largest number of new product releases and product refreshes completedduring any single quarter in Avocent’s history. We believe that the timely development of innovative products andenhancements to existing products is essential to maintaining our competitiveposition.

 

*Acquired in-process research and developmentexpense.*  Acquisitionrelated expenses in 2004 were comprised solely of the write-off of in-processresearch and development expenses related to our acquisitions, including $6.5million for Crystal Link, $21.7 million for OSA and $1.1 million for SonicMobility.  Acquisition related expensesin 2003 were comprised solely of the write-off of $3.9 million of in-processresearch and development expense related to our acquisition of Soronti.

 

*Selling, general and administrative expenses.*  Selling, general and administrative expensesinclude personnel 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. Selling, general and administrative expenses were$84.8 million, or 23.2% of net sales in 2004 compared to$70.4 million, or 23.1% of net sales for 2003.  The increase in selling, general andadministrative expenses is primarily related to increased headcount as a resultof the Soronti, Crystal Link, OSA and Sonic Mobility acquisitions.  We also continue to expand our internationalsales infrastructure.  Other factorscontributing to higher selling, general and administrative expenses were higherdepreciation expenses related to the SAP implementation, costs of compliancewith the Sarbanes-Oxley Act of 2002, and higher legal

 

24

----

 

fees associated withprotecting our intellectual property rights**.** In 2005, weexpect higher marketing expenses as we promote our brand and the new productsintroduced in early 2005 as well as other new products yet to be announced toincrease customer awareness of these products. We will also incur higher feesfor the continued protection of our intellectual property rights. We expectthat the cost of the Sarbanes-Oxley Act of 2002 Section 404 compliance willdecrease in 2005 as compared to 2004, since the initial labor intensive effortto comply with the Act was completed in 2004.

 

*Amortization of intangible assets.*  Amortization of $24.2 million in 2004includes the amortization of the identifiable intangible assets created as aresult of the merger transaction between Apex and Cybex and the acquisitions ofEquinox, 2C, Soronti, Crystal Link, OSA and Sonic Mobility.  Amortization of $21.8 million in 2003 iscomprised of the amortization of the identifiable intangible assets created asa result of the merger transaction between Apex and Cybex, the acquisitions ofEquinox and 2C and a small amount for Soronti, acquired in November 2003.

 

*Net investment income**.** *Net******investmentincome increased from $4.8 million in 2003 to $5.1 million in 2004, as a resultof an increase in cash and investments generated by our operations and slightlyhigher interest rates in 2004.

 

*Net realized investment gains (losses). *Net realized investmentgains (losses) declined significantly from a gain of $2.6 million in 2003 to aloss of $3.8 million in 2004.  Thischange was the result of recording other-than-temporary declines in our investmentsin VIEO and Rymic, two privately held entities, of $3.5 million in 2004 versusa gain of $3.2 million on the disposition of a previously written down equityinvestment recognized in the third quarter of 2003.** **Our investments in VIEO and Rymic arenow fully reserved**.**

 

*Other income (expense), net.*  Net other income (expense) improved fromexpense of  $288,000 in 2003 to income of$23,000 in 2004 primarily as a result of recording larger foreign currencyexchange losses in the first half of 2003.

 

*Provision for income taxes.*  The provision for income taxes was $12.5million in 2004 compared to $14.5 million in 2003. The increase in theeffective tax rate is primarily attributable to the impact of $21.7 million ofacquired in-process research and development expense, which is not deductiblefor tax purposes, and $4.2 million of additional deferred compensation expense(related to assumed incentive stock options which have no tax benefit to us)recorded as a result of the acquisition of OSA.   These amounts werepartially offset by the tax impact of a higher mix of pre-tax incomecontributed by our Shannon operations that is taxed at a lower rate.

 

*Net income.*  Net income in 2004 was $18.0 millioncompared to $38.5 million in 2003, as a result of the above factors,including the increase in our revenues, an increase in our margins, which wereoffset by realized investment losses, an increase in selling, general andadministrative expenses and higher research and development expenses. Thedifference in amounts charged for acquired research and development expenseupon the acquisitions of Soronti in 2003 versus the amounts charged upon theacquisitions of Crystal Link, OSA and Sonic Mobility also reduced net income in2004.  Net income as a percentage ofsales for 2004 was 4.9%, compared to 12.7% for 2003.

 

*Years Ended December 31,2003 and 2002*

 

*Net sales.*  Net sales increased 17% to$304.2 million for 2003 from $260.6 million for 2002. This increasein sales resulted from increased demand from our OEM and branded customersacross all geographic regions.  OEM salesin 2003 increased 17% over 2002, and branded sales for 2003 increased 17% over2002. OEM sales were 46% of sales in both 2003 and 2002, while branded salesaccounted for 54% of sales in both 2003 and 2002.  Continued strong demand for our digitalproduct line contributed to our sales growth. The primary contributor to thegrowth of our digital product revenue was the introduction of the OEM versionsof our digital product line in mid 2002. Sales of our digital solutions accounted for $114.8 million or 37.7% ofsales in 2003 compared with $64.1 million or 24.6% of sales in 2002.  Our analog line of products also contributedto our sales growth with contributions from our OEM line of analog products andour high-end analog solution, the AMXTM.

 

Sales were strong in the United States andinternationally in 2003.  Sales withinthe United States were 60% of sales in both 2003 and 2002, while internationalsales accounted for 40% of sales in both 2003 and 2002.  Sales in the U.S. increased 17% from $155.6million in 2002 to $182.1 million in 2003, while international sales increased16% from $105.0 million in 2002 to $122.1 million in 2003.  This increase in sales in the U.S. can beattributed to the stabilization of spending in the technology sector of theeconomy, the strengthening of our branded sales, and the strong sales of ourdigital and analog OEM solutions.  Thestrength in our international sales was most evident in the European and theAsia Pacific regions, where both branded and OEM sales were strong. We believethe overall strength in these regions is the result of our increasedinvestments in international sales and marketing programs over the past twoyears.

 

*Gross profit.*  Gross margins improved significantly to 56.5%in 2003 from 50.5% in 2002.  Gross marginin 2003 benefited from higher sales of our digital solutions, which typicallyhave a higher margin than our analog products, and accounted for almost 38 % ofsales in 2003 compared to 25% of sales in 2002. Gross margins also benefited from changing contract manufacturers toachieve lower costs for a significant portion of our business. Our margins alsobenefited from a full year of sales of our AMX product, which has a highergross margin than our other analog products and only began shipping in thethird quarter of 2002.  These factorswere offset in part by price reductions granted to certain OEM customers andlarger discounts given to certain new international resellers as we continue to

 

25

----

 

expand the regions wherewe sell our products.  Margins werepositively affected by our efforts both to lower product costs through productredesigns that eliminated costly components and to reduce costs in our supplychain.

 

*Research and development expenses.*  Research and development expenses were$29.8 million, or 9.8% of net sales in 2003, compared to$26.5 million, or 10.2% of net sales in 2002. The increase in the amountspent on research and development was attributable to an increase in the numberof engineers, and an increase in materials, certification, and testing ofproducts currently in development. The increase in headcount was the result ofhiring software engineers to support the software embedded within our expandingsuite of digital offerings and the addition of engineers through ouracquisitions.   In addition, we continuedto enhance our existing engineering test labs and establish new labs in orderto improve completion time for developing and testing new products.  We believe that the timely development ofinnovative products and enhancements to existing products is essential tomaintaining our competitive position.

 

*Acquired in-process research and developmentexpense.*  Acquisitionrelated expenses in 2003 are comprised solely of the write-off of$3.9 million of in-process research and development expense related to theacquisition of Soronti.  Acquisitionrelated expenses in 2002 were comprised solely of the write-off of$6.0 million of in-process research and development expense related to theacquisition of 2C.

 

*Selling, general and administrative expenses.*  Selling, general and administrative expenseswere $70.4 million, or 23.1% of net sales for 2003 compared to$66.9 million, or 25.7% of net sales for 2002.  The increase in selling, general andadministrative expenses was due primarily to increased labor costs as a resultof additions to headcount and higher advertising costs.  Our additions to headcount were the result ofhiring sales staff in Europe, Asia, and certain regions of the U.S. tostrengthen our sales force in key regions, and the hiring of additionalinformation technology staff to support our enterprise resource planninginformation system project and the acquisition of Soronti.   The increased advertising expense was theresult of advertising expenses related to the rollout of new products. Thefirst quarter of 2002 was affected by $2.7 million in legal fees related topatent litigation, as well as $2.0 million of compensation expense recorded asthe result of a cashless option exercise. However, selling, general and administrative expenses in 2002 benefitedfrom a $1.4 million recapture of a receivable previously reserved in 2001,related to a contract manufacturer that had filed for bankruptcy.  We received a favorable ruling by thebankruptcy judge, which allowed the offset of receivables and payables betweenthe contract manufacturer and certain customers, including Avocent.

 

*Amortization of intangible assets.* Amortization of $21.8 million in 2003 iscomprised of the amortization of the identifiable intangible assets created asa result of the merger transaction between Apex and Cybex, the acquisitions ofEquinox and 2C and a small amount for Soronti, acquired in November 2003.  Amortization of $22.2 million in 2002includes the amortization of the identifiable intangible assets created as aresult of the merger transaction between Apex and Cybex and the acquisitions ofEquinox and 2C.

 

*Net investment income**.** *Net******investmentincome decreased from $5.6 million in 2002 to $4.8 million in 2003.  Although we had more cash and investmentsduring 2003 than in 2002, our interest income declined due to lower interestrates.

 

*Net realized investment gains (losses). *Net realized investmentgains (losses) increased from a loss of $305,000 in 2002 to a gain of over $2.6million in 2003 almost entirely as a result of the gain on the disposition of apreviously written down equity investment recognized in the third quarter of 2003.

 

*Other income (expense), net.*  Net other expense increased from $178,000 in2002, to $288,000 in 2003. This increase was due primarily to larger foreignexchange losses in the first half of 2003 as compared to 2002.  The larger foreign exchange losses in thefirst half of 2003 were offset somewhat by exchange gains in the second half of2003.

 

*Provision for income taxes.*  The provision for income taxes was $14.5million in 2003 compared to $4.5 million in 2002. The effective tax rate for2003 was 27.3% in 2003 compared to an effective tax rate of 29.5% in 2002.  Our effective tax rate is affected by manyfactors, including the composition of pretax profit among our locations.  In recent years, we have increased ourinternational shipments from our Shannon, Ireland facility, which operatesunder a 10% tax rate.

 

*Net income.*  Net income for 2003 was $38.5 millioncompared to $10.7 million for 2002, as a result of the above factors,including the increase in our revenues, an increase in our margins, and anincrease in realized investment gains, partially offset by an increase inselling, general and administrative expenses and research and developmentexpenses. The difference in amounts charged for acquired research anddevelopment expense upon the acquisitions of 2C in 2002 and Soronti in 2003also positively affected net income in 2003. Net income as a percentage of sales for 2003 was 12.7%, compared to 4.1%for 2002.

 

**Liquidity and Capital Resources**

 

As of December 31, 2004 our principal sources ofliquidity consisted of approximately $330 million in cash, cashequivalents, and investments.  Inprevious years, we had a bank line of credit for borrowings but have determinedthat our cash position and expected

 

26

----

 

maturities of investmentsare and will continue to be adequate to cover our current and futureliabilities and capital needs.  We haveno outstanding debt.

 

Our operating activities generated cash ofapproximately $76.5 million in 2004, $82.5 million in 2003, and$71.1 million in 2002.  The slightreduction in positive cash flow in 2004 is primarily the result of an increasein accounts receivable and higher operating expenses from our acquisitions.   We experienced an increase in receivables asa result of the timing and volume of sales in the fourth quarter of 2004, whichalso caused our days sales outstanding (“DSOs”) to increase to 55 days from 47days for the same period in 2003.  Ourgoal is to keep DSOs under 60 days.  Adecline in accounts payable also affected cash flow from operations in2004.  Although net inventories decreasedslightly at the end of 2004 compared to 2003 and were not a large factor indetermining cash from operations for 2004, we experienced a significantdecrease in inventories during 2003 as compared to 2002. The decrease ininventories in 2003 had a significant positive impact on cash flows fromoperations in 2003 that was not repeated in 2004.  Inventory levels at the end of 2004 wereaffected by two offsetting factors.  Inventorylevels increased during the fourth quarter of 2004 due to expected new productlaunches at the end of 2004 and early 2005, but this increase was largelyoffset by our increased sales volume at year-end.

 

We implemented anew enterprise resource planning system in the fourth quarter of 2003 at ourUnited States locations and at our international locations (except for OSA) inJuly 2004. We have capitalized the costs of the new system to date and havebegun depreciating the costs for the system. As of December 31, 2004, $12.1 million had been capitalized for this newsystem. We expect the new system to provide many benefits, including moredetailed information to improve the ways we manage inventory, customerrelationships, and operating expenses on a more timely basis.

 

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. Thesecommitments relate primarily to our need to schedule the purchase ofinventories in advance of the related forecasted sales to customers. We havelonger lead times for the products we purchase from suppliers based in Asiathan those from suppliers based in the U.S. and Europe. Our actual contractualcommitments are typically limited to products needed for one to three months offorecasted sales. The liabilities for these inventory purchases along with therelated inventory assets are typically recognized upon our receipt of theproducts. We also have at any point in time a variety of short-term contractualcommitments for services such as advertising, marketing, accounting, legal, andresearch and development activities. The liabilities for these services and therelated expenses are typically recognized upon our receipt of the relatedservices.  None of our purchasecommitments require payment beyond the next year.

 

The following table setsforth the annual payments we are required to make under contractual obligationsand other commercial commitments for operating leases and for purchases of inventoryand services, in thousands, at December 31, 2004.

 

| ** ** | ** ** | **Operating Leases** | ** ** | **Purchase Commitments** | ** ** |
|------------|------------|----------------------|------------|--------------------------|------------|
|       |       |                 |       |                     |       |
| 2005       |       | $                    | 2,636      |                     | $          | 26,941 |   |
| 2006       |       | 1,788                |       | —                   |       |
| 2007       |       | 1,625                |       | —                   |       |
| 2008       |       | 1,088                |       | —                   |       |
| 2009       |       | 202                  |       | —                   |       |
| Thereafter |       | —               |       | —                   |       |
|       |       |                 |       |                     |       |
| Total      |       | $                    | 7,339      |                     | $          | 26,941 |   |

 

We intend to use a portion of our cash and investmentsfor strategic acquisitions of technologies and companies that will enhance andcomplement our existing technologies and help increase our sales.  In the fourth quarter of 2004 our Board ofDirectors approved a stock repurchase program whereby we may, from time totime, purchase up to 2 million shares of our common stock in the open market,in privately negotiated transactions or otherwise, at prices that we deemappropriate. We purchased 100,000 shares of stock for a total cost ofapproximately $4.0 million during December 2004 under the repurchaseprogram.  During the period January 1,2005 through March 7, 2005 we purchased 350,000 shares under this program at atotal cost of approximately $12.5 million.

 

**CertainTransactions**

 

***Acquisition of Crystal Link Technologies***

** **

On January 6, 2004,we acquired Crystal Link Technologies for an initial payment of cash and commonstock of approximately $6.7 million, plus assumed liabilities of approximately$2.1 million and acquisition costs of approximately $163,000. The purchaseagreement called for possible additional earn-out payments of up to $5.0million based on defined future technical enhancements and sales goals.  The technology enhancement milestones were metsubsequent to October 1, 2004, and we paid $2 million of earn-out considerationin October 2004.  The remaining earn-outconsideration will not be paid as the other milestones were not met.  Crystal Link, based in Escondido, California,has developed wireless technology for KVM switching and extension products,which is incorporated into our LongView Wireless product.

 

27

----

 

We recorded theacquisition under the purchase method of accounting, and allocated the purchaseprice based on the fair value of the assets acquired and liabilities assumed.In accordance with generally accepted accounting principles, purchased researchand development costs allocated to patent-pending technology were capitalizedand will be amortized over the respective estimated useful lives.  The remaining amounts of purchased researchand development were expensed upon the closing of the transaction.  The initial valuation resulted in an excessof acquired net assets over cost, or negative goodwill of approximately$143,000. As prescribed under FAS 141, *Business Combinations*,the negative goodwill was recorded as a contingent liability due to thepotential future earn-outs.  Goodwill wasrecorded in the fourth quarter of 2004 for the earn-outs achieved.  The goodwill will not be amortized but willbe included in our review of goodwill for impairment.

 

***Acquisition ofOSA Technologies, Inc.***

** **

On April 6, 2004, weacquired OSA Technologies, Inc. for cash and common stock of $97.5 million,plus assumed liabilities of approximately $1.7 million, employee stock optionsof approximately $2.5 million and acquisition costs of approximately $1.1million.  Additionally, we recorded $6.4million of deferred compensation related to the OSA employee stock options atthe time of the acquisition.  OSA isheadquartered in San Jose, California and has additional research anddevelopment offices in Shanghai, China and Taipei, Taiwan. OSA has developedembedded manageability firmware and software using IPMI solutions. The resultsof OSA’s operations have been included in our consolidated financial statementssince the date of acquisition.

 

The acquisition was recorded under the purchase methodof accounting, and the purchase price was allocated based on the fair value ofthe assets acquired and liabilities assumed. In accordance with generallyaccepted accounting principles, purchased research and development costsallocated to patent-pending technology were capitalized and will be amortizedover the respective estimated useful lives. The remaining amounts of purchased research and development wereexpensed upon the closing of the transaction. The goodwill recorded as result of the acquisition will not be amortizedbut will be included in our review of goodwill for impairment. The excess ofthe fair value over the intrinsic value of the unvested OSA options and thefair value of the vested OSA options at the date of consummation have beenincluded in the purchase consideration.

 

***Acquisition of Sonic Mobility Inc..***

** **

On August 31, 2004, weacquired the outstanding stock of Sonic Mobility Inc., headquartered inCalgary, Canada for $8.9 million in cash plus an additional $300,000 inacquisition related costs. Sonic Mobility has developed (i) software solutionsthat allow for management of network and data center infrastructure from mobiledevices, (ii) security software for intranet and extranet resource access frommobile handheld devices and (iii) software solutions for managing mobiledevices centrally by IT administrators. Our current management solutionsprimarily provide management and access solutions for fixed place ITdevices.  The addition of Sonic Mobility’sproprietary products expands our markets to include both integrated andstand-alone solutions for the  mobile ITdevice market. The results of Sonic Mobility’s operations have been included inthe consolidated financial statements since the date of acquisition.

 

The acquisition was recorded under the purchase methodof accounting, and the purchase price was allocated based on the fair value ofthe assets acquired and liabilities assumed. In accordance with generallyaccepted accounting principles, purchased research and development costsallocated to patent-pending technology were capitalized and will be amortizedover the respective estimated useful lives. The remaining amounts of purchased research and development wereexpensed upon the closing of the transaction. The goodwill recorded as result of the acquisition will not be amortizedbut will be included in our review of goodwill for impairment.

 

**Critical Accounting Policies**

 

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

 

•                                          Wereview customer contracts to determine if all of the requirements for revenuerecognition have been met prior to recording revenues from salestransactions.  We generally record salesrevenue upon shipment of our products, net of any discounts, since we generallydo not have significant post delivery obligations, the product price is fixedand determinable, collection of the resulting receivable is probable, andproduct returns are reasonably estimable. We generally ship products upon receipt of a purchase order from acustomer.  We record revenue inaccordance with the applicable 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 operations.

 

We generally record royalty revenue from OEMs uponshipment of the related products in which our software or firmware is embeddedby the OEMs, based upon shipment data provided by the OEMs.  We generally record license revenue fromsales of our software upon shipment or electronic transfer of thesoftware.  We generally defer

 

28

----

 

revenues from the sale of extended warranty agreementsand software support and maintenance agreements.  The deferred revenue is amortized into incomeon a pro rata basis over the applicable contract lives.

 

We accrue for sales returns as a reduction of salesand cost of sales based on our experience from historical customer returns,which we believe provides a reasonable estimate of future returns.  Our sales agreements generally include aone-month unconditional return policy. We also allow additional rights of return to certain distributors, whichgenerally 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 $3.2 million and $3.9 million at December 31, 2004 and 2003,respectively.  The reserve is included asa reduction in the carrying value of accounts receivable in the accompanyingconsolidated balance sheets.

 

Prior to extending creditto a new customer, we perform a detailed credit review of the customer andestablish credit limits based on the results of our credit review.  We review collection experience periodicallyto determine if the customer’s payment terms and credit limits need to berevised.  We maintain allowances fordoubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments.  Ifthe financial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments, 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 $1.7million and $2.0 million at December 31, 2004 and 2003, respectively.

 

We participate incooperative advertising and market development programs with certaindistributors and OEMs. We use these programs to reimburse distributors and OEMsfor the actual costs of certain forms of advertising, and in general, allowdistributors and OEMs reimbursement up to a specified percentage of netpurchases. Our costs associated with these programs are estimated and accruedat the time of sale, and are included in sales and marketing expenses in theaccompanying consolidated statements of operations.

 

•                                          Wecarry our inventory at the lower of cost or market, with cost being determinedusing the first-in, first-out method.  Weuse standard costs for material, labor, and manufacturing overhead to value ourinventory.  We review and revise ourstandard costs on a quarterly basis. Therefore, our inventory costs approximate actual costs at the end ofeach reporting period.  We write down our inventory forestimated obsolescence or unmarketable inventory to the estimated market valuebased upon assumptions about future demand and market conditions.  If actual future demand or market conditionsare less favorable than those projected by management, additional inventory write-downsmay be required.  Our reserve for excessand obsolete inventory was $3.8 million and $4.0 million at December 31, 2004and 2003, respectively.

 

•                                          Weprovide for the estimated cost of product warranties at the time revenue isrecognized.  While we engage in extensiveproduct quality programs and processes, including actively monitoring andevaluating the quality of our component suppliers and contract manufacturers,our warranty obligation is affected by product failure rates, failure rates ofpurchased components integrated into our products, material usage, and otherrework costs incurred in correcting a product failure.  Should actual product failure rates, materialusage, or other rework costs differ from our estimates, revisions to ourestimated warranty liability may be required. Our warranty reserve was $2.8 million and $2.7 million at December 31,2004 and 2003, respectively.

 

•                                          Wehold investments in various publicly traded equity and debt securities,including mortgaged-backed and other asset-backed securities.  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 2004, 2003 or 2002.

 

We also invest in privately held entities andgenerally record our investments in these entities at cost or we use the equitymethod if we have the ability to exercise significant influence over theentity.  We review our investments inthese entities periodically to determine if circumstances (both financial andnon-financial) exist that indicate that we will not recover our initial investment.  We record impairment charges on investmentshaving a carrying value that is greater than the value that we would reasonablyexpect to receive in an arm’s length sale of the investment.  We recorded $3.5 million of write-downsagainst such investments for the year ended December 31, 2004 and $550,000 for the year ended December 31,2002.  We did not record any suchwrite-downs against these investments in 2003. As of December 31, 2004 our net carrying value of such investments isnil.

 

29

----

 

**•**                                          Effective January 1, 2002, we adopted SFAS No. 142, *Goodwill andOther Intangible Assets*,  andceased amortizing goodwill.  Our initialtest for goodwill impairment as of January 1, 2002 determined that noadjustment for impairment was required. Additionally, our annual tests for goodwill impairment, performed in thefourth quarters of 2004, 2003 and 2002, determined that no adjustment forimpairment was required.  Our testingindicated that the implied fair value of our goodwill exceeded its carrying value;accordingly, in accordance with SFAS 142, no further impairment analysis wasrequired.  If economic conditionsdeteriorate and indicators of impairment become present, an adjustment to thecarrying value of goodwill and other intangible assets may be required.

 

•**                                         **We review long-lived assets forimpairment under the guidance prescribed by SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*. We recognizeimpairment losses on long-lived assets used in operations when indicators of impairmentare present and the undiscounted cash flows estimated to be generated by thoseassets are less than the assets’ carrying values. An impairment loss would berecognized in the amount by which the recorded value of the asset exceeds thefair value of the asset, measured by the quoted market price of an asset or anestimate based on the best information available in the circumstances.  There were no such losses recognized during2004, 2003, or 2002.

 

•**                                         **We account for income taxes using theasset and liability method. We provide for income taxes currently payable and,in addition, provide deferred income taxes for temporary differences betweenthe tax bases of assets and liabilities and their reported amounts in thefinancial statements and for known contingencies. Temporary differences relateprincipally to the allowance for doubtful accounts, allowance for salesreturns, liability for warranty claims, unrealized gain (loss) on investments,acquired intangible assets, accumulated depreciation, loss on write-down ofinvestments, and inventory reserves. Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to berealized.  We have a valuation allowancerecorded against a deferred tax asset arising from a foreign subsidiary of $2.0million at December 31, 2004 and 2003.

 

**RecentlyIssued Accounting Standards and Recent Tax Legislation**

 

In March 2004, the Financial Accounting StandardsBoard (“FASB”) reached consensus on the guidance provided by Emerging IssuesTask Force (“EITF”) Issue 03-1, *The Meaningof Other-Than-Temporary Impairment and its Application to Certain Investments*.EITF 03-1 specifies that an impairment would be considered other-than-temporaryunless (a) the investor has the ability and intent to hold an investment for areasonable period of time sufficient for the recovery of the fair value up to(or beyond) the cost of the investment and (b) evidence indicating the cost ofthe investment is recoverable within a reasonable period of time outweighsevidence to the contrary. The disclosure provisions of EITF 03-1 were effectivefor annual reporting periods ending after December 15, 2003. In September 2004,the EITF delayed the effective date for the measurement and recognitionguidance included in paragraphs 10 through 20 of EITF 03-1. We continue toevaluate our investment portfolio in order to determine the applicability ofEITF 03-1.

 

In December 2004, the FASB issued SFAS No. 123(revised 2004), “*Share based Payment*”, whichreplaces SFAS No. 123. “*Accounting for Stock BasedCompensation*” and APB Opinion No 25 “*Accountingfor Stock Issued to Employees*.” SFAS 123R requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the financial statementsbased on their fair values beginning with the first interim or annual periodafter June 15, 2005.  The pro-formadisclosures previously permitted under SFAS No. 123 no longer will be analternative to inclusion of the expense in the financial statements.  We are required to adopt SFAS 123R in thethird quarter of 2005, beginning July 2, 2005. Under SFAS 123R, we must determine the appropriate fair value model tobe used for valuing share-based payments, the amortization method forcompensation cost and the transition method to be used at date ofadoption.  The transition methods includeprospective and retroactive adoption options. Under the retroactive option,prior periods may be restated either as of the beginning of the year ofadoption or for all periods presented. The prospective method requires thatcompensation expense begin being recorded for all unvested stock options andrestricted stock at the beginning of the first quarter of adoption of SFAS123R, while the retroactive methods would record compensation expense for allunvested stock options and restricted stock beginning with the first periodpresented.  We are evaluating therequirements of SFAS 123R and expect the adoption of SFAS 123R will have a materialimpact on our consolidated results of operations and earnings per share.  We have not determined the method of adoptionor the effect of adopting SFAS 123R and we have not determined whether theadoption will result in amounts similar to the current pro-forma disclosuresunder SFAS 123.

 

On October 4, 2004, the Working Families TaxRelief Act of 2004 became law.  This legislation, among other things,extends the research and development (R&D) tax credit for 18 months, fromJuly 1, 2004 to December 31, 2005, allowing U.S. companies conductingqualifying research and development activities to receive a tax credit of up to10 percent of R&D spending.  We we do not expect this extension tohave a material impact on our effective tax rate or provision for taxes.

 

On October 22, 2004, the American Jobs CreationAct of 2004 became law. This legislation repeals export tax benefits, whichhave historically reduced our effective tax rate. This legislation phases inthe repealed export tax benefits by allowing 100 percent of the repealed exportbenefits in 2004, 80 percent in 2005 and 60 percent in 2006.

 

30

----

 

The legislation also transitions in a new taxdeduction for qualifying U.S. manufacturing activities and at a lower thanusual tax rate. Under the guidance in FASB Staff Position No. FAS 109-1 whicharticulates the application of FASB Statement 109, “Accounting for Incometaxes,” to the Tax Deduction on Qualified Production Activities Provided by theAmerican Jobs Creation Act of 2004, the deduction will be treated as a “specialdeduction” as described in FASB Statement No. 109. As such, we expect the newmanufacturing activities deduction provisions of the new legislation will reduceour effective rate in future periods as the deduction is taken on the taxreturn.

 

Another provision of the legislation providesfor the optional repatriation of cash from foreign subsidiaries allowing an 85percent dividends received deduction. The deduction is subject to a number oflimitations.   We have not yet initiatedan analysis nor determined if we will repatriate any overseas earnings pursuantto this provision.  If our intention topermanently reinvest overseas earnings in our overseas operations changes andwe decide to repatriate any of the earnings to the U.S., we would incuradditional income tax expense equal to the incremental U.S. income tax inexcess of the credits available for taxes already paid overseas.

 

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

 

Our primary market risk is the potential loss arisingfrom increases in interest rates, which could have an adverse impact on thefair value of our investment securities. Our investment policy is to manage ourinvestment portfolio to preserve principal and liquidity while maximizing thereturn on our investment portfolio through the investment of available funds.We diversify our investment portfolio by investing in a variety of highly-ratedinvestment-grade securities and through the use of different investmentmanagers. Our investment securities portfolio is primarily invested insecurities with maturities (or interest rate resets) of two years or less withat least an investment grade rating to minimize interest rate and credit riskas well as to provide for an immediate source 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 atDecember 31, 2004. We generally hold investment securities until maturity.

 

We also face foreign currency exchange rate risk tothe extent that the value of certain foreign currencies relative to the U.S.dollar affects our financial results. Our international operations transact a portion of our business incurrencies other than the U.S. dollar, predominantly the euro, and changes inexchange rates may positively or negatively affect our revenues, gross margins,operating expenses, and retained earnings since these transactions are reportedby us in U.S. dollars.  We occasionallypurchase foreign currency forwards aimed at limiting the impact of currencyfluctuations.  These instruments provideonly limited protection against currency exchange risks, and there can be noassurance that such an approach will be successful, especially if a significantand sudden decline occurs in the value of local currencies. There were no suchinstruments outstanding as of December 31, 2004.

 

31

----

 

**Item 8. Financial Statements.**

 

**Index to Consolidated FinancialStatements**

 
| 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, 2004 and 2003                                               |   |
| Consolidated  Statements of Income for the years ended December 31, 2004, 2003 and  2002                    |   |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31, 2004,  2003 and 2002 |   |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2004, 2003 and  2002                |   |
| Notes to  Consolidated Financial Statements                                                                      |   |
| Schedule  II - Valuation and Qualifying Accounts                                                                 |   |

 

32

----

 

**Management’s Report on InternalControl over Financial Reporting**

 

Management of Avocent Corporation is responsible for establishing andmaintaining adequate internal control over financial reporting.  The Company’s internal control over financialreporting is a process designed under the supervision of Avocent’s principalexecutive and principal financial officers to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of theCompany’s financial statements for external purposes in accordance with U.S.generally accepted accounting principles.

 

As of the end of the Company’s 2004 fiscal year, management conductedan assessment of the Company’s internal control over financial reporting basedon the framework established in Internal Control - Integrated Framework issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO).Based on this assessment, management has determined that the Company’s internalcontrol over financial reporting as of December 31, 2004 was effective.

 

The Company’s internal control over financial reporting includes policiesand procedures that pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect transactions and dispositions of assets;provide reasonable assurance that transactions are recorded as necessary topermit preparation of financial statements in accordance with U.S. generallyaccepted accounting principles, and that receipts and expenditures are beingmade only in accordance with authorizations of management and the directors ofthe Company; and provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use or disposition of the Company’sassets that could have a material effect on the financial statements.

 

Management’s assessment of the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2004 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report appearing on page 34, which expresses unqualifiedopinions on management’s assessment of the effectiveness of internal controlover financial reporting and on the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2004.

 

33

----

 

**Report of Independent RegisteredPublic Accounting Firm**

 

To the Board of Directors and Stockholders

of Avocent Corporation

 

We have completed an integrated audit ofAvocent Corporation’s 2004 consolidated financial statements and of itsinternal control over financial reporting as of December 31, 2004 and audits ofits 2003 and 2002 consolidated financial statements in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Our opinions, based on our audits, are presented below.

 

Consolidated financialstatements and financial statement schedule

 

In our opinion, the consolidated financialstatements listed in the accompanying index present fairly, in all materialrespects, the financial position of Avocent Corporation and its subsidiaries****at December 31, 2004 and 2003, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2004****in conformity with accountingprinciples generally accepted in the United States of America.  In addition, in our opinion, the financialstatement schedule listed in the accompanying index****presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements.  These financial statements and financialstatement schedule are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements and financial statement schedule****based on our audits. We conducted our audits of these statements in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit of financial statements includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

Internal control overfinancial reporting

 

Also, in our opinion, management’s assessment,included in Management’s Report on Internal Control over Financial Reportingappearing on page 33, that the Company maintained effective internal controlover financial reporting as of December 31, 2004 based on criteria establishedin *Internal Control - Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), is fairly stated, in all material respects, based on those criteria.Furthermore, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31, 2004,based on criteria established in *Internal Control -Integrated Framework* issued by the COSO.  The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financialreporting.  Our responsibility is toexpress opinions on management’s assessment and on the effectiveness ofthe Company’s internal control over financial reporting based on our audit. Weconducted our audit of internal control over financial reporting in accordancewith the standards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects.  An audit of internalcontrol over financial reporting includes obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we consider necessary in thecircumstances.  We believe that our auditprovides a reasonable basis for our opinions.

 

A company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples.  A company’s internal controlover financial reporting includes those policies and procedures that(i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and(iii) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of the company’sassets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 
| /s/ PricewaterhouseCoopers  LLP |   |
|---------------------------------|--------|
| Birmingham, Alabama             |
| March 14, 2005                  |

 

34

----

 

**AvocentCorporation**

**Consolidated Balance Sheets**

**December 31, 2004 and 2003**

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

 

 
| ** **                                                                                                                                                                       | ** ** | **2004**  | ** ** | **2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------|------------|
| **ASSETS**                                                                                                                                                                       |       |      |       |     |       |
| Current assets:                                                                                                                                                                  |       |      |       |     |       |
| Cash and cash equivalents                                                                                                                                                        |       | $         | 44,724     |     | $          | 76,492 |   |
| Investments  maturing within one year                                                                                                                                            |       | 195,075   |       | 146,900  |       |
| Accounts  receivable, less allowance for doubtful accounts of $1,740 and $1,991 at  December 31, 2004 and 2003, respectively                                                     |       | 60,948    |       | 45,011   |       |
| Inventories, net                                                                                                                                                                 |       | 21,232    |       | 21,324   |       |
| Other current  assets                                                                                                                                                            |       | 5,923     |       | 4,891    |       |
| Deferred tax  assets                                                                                                                                                             |       | 6,720     |       | 4,616    |       |
| Total current  assets                                                                                                                                                            |       | 334,622   |       | 299,234  |       |
|                                                                                                                                                                             |       |      |       |     |       |
| Investments                                                                                                                                                                      |       | 90,217    |       | 82,884   |       |
| Property held  for lease, net                                                                                                                                                    |       | 1,330     |       | 1,526    |       |
| Property and  equipment, net                                                                                                                                                     |       | 39,896    |       | 38,473   |       |
| Goodwill                                                                                                                                                                         |       | 269,892   |       | 206,037  |       |
| Other intangible  assets, net                                                                                                                                                    |       | 33,981    |       | 31,889   |       |
| Other assets                                                                                                                                                                     |       | 843       |       | 720      |       |
| Total assets                                                                                                                                                                     |       | $         | 770,781    |     | $          | 660,763 |   |
|                                                                                                                                                                             |       |      |       |     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                    |       |      |       |     |       |
| Current  liabilities:                                                                                                                                                            |       |      |       |     |       |
| Accounts payable                                                                                                                                                                 |       | $         | 9,171      |     | $          | 10,034 |   |
| Accrued wages  and commissions                                                                                                                                                   |       | 12,197    |       | 9,120    |       |
| Accrued  liabilities                                                                                                                                                             |       | 15,661    |       | 15,769   |       |
| Income taxes  payable                                                                                                                                                            |       | 8,494     |       | 6,702    |       |
| Other current  liabilities                                                                                                                                                       |       | 1,106     |       | 479      |       |
| Total current  liabilities                                                                                                                                                       |       | 46,629    |       | 42,104   |       |
|                                                                                                                                                                             |       |      |       |     |       |
| Deferred tax  liabilities                                                                                                                                                        |       | 8,985     |       | 10,884   |       |
| Other  non-current liabilities                                                                                                                                                   |       | 1,870     |       | 618      |       |
| Total  liabilities                                                                                                                                                               |       | 57,484    |       | 53,606   |       |
|                                                                                                                                                                             |       |      |       |     |       |
| Commitments and  contingencies*(Note 13 and Note 18)*                                                                                                                            |       |      |       |     |       |
|                                                                                                                                                                             |       |      |       |     |       |
| 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; 2004 – 50,332 shares  issued and 50,232 outstanding; 2003 – 47,350 shares issued and outstanding |       | 50        |       | 47       |       |
| Additional  paid-in capital                                                                                                                                                      |       | 1,075,171 |       | 982,218  |       |
| Unrealized gain  (loss) on investments, net of deferred taxes                                                                                                                    |       | (287      | )          | 163      |       |
| Foreign currency  translation adjustment                                                                                                                                         |       | 231       |       | 64       |       |
| Accumulated  deficit                                                                                                                                                             |       | (355,852  | )          | (373,892 | )          |
| Deferred  compensation                                                                                                                                                           |       | (2,038    | )          | (1,443   | )          |
| Treasury stock,  at cost; 2004 - 100 shares; 2003 - No shares                                                                                                                    |       | (3,978    | )          | —   |       |
| Total  stockholders’ equity                                                                                                                                                 |       | 713,297   |       | 607,157  |       |
|                                                                                                                                                                             |       |      |       |     |       |
| Total  liabilities and stockholders’ equity                                                                                                                                 |       | $         | 770,781    |     | $          | 660,763 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

35

----

 

**AvocentCorporation**

**Consolidated Statements of Income**

**For theYears Ended December 31, 2004, 2003 and 2002**

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

 
| ** **                                                       | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net sales                                                        |       | $        | 365,255    |     | $          | 304,238  |       | $ | 260,600 |   |
|                                                             |       |     |       |     |       |     |       |
| Cost of sales                                                    |       | 152,400  |       | 132,412  |       | 128,873  |       |
|                                                             |       |     |       |     |       |     |       |
| Gross profit                                                     |       | 212,855  |       | 171,826  |       | 131,727  |       |
|                                                             |       |     |       |     |       |     |       |
| Research and  development expenses                               |       | 45,353   |       | 29,793   |       | 26,522   |       |
| Acquired  in-process research and development expense *(Note 3)* |       | 29,260   |       | 3,940    |       | 6,000    |       |
| Selling, general  and administrative expenses                    |       | 84,823   |       | 70,398   |       | 66,891   |       |
| Amortization of  intangible assets                               |       | 24,279   |       | 21,805   |       | 22,189   |       |
|                                                             |       |     |       |     |       |     |       |
| Total operating  expenses                                        |       | 183,715  |       | 125,936  |       | 121,602  |       |
|                                                             |       |     |       |     |       |     |       |
| Income from  operations                                          |       | 29,140   |       | 45,890   |       | 10,125   |       |
|                                                             |       |     |       |     |       |     |       |
| Net investment  income                                           |       | 5,133    |       | 4,825    |       | 5,598    |       |
| Net realized  investment gains (losses)                          |       | (3,804   | )          | 2,619    |       | (305     | )          |
| Other income  (expense), net                                     |       | 23       |       | (288     | )          | (178     | )          |
|                                                             |       |     |       |     |       |     |       |
| Income before  provision for income taxes                        |       | 30,492   |       | 53,046   |       | 15,240   |       |
|                                                             |       |     |       |     |       |     |       |
| Provision for  income taxes                                      |       | 12,452   |       | 14,499   |       | 4,502    |       |
|                                                             |       |     |       |     |       |     |       |
| Net income                                                       |       | $        | 18,040     |     | $          | 38,547   |       | $ | 10,738 |   |
|                                                             |       |     |       |     |       |     |       |
| Net income per  common share:                                    |       |     |       |     |       |     |       |
| Basic                                                            |       | $        | 0.37       |     | $          | 0.83     |       | $ | 0.24 |   |
|                                                             |       |     |       |     |       |     |       |
| Diluted                                                          |       | $        | 0.36       |     | $          | 0.81     |       | $ | 0.24 |   |
|                                                             |       |     |       |     |       |     |       |
| Weighted average  common shares outstanding:                     |       |     |       |     |       |     |       |
| Basic                                                            |       | 48,964   |       | 46,194   |       | 44,977   |       |
|                                                             |       |     |       |     |       |     |       |
| Diluted                                                          |       | 50,530   |       | 47,693   |       | 45,549   |       |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

36

----

 

**Avocent Corporation**

**ConsolidatedStatements of Stockholders’ Equity**

**For theYears Ended December 31, 2004, 2003 and 2002**

**(Inthousands)**

 
| ** **                                                                                 | ** ** | ** ** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Unrealized  Gain (Loss) on  Investments** | ** ** | **Foreign  Currency  Translation  Adjustment** | ** ** | **Retained  Earnings  (Accumulated  Deficit)** | ** ** | **Deferred  Compensation** | ** ** | **Treasury  Stock** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------|------------|----------------------------------|------------|---------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|----------------------------|------------|---------------------|------------|-----------|------------|
| **Common Stock**                                                                           |
| **Shares**                                                                                 | ** ** | **Amount** |
| Balance, December  31, 2001                                                                |       | 44,650     |       | $                                | 45         |                                        | $          | 926,746                                        |       | $                                              | 78         |                       | $          | (120                | )          | $         | (423,177   | ) | $ | (16,964 | ) | $ | — |   | $ | 486,608 |   |
| Acquisition of 2C  Computing, Inc.                                                         |       | —     |       | —                           |       | 1,965                                       |       | —                                         |       | —                                         |       | —                     |       | (115                | )          | —    |       | 1,850 |   |
| Net income                                                                                 |       | —     |       | —                           |       | —                                      |       | —                                         |       | —                                         |       | 10,738                     |       | —              |       | —    |       | 10,738 |   |
| Change in foreign  currency translation adjustment                                         |       | —     |       | —                           |       | —                                      |       | —                                         |       | 91                                             |       | —                     |       | —              |       | —    |       | 91 |   |
| Change in net unrealized  gains on investments, net of deferred income taxes of $23        |       | —     |       | —                           |       | —                                      |       | (35                                            | )          | —                                         |       | —                     |       | —              |       | —    |       | (35 | ) |
| Issuances of  common stock                                                                 |       | 560        |       | —                           |       | 4,918                                       |       | —                                         |       | —                                         |       | —                     |       | —              |       | —    |       | 4,918 |   |
| Income tax  benefit from exercise of stock options                                         |       | —     |       | —                           |       | 1,150                                       |       | —                                         |       | —                                         |       | —                     |       | —              |       | —    |       | 1,150 |   |
| Stock-based  compensation                                                                  |       | —     |       | —                           |       | 1,509                                       |       | —                                         |       | —                                         |       | —                     |       | 10,843              |       | —    |       | 12,352 |   |
| Balance, December  31, 2002                                                                |       | 45,210     |       | 45                               |       | 936,288                                     |       | 43                                             |       | (29                                            | )          | (412,439                   | )          | (6,236              | )          | —    |       | 517,672 |   |
| Acquisition of  Soronti, Inc.                                                              |       | 31         |       | —                           |       | 1,152                                       |       | —                                         |       | —                                         |       | —                     |       | —              |       | —    |       | 1,152 |   |
| Net income                                                                                 |       | —     |       | —                           |       | —                                      |       | —                                         |       | —                                         |       | 38,547                     |       | —              |       | —    |       | 38,547 |   |
| Change in foreign  currency translation adjustment                                         |       | —     |       | —                           |       | —                                      |       | —                                         |       | 93                                             |       | —                     |       | —              |       | —    |       | 93 |   |
| Change in net  unrealized gains on investments, net of deferred income taxes of $65        |       | —     |       | —                           |       | —                                      |       | 120                                            |       | —                                         |       | —                     |       | —              |       | —    |       | 120 |   |
| Issuances of  common stock                                                                 |       | 2,109      |       | 2                                |       | 34,618                                      |       | —                                         |       | —                                         |       | —                     |       | —              |       | —    |       | 34,620 |   |
| Income tax  benefit from exercise of stock options                                         |       | —     |       | —                           |       | 10,239                                      |       | —                                         |       | —                                         |       | —                     |       | —              |       | —    |       | 10,239 |   |
| Stock-based  compensation                                                                  |       | —     |       | —                           |       | (79                                         | )          | —                                         |       | —                                         |       | —                     |       | 4,793               |       | —    |       | 4,714 |   |
| Balance, December  31, 2003                                                                |       | 47,350     |       | 47                               |       | 982,218                                     |       | 163                                            |       | 64                                             |       | (373,892                   | )          | (1,443              | )          | —    |       | 607,157 |   |
| Acquisition of  Crystal Link Technologies                                                  |       | 107        |       | —                           |       | 3,500                                       |       | —                                         |       | —                                         |       | —                     |       | —              |       | —    |       | 3,500 |   |
| Acquisition of  OSA Technologies                                                           |       | 1,229      |       | 1                                |       | 54,707                                      |       | —                                         |       | —                                         |       | —                     |       | (6,351              | )          | —    |       | 48,357 |   |
| Net income                                                                                 |       | —     |       | —                           |       | —                                      |       | —                                         |       | —                                         |       | 18,040                     |       | —              |       | —    |       | 18,040 |   |
| Change in foreign  currency translation adjustment                                         |       | —     |       | —                           |       | —                                      |       | —                                         |       | 167                                            |       | —                     |       | —              |       | —    |       | 167 |   |
| Change in net  unrealized gains on investments, net of deferred income tax benefit of $207 |       | —     |       | —                           |       | —                                      |       | (450                                           | )          | —                                         |       | —                     |       | —              |       | —    |       | (450 | ) |
| Issuances of  common stock                                                                 |       | 1,646      |       | 2                                |       | 29,085                                      |       | —                                         |       | —                                         |       | —                     |       | —              |       | —    |       | 29,087 |   |
| Income tax  benefit from exercise of stock options                                         |       | —     |       | —                           |       | 5,748                                       |       | —                                         |       | —                                         |       | —                     |       | —              |       | —    |       | 5,748 |   |
| Stock-based  compensation                                                                  |       | —     |       | —                           |       | (87                                         | )          | —                                         |       | —                                         |       | —                     |       | 5,756               |       | —    |       | 5,669 |   |
| Purchase of 100  shares of treasury stock                                                  |       | —     |       | —                           |       | —                                      |       | —                                         |       | —                                         |       | —                     |       | —              |       | (3,978    | )          | (3,978 | ) |
| Balance, December  31, 2004                                                                |       | 50,332     |       | $                                | 50         |                                        | $          | 1,075,171                                      |       | $                                              | (287       | )                          | $          | 231                 |       | $         | (355,852   | ) | $ | (2,038 | ) | $ | (3,978 | ) | $ | 713,297 |   |

 

Comprehensiveincome in 2004 of $17,757 consists of $18,040 of net income, $450 of unrealizedloss on investments (net of deferred income taxes) and $167 of foreign currencytranslation adjustment (net of deferred income taxes).  The unrealized loss on investments is net of$230, net of $124 tax benefit, of realized gains that are included in netrealized investment gains (losses) in the accompanying consolidated statementof operations.

 

Comprehensiveincome in 2003 of $38,760 consists of $38,547 of net income, $120 of unrealizedgain on investments (net of deferred income taxes) and $93 of foreign currencytranslation adjustment (net of deferred income taxes).  The unrealized gain on investments is net of$1,702, net of $917 tax expense, of realized gains that are included in netrealized investment gains (losses) in the accompanying consolidated statementof operations.

 

Comprehensiveincome in 2002 of $10,794 consists of $10,738 of net income, $35 of unrealizedloss on investments (net of deferred income taxes) and $91 of foreign currencytranslation adjustment (net of deferred income taxes).  The unrealized loss on investments is net of$199, net of $106 tax benefit, of realized losses that are included in netrealized investment gains (losses) in the accompanying consolidated statementof operations.

 

The accompanying notesare an integral part of these consolidated financial statements.

 

37

----

 

**AvocentCorporation**

**ConsolidatedStatements of Cash Flows**

**For theYears Ended December 31, 2004, 2003 and 2002**

**(Inthousands)**

 
| ** **                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                             |       |     |       |     |       |     |       |
| Net income                                                                         |       | $        | 18,040     |     | $          | 38,547   |       | $ | 10,738 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |     |       |     |       |     |       |
| Depreciation                                                                       |       | 6,222    |       | 4,859    |       | 4,361    |       |
| Amortization of  intangible assets                                                 |       | 24,279   |       | 21,805   |       | 22,189   |       |
| Stock-based  compensation                                                          |       | 5,669    |       | 4,714    |       | 12,352   |       |
| Acquired  in-process research and development expenses                             |       | 29,260   |       | 3,940    |       | 6,000    |       |
| Other-than-temporary  decline in fair value of investments                         |       | 3,450    |       | —   |       | 550      |       |
| Amortization of  premium on investments                                            |       | 3,236    |       | 3,339    |       | 2,457    |       |
| Net (gain) loss  on sales of investments                                           |       | 354      |       | (2,619   | )          | 305      |       |
| Deferred income  taxes                                                             |       | (7,548   | )          | (4,283   | )          | (5,735   | )          |
| Income tax  benefit from exercise of stock options                                 |       | 5,748    |       | 10,239   |       | 1,150    |       |
| Changes in  operating assets and liabilities (net of effects of acquisitions):     |       |     |       |     |       |     |       |
| Accounts  receivable, net                                                          |       | (15,668  | )          | (8,677   | )          | 12,811   |       |
| Income taxes  receivable                                                           |       | 40       |       | 194      |       | 1,721    |       |
| Inventories, net                                                                   |       | 238      |       | 3,300    |       | 3,663    |       |
| Other assets                                                                       |       | 162      |       | (17      | )          | 1,370    |       |
| Accounts payable                                                                   |       | (1,447   | )          | 3,430    |       | (3,062   | )          |
| Accrued  liabilities, wages and commissions                                        |       | 2,080    |       | 1,277    |       | 393      |       |
| Income taxes  payable                                                              |       | 1,791    |       | (199     | )          | (115     | )          |
| Other  liabilities                                                                 |       | 615      |       | 2,654    |       | (64      | )          |
| Net cash  provided by operating activities                                         |       | 76,521   |       | 82,503   |       | 71,084   |       |
| Cash flows from  investing activities:                                             |       |     |       |     |       |     |       |
| Purchase of  Sonic Mobility, net of cash acquired                                  |       | (9,141   | )          | —   |       | —   |       |
| Purchase of OSA,  net of cash acquired                                             |       | (47,179  | )          | —   |       | —   |       |
| Purchase of  Crystal Link, net of cash acquired                                    |       | (5,311   | )          | —   |       | —   |       |
| Purchase of  Soronti, net of cash acquired                                         |       | —   |       | (5,520   | )          | —   |       |
| Purchase of 2C,  net of cash acquired                                              |       | —   |       | —   |       | (23,189  | )          |
| Purchases of  property and equipment                                               |       | (7,137   | )          | (18,983  | )          | (7,064   | )          |
| Purchases of  available-for-sale investments                                       |       | (306,634 | )          | (243,698 | )          | (74,192  | )          |
| Purchases of  held-to-maturity investments                                         |       | —   |       | —   |       | (91,911  | )          |
| Proceeds from  maturities and sales of available-for-sale investments              |       | 243,634  |       | 115,376  |       | 89,510   |       |
| Proceeds from  maturities of held-to-maturity investments                          |       | —   |       | 50,405   |       | 12,836   |       |
| Net cash used in  investing activities                                             |       | (131,768 | )          | (102,420 | )          | (94,010  | )          |
| Cash flows from  financing activities:                                             |       |     |       |     |       |     |       |
| Repayment of  short-term debt assumed in acquisitions                              |       | (1,797   | )          | (3       | )          | (890     | )          |
| Proceeds from  employee stock option exercises                                     |       | 25,876   |       | 32,811   |       | 3,675    |       |
| Proceeds from  employee stock purchase plan                                        |       | 3,211    |       | 1,809    |       | 1,243    |       |
| Purchases of  treasury stock                                                       |       | (3,978   | )          | —   |       | —   |       |
| Net cash  provided by financing activities                                         |       | 23,312   |       | 34,617   |       | 4,028    |       |
|                                                                               |       |     |       |     |       |     |       |
| Effect of  exchange rate changes on cash and cash equivalents                      |       | 167      |       | 93       |       | 91       |       |
|                                                                               |       |     |       |     |       |     |       |
| Net increase  (decrease) in cash and cash equivalents                              |       | (31,768  | )          | 14,793   |       | (18,807  | )          |
| Cash and cash  equivalents, beginning of year                                      |       | 76,492   |       | 61,699   |       | 80,506   |       |
|                                                                               |       |     |       |     |       |     |       |
| Cash and cash  equivalents, end of year                                            |       | $        | 44,724     |     | $          | 76,492   |       | $ | 61,699 |   |
|                                                                               |       |     |       |     |       |     |       |
| Supplemental  disclosures of cash flow information:                                |       |     |       |     |       |     |       |
| Cash paid during  the year for income taxes                                        |       | $        | 12,496     |     | $          | 9,658    |       | $ | 7,845 |   |

 

----

(1)          Supplemental disclosure – In addition to thecash paid at the respective closings, the Company issued 106 shares of itscommon stock valued at $3,500 to Crystal Link shareholders and 1,229 shares ofits common stock valued at $45,831 to OSA shareholders. The issuance of commonstock was recorded as non-cash consideration for the acquisitions.

 

The accompanying notesare an integral part of these consolidated financial statements.

 

38

----

 

**AvocentCorporation**

**Notes toConsolidated Financial Statements**

**For theYears Ended December 31, 2004, 2003 and 2002**

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

 

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

** **

Avocent Corporation (theCompany or Avocent) designs, manufactures and sells analog and digital KVM(keyboard, video and mouse) switching systems, serial connectivity devices,extension, wireless extension, remote access and management products,Intelligent Platform Management Interface (“IPMI”) firmware and software, andrelated technologies for the computer industry. The Company’s analog, digital and serial switching solutions, as well asthe IPMI, extension, remote access and management products and technologieshelp network administrators manage multiple servers, serially controlleddevices  and mobile devices from a singlelocal or remote console consisting of a keyboard, video monitor and mousefacilitating efficient network management and administration. The Company sellsproducts to distributors, resellers, original equipment manufacturers (“OEMs”)and end-users in the United States and internationally.

 

The results of acquiredcompanies are included in the consolidated results from the respective dates ofacquisition, including 2C Computing, Inc. (“2C”), which was acquired on August20, 2002, Soronti, Inc. (“Soronti”), which was acquired on November 17, 2003,Crystal Link Technologies (“Crystal Link”), which was acquired on January 6,2004, OSA Technologies, Inc. (“OSA”), which was acquired on April 6, 2004 andSonic Mobility Inc. (“Sonic Mobility”), which was acquired on August 31, 2004.

 

**2.**                                Summary of Significant Accounting Policies

 

The principal accountingpolicies of the Company are as follows:

 

**Principlesof Consolidation**- The Company’s consolidated financial statements include the Company and itswholly-owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

**Cash andCash Equivalents**- The Company considers all highly liquid instruments with an original maturityof three months or less when purchased to be cash equivalents, except thatcertain investments with original maturities of less than 90 days areclassified as short term investments when such investments are a part of our non-operatinginvestment portfolio.

 

**Inventories** - Raw materials, work in process andfinished goods inventories are recorded using the lower of standard cost, whichapproximates first-in first-out (FIFO), or market.  Standard costs are reviewed and revised on aquarterly basis. Therefore, inventory costs approximate actual costs at the endof each reporting period.  The Company writes down inventory forestimated obsolescence or unmarketable inventory to the estimated market valuebased upon assumptions about future demand and market conditions.

 

**FinancialInstruments**- Thecarrying amounts reported in the balance sheets for cash and cash equivalents,short-term investments, accounts receivable and accounts payable approximatefair value because of the immediate or short-term maturity of these financialinstruments.

 

**Investments -**The Company’s investments consist primarily ofbank deposits, corporate bonds, commercial paper, asset-backed securities,municipal bonds, U.S. government agency securities, mortgage-backed securitiesguaranteed by U.S. government agencies, preferred stock and common stock.  Debt securities that the Company has thepositive intent and ability to hold to maturity are classified as held-to-maturitysecurities and are reported at amortized cost. Debt and equity securities not classified as either held-to-maturitysecurities or trading securities and that have readily determinable fair valuesare classified as available-for-sale securities and are reported at fair value,with unrealized gains and losses excluded from earnings and reported as aseparate component of stockholders’ equity, net of deferred income taxes.Unrealized losses are charged against earnings when a decline in fair value isdetermined to be other than temporary.  Certaininvestments with original maturities of less than 90 days are classified asshort term investments when such are a part of our investment portfolio.  Realizedgains and losses are accounted for on the specific identification method.

 

The Company also investsin privately-held companies and generally records its investments in theseentities at cost or using the equity method if the Company has the ability toexercise significant influence over the entity. The Company’s carrying value for such investments was nil as of December31, 2004 and $3,450 as of December 31, 2003. These investments are included in total long-term investments in theaccompanying consolidated balance sheets. The Company reviews its investments in these entities periodically to determineif circumstances (both financial and non-financial) exist that indicate thatthe investment will not be recovered. Impairment charges are recorded on investments having a basis that isgreater than

 

39

----

 

the value that theCompany would reasonably expect to receive in an arm’s length sale of theinvestment.  The Company recognized impairmentlosses on these investments of $3,450 in 2004, zero in 2003 and $550 in 2002 (*see note 5*).

 

**PropertyHeld for Lease -**Propertyheld for lease is carried at cost, less accumulated depreciation, which iscomputed using the straight-line method over the estimated useful lives of theassets. Rental income from this property is recorded on a monthly basis inaccordance with the lease terms. Initial direct costs are deferred and matchedagainst rental income over the initial term of the lease *(see Note 6).*  Net rental income is reportedwithin net investment income.

 

**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.

 

Depreciation expense iscomputed using the straight-line method over the following estimated usefullives:

 
| **Description**                  | ** ** | **Useful Life**  | ** ** |
|----------------------------------|------------|------------------|------------|
| Land  improvements               |       | 30 years         |       |
| Buildings                        |       | 39 years         |       |
| Leasehold  improvements          |       | lease terms      |       |
| Computer  software and equipment |       | 3 – 5 years |       |
| Other equipment                  |       | 3 – 5 years |       |

 

**OtherIntangible Assets**- Intangible assets are amortized on a straight-line basis over the followingestimated useful lives:

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

 

**Long-LivedAssets –**TheCompany reviews long-lived assets for impairment under the guidance prescribedby SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*. The Company recognizes impairment losses onlong-lived assets used in operations when indicators of impairment are presentand the undiscounted cash flows estimated to be generated by those assets areless than the assets’ carrying values. An impairment loss would be recognizedin the amount by which the recorded value of the asset exceeds the fair valueof the asset, measured by the quoted market price of an asset or an estimatebased on the best information available in the circumstances.  There were no such losses recognized during2004, 2003 or 2002.

 

**Goodwill -** The Company records goodwillwhen the cost of an acquired entity exceeds the net amounts assigned to the assetsacquired and liabilities assumed.  Inaccordance with SFAS No. 142, *Goodwill and OtherIntangible Assets*, the Company completed a transitional impairmenttest of all goodwill as of January 1, 2002.  The test concluded that no adjustment was required uponadoption.  Additionally, the Companyperformed an annual impairment test of goodwill, as prescribed by thisstandard, in the fourth quarters of 2004, 2003 and 2002.  The tests conducted during 2004, 2003 and2002 concluded that there had been no impairment of goodwill and that noadjustments were required (*see note 8*).

** **

**Allowance for Doubtful Accounts** - Prior to extending credit to anew customer, the Company performs a detailed credit review of the customer andestablishes credit limits based on the results of the credit review. TheCompany reviews collection experience periodically to determine if thecustomer's payment terms and credit limits need to be revised. The Companymaintains allowances for doubtful accounts for estimated losses resulting fromthe inability of its customers to make required payments. If the financialcondition of the Company's customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired. If circumstances change with regard to individual receivable balancesthat had previously been determined to be uncollectible (and for which aspecific reserve had been established), a reduction in the Company's allowancefor doubtful accounts may be required. The Company's allowance for doubtfulaccounts was $1.7 million and $2.0 million at December 31, 2004 and 2003,respectively.

** **

**Allowancefor Sales Returns -**The Company’s sales generally include a one-month unconditional returnpolicy.  The Company also allowsadditional rights of return to certain of its distributors, which generallyextend the return period to 90 days. The Company reserves for estimated salesreturns as a reduction of revenue and cost of sales at the time the productrevenue is recognized based on historical sales return experience, whichmanagement believes provides a reasonable estimate of future returns.  The allowance for sales returns totaledapproximately $3,174 and $3,909 at December 31, 2004 and 2003, respectively.The reserve is included as a reduction in the carrying value of accounts receivablein the accompanying consolidated balance sheets.

 

**Liabilityfor Warranty Returns**- The Company’s products generally include warranties of one to three years forproduct defects. The Company accrues for warranty returns at cost to repair orreplace products. The Company also offers extended warranties to customers andrecognizes the revenue associated with the extended warranties over the life ofthe warranty (Note 9).  The liability forwarranty returns totaled approximately $2,760 and $2,652 at December 31, 2004and 2003, respectively. These liabilities are included in accrued liabilitiesin the accompanying consolidated balance sheets.

 

40

----

 

**Stock-BasedCompensation -**TheCompany generally records compensation expense for all stock-based compensationplans using the intrinsic value method in which compensation expense, if any,is measured as the excess of the market price of the stock over the exerciseprice of the award on the measurement date. For unvested options of companiesacquired that existed as of their respective acquisition dates, the intrinsicvalue was computed as of the acquisition date and the pro rata portion relatedto future service was deferred (included in deferred compensation in theconsolidated balance sheets) and is being amortized over the remaining vestingperiod of the stock options. The fair value of these unvested options as of theconsummation date was computed and the amount in excess of the intrinsic valuewas included in the respective purchase consideration (*see**Note 3*).

 

The Company appliesAccounting Principles Board Opinion No. 25, *Accounting for StockIssued to Employees*, and related Interpretations in accounting forits stock-based compensation plans. Had compensation cost for the Company’sstock-based compensation plans been determined based on the fair value at thegrant dates for awards under those plans consistent with the method prescribedin SFAS No. 123, *Accounting for Stock-Based Compensation*,the Company’s net income and earnings per share would have been reduced to thepro forma amounts indicated below:

 

| ** **                                                                                                                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income — as  reported                                                                                                          |       | $        | 18,040     |     | $          | 38,547   |       | $ | 10,738 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                            |       | 5,617    |       | 4,367    |       | 11,110   |       |
| Deduct: Total  stock based employee compensation expense determined under fair value method  for all awards, net of related tax effects |       | (31,805  | )          | (29,001  | )          | (36,717  | )          |
| Net income  (loss) — pro forma                                                                                                     |       | $        | (8,148     | )        | $          | 13,913   |       | $ | (14,869 | ) |
|                                                                                                                                    |       |     |       |     |       |     |       |
| Basic earnings  per share — as reported                                                                                            |       | $        | 0.37       |     | $          | 0. 83    |       | $ | 0.24 |   |
| Basic earnings  (loss) per share — pro forma                                                                                       |       | $        | (0.17      | )        | $          | 0.30     |       | $ | (0.33 | ) |
| Diluted earnings  per share — as reported                                                                                          |       | $        | 0.36       |     | $          | 0.81     |       | $ | 0.24 |   |
| Diluted earnings  (loss) per share — pro forma                                                                                     |       | $        | (0.17      | )        | $          | 0.29     |       | $ | (0.33 | ) |
|                                                                                                                                         |            |          |            |          |            |          |            |  |  |  |  |  |  |

 

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. The fair value of eachoption grant is estimated on the grant date using the Black-Scholesoption-pricing model using the following weighted-average assumptions:

 

| ** **               | ** ** | **2004**         | ** ** | **2003**         | ** ** | **2002**         | ** ** |
|--------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| Dividend yield           |       | 0.0              | %          | 0.0              | %          | 0.0              | %          |
| Expected life (years)    |       | 1.0 — 4.5   |       | 4.5              |       | 5                |       |
| Expected  volatility     |       | 33.0 — 55.0 | %          | 60.0             | %          | 67.5             | %          |
| Risk-free  interest rate |       | 1.17 — 3.54 | %          | 2.38 — 3.03 | %          | 2.93 — 4.47 | %          |

 

**Concentrationsof Customer Base and Credit Risk –**Four customers each exceeded 10% of the Company’ssales for 2004, while only three customers exceeded 10% of sales for 2003 and2002.** **The****four customers accounted for 57% of net sales in 2004,while the three customers accounted for 48% of net sales in 2003 and 47% of netsales for 2002.  Accounts receivable fromthese customers represented approximately 61% of trade receivables at December31, 2004 and 56% of trade receivables at December 31, 2003.  The Company’s top five customers, whichinclude three OEMs and two distributors, accounted for 64% of net sales for2004 and 2003 and 65% of net sales for 2002.

 

The Company places cashand investments in several high-quality financial institutions and seeks tolimit the credit exposure from any one institution, issuer or instrument.

 

**IncomeTaxes** - TheCompany accounts for income taxes using the asset and liability method. TheCompany provides for income taxes currently payable and, in addition, providesdeferred income taxes for temporary differences between the tax bases of assetsand liabilities and their reported amounts in the financial statements.Temporary differences relate principally to the allowance for doubtfulaccounts, allowance for sales returns, liability for warranty claims,unrealized gain (loss) on investments, acquired in-process research and developmentexpenses, acquired intangible assets, foreign subsidiary intangibles,accumulated depreciation, loss on write-down of investments and inventoryreserves. Valuation allowances are established when necessary to reducedeferred tax assets to the amount expected to be realized.

 

41

----

 

**ForeignCurrency** - TheCompany records transactions denominated in foreign currencies on a monthlybasis using the average monthly exchange rate. Assets and liabilities denominatedin foreign currencies are translated at the balance sheet dates using theclosing rates of exchange between those foreign currencies and the U.S. Dollarwith any transaction gains or losses reported in other income (expense).Adjustments from translating financial statements of international subsidiariesare recorded as a separate component of stockholders’ equity.

 

The Company uses forwardcontracts to reduce its foreign currency exposure related to the net cash flowsfrom its European and Asian operations. The majority of these contracts areshort-term contracts (three months or less) and are marked-to-market eachquarter and included in trade payables, with the offsetting gain or lossincluded in other income (expense) in the accompanying consolidated statementsof operations. At December 31, 2004 the Company had one such contractoutstanding with a fair value of zero. At December 31, 2003, the Company had no open forward contracts.

 

**RevenueRecognition** - TheCompany generally records sales upon shipment of the related product, net ofany discounts as the Company generally has no significant post deliveryobligations, the product price is fixed and 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. The Company’s shipping and handling fees are includedin net sales, and the related costs are included in cost of sales in theaccompanying consolidated statements of operations.

 

The Company generally records royalty revenue fromOEMs upon shipment of the related products in which its software or firmware isembedded by the OEMs, based upon shipment data provided by the OEMs.  The Company generally records license revenuefrom sales of its software upon shipment or electronic transfer of thesoftware.  The Company generally defersrevenues from the sale of extended warranty agreements and software support andmaintenance agreements.  The deferredrevenue is amortized into income on a pro rata basis over the applicablecontract lives.

 

**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 -**Thecosts of software development for the Company’s products incurred betweenachieving technological feasibility and the integration into the Company’sproducts available for sale to customers have not been material to date. Suchcosts, if material, would be capitalized. Additionally, costs related todevelopment of internal use software, other than those incurred during theapplication development stage, are expensed as incurred.

 

**AdvertisingExpense****–** Advertising costs are expensed as incurred and areincluded as a component of selling, general and administrative expenses.Advertising expense totaled approximately $6,254, $6,793 and $6,983 for theyears ended December 31, 2004, 2003 and 2002, respectively.

 

The Company participatesin cooperative advertising and market development programs with certaindistributors and OEMs. These programs are used by the Company to reimbursedistributors and OEMs for the actual costs of certain forms of advertising, andin general, allow distributors and OEMs reimbursement up to a specifiedpercentage of net purchases. The Company’s costs associated with these programsare estimated and accrued at the time of sale, and are included in sales andmarketing expenses in the accompanying consolidated statements of operations.

 

**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 the sales or calls of investments and losses realized oninvestments when a decline in fair value is determined by management to beother than temporary.

 

**OtherIncome (Expense), net –**Other income (expense), net consists primarily of foreign currencyexchange gains or losses and interest expense.

 

**ComprehensiveIncome  -** Comprehensive income includes all changes in equity(net assets) during a period from non-owner sources. Items included incomprehensive income include net income, foreign currency translationadjustments, and unrealized gains and losses on available-for-sale securities.

 

**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*).

 

42

----

 

**Use ofEstimates -** Thepreparation of the Company’s consolidated financial statements in conformitywith accounting 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 ofrevenues and expenses during the reporting periods. Actual results could differfrom those estimates.

 

**Reclassifications**– Certainreclassifications have been made to the 2003 and 2002 consolidated financialstatements in order to conform to the 2004 presentation. These reclassificationshad no effect on previously reported net income, net cash provided by operatingactivities, net cash used in investing activities or total stockholders’equity.

 

**Recently Issued AccountingStandards** - In March 2004, the Financial Accounting StandardsBoard (“FASB”) reached consensus on the guidance provided by Emerging IssuesTask Force (“EITF”)  Issue 03-1, *The Meaning of Other-Than-Temporary Impairment andits Application to Certain Investments*. EITF 03-1 specifies that animpairment would be considered other-than-temporary unless (a) the investor hasthe ability and intent to hold an investment for a reasonable period of timesufficient for the recovery of the fair value up to (or beyond) the cost of theinvestment and (b) evidence indicating the cost of the investment isrecoverable within a reasonable period of time outweighs evidence to thecontrary. The disclosure provisions of EITF 03-1 were effective for annualreporting periods ending after December 15, 2003. In September 2004, the EITF delayedthe effective date for the measurement and recognition guidance included inparagraphs 10 through 20 of EITF 03-1. The Company continues to evaluate its investment portfolio in order todetermine the applicability of EITF 03-1.

 

In December 2004, the FASB issued SFAS NO. 123(revised 2004), “*Share based Payment*”, whichreplaces SFAS No. 123. “*Accounting for Stock BasedCompensation*” and APB Opinion No 25 “*Accountingfor Stock Issued to Employees*.” SFAS 123R requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the financial statementsbased on their fair-values beginning with the first interim or annual periodafter June 15, 2005, with early adoption encouraged.  The pro-forma disclosures previouslypermitted under SFAS No. 123 no longer will be an alternative to inclusion ofthe expense in the financial statements. The Company is required to adopt SFAS 123R in the third quarter of 2005,beginning July 2, 2005.  Under SFAS 123R,Avocent must determine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost and thetransition method to be used at date of adoption.  The transition methods include prospectiveand retroactive adoption options. Under the retroactive option, prior periodsmay be restated either as of the beginning of the year of adoption or for allperiods presented. The prospective method requires that compensation expensebegin being recorded for all unvested stock options and restricted stock at thebeginning of the first quarter of adoption of SFAS 123R, while the retroactivemethods would require compensation expense to be recorded for all unvestedstock options and restricted stock beginning with the first period presented.  Avocent is evaluating the requirements ofSFAS 123R and expects the adoption of SFAS 123R will have a material impact onthe Company’s consolidated results of operations and earnings per share.  The Company has not determined the method ofadoption or the effect of adopting SFAS 123R and it has not determined whetherthe adoption will result in amounts similar to the current pro-formadisclosures under SFAS 123.

 

**3.**                                      Acquisitions

** **

**SonicMobility Inc.** - On August 31, 2004, the Company acquired allof the outstanding stock of Sonic Mobility, based in Calgary, Canada. SonicMobility has developed (i) software solutions that allow for management ofnetwork and data center infrastructure from mobile devices, (ii) securitysoftware for intranet and extranet resource access from mobile handheld devicesand (iii) software solutions for managing mobile devices centrally by ITadministrators. The Company’s current management solutions primarily providemanagement and access solutions for fixed place IT devices.  The addition of Sonic Mobility’s proprietaryproducts expands the Company’s markets to include both integrated andstand-alone solutions for the expanding mobile IT device market. The results ofSonic Mobility’s operations have been included in the consolidated financialstatements since the date of acquisition.

 

The acquisition wasrecorded under the purchase method of accounting, and the purchase price wasallocated based on the fair value of the assets acquired and liabilitiesassumed. In accordance with generally accepted accounting principles, purchasedresearch and development costs allocated to patent-pending technology werecapitalized and will be amortized over the respective estimated usefullives.  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 theCompany’s review of goodwill for impairment. The goodwill is amortizable fortax purposes.  A summary of the totalpurchase consideration is as follows:

 
| Cash paid for  outstanding shares |   | $      | 8,948  |   |
|-----------------------------------|--------|--------|--------|--------|
| Acquisition  costs                |   | 299    |   |
|                              |   |   |   |
| Total purchase  consideration     |   | $      | 9,247  |   |

 

43

----

 

The Company funded theacquisition through available cash. On the closing of the Sonic Mobilitytransaction, the Company acquired $106 in cash held by Sonic Mobility.

 

The purchaseconsideration was allocated, on a preliminary basis, to the estimated fairvalues of the assets acquired and liabilities assumed, as follows:

 
| ** **                           | ** ** | **Purchase  Price  Allocation** | ** ** | **Amortization  Period** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|--------------------------|------------|
| Tangible assets                      |       | $                               | 491        |                     | Various    |   |
| In-process  research and development |       | 1,050                           |       | —                   |       |
| Developed  technology                |       | 1,420                           |       | 3 years                  |       |
| Customer base                        |       | 610                             |       | 5 years                  |       |
| Non-compete  agreements              |       | 1,060                           |       | 3 years                  |       |
| Goodwill                             |       | 5,203                           |       | —                   |       |
| Assumed  liabilities                 |       | (587                            | )          | —                   |       |
|                                 |       |                            |       |                     |       |
|                                 |       | $                               | 9,247      |                     |       |   |

 

Thefair value of all of the in-process research and development (“IPR&D”)received in the acquisition was determined using a form of the discounted cashflow method known as the multi-period excess earnings method.  These amounts were deemed to be forparticular research and development projects that have no alternative futureuses and were therefore expensed rather than capitalized at the time ofpurchase.

 

SonicMobility’s in-process research and development activities consisted of anupgrade of its Sonic Sentry product, software that allows for managing mobiledevices centrally by IT administrators. The upgrade was planned to roll out in two phases, one in the fall of2004 and the second in 2005.   The firstphase was completed and available for shipping during the fourth quarter of2004, while the second phase was still in process at the end of 2004.

 

Thenew generation of Sonic Sentry upgrades under development is projected to sellthrough sales channels and to customers that are substantially the same ascurrent and historical sales channels and customers. Pricing and margins willnot differ significantly from historical pricing and margins.  Revenue for the projects under developmentwas projected through 2012, with over 90% of Sonic Mobility’s forecastedrevenue in 2006 coming from projects currently in development.   Net income attributable to IPR&D wascalculated by applying Sonic Mobility’s projected gross, operating and netprofit margins to IPR&D revenue, while considering Avocent’s historicalresults and industry prospects.

 

Revenuegrowth related to the in-process research and development is embodied inproducts to be launched in late 2004 and during 2005. The Sonic Sentry producthas an estimated economic life of approximately nine years. The product lifecycle is characterized by a 4 to 5 year ramp up period, followed by a 2 to 3year plateau, followed by a 1 to 2 year decline period. Gross margins areprojected to be well above historical Avocent margins as these products areprimarily software. The discount rate used to value IPR&D was 41%.

 

**OSATechnologies, Inc.** - On April 6, 2004, the Company acquiredthe outstanding stock of OSA.  OSA isheadquartered in San Jose, California and has additional offices in Shanghai,China and Taipei, Taiwan. OSA has developed embedded manageability firmware andsoftware using Intelligent Platform Management Interface (“IPMI”) solutions.The acquisition of OSA will enhance the Company’s position in the embeddedmanagement market and OSA’s embedded management solutions for the IPMI marketcomplements the Company’s core KVM business and builds upon prioracquisitions.  The results of OSA’soperations have been included in the consolidated financial statements sincethe date of acquisition.

 

The acquisition wasrecorded under the purchase method of accounting, and the purchase price wasallocated based on the fair value of the assets acquired and liabilitiesassumed. In accordance with generally accepted accounting principles, purchasedresearch and development costs allocated to patent-pending technology werecapitalized and will be 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 result of theacquisition will not be amortized but will be included in the Company’s reviewof goodwill for impairment. Additionally, the goodwill recorded upon the OSAacquisition is not amortizable for tax purposes.  The excess of the fair value over theintrinsic value of the unvested OSA options and the fair value of the vested OSAoptions at the date of consummation have been included in the purchaseconsideration. A summary of the total purchase consideration is as follows:

 

44

----

 
| Cash paid for  outstanding shares                    |   | $      | 51,685  |   |
|------------------------------------------------------|--------|--------|---------|--------|
| Value of common  stock issued for outstanding shares |   | 45,831 |    |
| Value of stock  options assumed                      |   | 2,526  |    |
| Acquisition  costs                                   |   | 1,113  |    |
|                                                 |   |   |    |
| Total purchase  consideration                        |   | $      | 101,155 |   |
|                                                      |        |        |         |        |  |

 

The Company funded theacquisition through available cash and by the issuance of 1,229 shares ofAvocent common stock.  The common stock,valued at approximately $45,831, was recorded as non-cash consideration for theacquisition of OSA. On the closing of the OSA transaction, the Company acquired$5,619 in cash held by OSA.

 

The purchaseconsideration was allocated, on a preliminary basis, to the estimated fairvalues of the assets acquired and liabilities assumed, as follows:

 
| ** **                           | ** ** | **Purchase  Price  Allocation** | ** ** | **Amortization  Period** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|--------------------------|------------|
| Tangible assets                      |       | $                               | 11,718     |                     | Various    |   |
| In-process  research and development |       | 21,720                          |       | —                   |       |
| Developed technology                 |       | 12,380                          |       | 3 years                  |       |
| Customer base                        |       | 4,260                           |       | 5 years                  |       |
| Trademarks                           |       | 3,240                           |       | 3 years                  |       |
| Non-compete  agreements              |       | 960                             |       | 3 years                  |       |
| Goodwill                             |       | 57,131                          |       | —                   |       |
| Deferred taxes                       |       | (8,544                          | )          | Various                  |       |
| Assumed  liabilities                 |       | (1,710                          | )          | —                   |       |
|                                 |       |                            |       |                     |       |
|                                 |       | $                               | 101,155    |                     |       |   |

 

Additionally, the Companyrecorded $6,351 of deferred compensation related to the intrinsic value of theunvested OSA employee stock options at the time of the acquisition on April 6,2004.  The deferred compensation is beingamortized on a straight-line basis over the vesting period of the options forwhich it was recorded.

 

The fair value of all ofthe in-process research and development (“IPR&D”) received in theacquisition was determined using a form of the discounted cash flow methodknown as the multi-period excess earnings method.  These amounts were deemed to be forparticular research and development projects that have no alternative futureuses and were therefore expensed rather than capitalized at the time ofpurchase.

 

OSA’s in-process researchand development activities consisted of an upgrade of its Firmware Suite toVersion 2.0 and an embedded server management product.  The status of these projects varied, however,it is anticipated that the products will be completed during 2005 and 2006.   These projects were still in process at theend of 2004.

 

The new generations ofproducts under development are projected to sell through sales channels and tocustomers that are substantially the same as current and historical saleschannels and customers. Pricing and margins will not differ significantly fromhistorical pricing and margins.  Revenuefor the projects under development was projected through 2012, with 50% of OSA’sforecasted revenue in 2006 coming from projects currently in development.   Net income attributable to IPR&D wascalculated by applying OSA’s projected gross, operating and net profit marginsto IPR&D revenue, while considering Avocent’s historical results andindustry prospects.

 

Revenue growth related tothe in-process research and development is embodied in products to be launchedduring 2005 and 2006. These products have estimated economic lives ranging fromapproximately six to nine years. The product life cycle is characterized by agradual 2 to 3 year ramp up period, followed by a 1 to 2 year plateau, followedby a 3 to 4 year decline period. Gross margins are projected to be well abovehistorical Avocent margins as these products are primarily software. Thediscount rate used to value IPR&D was 24%.

 

**Crystal Link Technologies**- On January 6,2004, the Company acquired the outstanding common shares of Crystal Link forapproximately $6,652 in cash and common stock, plus the assumption ofliabilities and payment of certain acquisition costs.  The purchase agreement called for additionalpotential earn-out payments of up to $5,000 based on future technicalenhancements and achievement of certain sales goals.  In October 2004, the Company paid $2,000 ofthe earn-out consideration based on the achievement of the specified technologyenhancements.  The remaining $3,000 ofpotential earn-out consideration was not paid as the goals specified were notmet.  The results of Crystal Link’soperations have been included in the consolidated financial statements sincethe date of acquisition.  Crystal Link,headquartered in Escondido, CA, has developed

** **

**45**

----

** **

**wireless technology for KVM switching and extensionproducts.**

** **

The acquisition wasrecorded under the purchase method of accounting, and the purchase price wasallocated based on the fair value of the assets acquired and liabilitiesassumed. In accordance with generally accepted accounting principles, purchasedresearch and development costs allocated to patent-pending technology werecapitalized and will be amortized over the respective estimated usefullives.  The remaining amounts ofpurchased research and development were expensed upon the closing of thetransaction.  The goodwill recorded as aresult of the acquisition, including the earn-out consideration, will not beamortized but will be included in our review of goodwill for impairment.  The goodwill is amortizable for tax purposes.A summary of the total purchase consideration is as follows:

 
| Cash paid for  outstanding shares                    |   | $      | 5,152  |   |
|------------------------------------------------------|--------|--------|--------|--------|
| Value of common  stock issued for outstanding shares |   | 3,500  |   |
| Acquisition  costs                                   |   | 163    |   |
|                                                 |   |   |   |
| Total purchase  consideration                        |   | $      | 8,815  |   |

 

Thepurchase consideration was allocated to the estimated fair values of the assetsacquired and liabilities assumed, as follows:

 
| ** **                           | ** ** | **Purchase  Price  Allocation** | ** ** | **Amortization  Period** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|--------------------------|------------|
| Tangible assets                      |       | $                               | 295        |                     | Various    |   |
| In-process  research and development |       | 6,490                           |       | —                   |       |
| Developed  technology                |       | 520                             |       | 3 years                  |       |
| Non-compete  agreements              |       | 500                             |       | 3 years                  |       |
| International  marketing rights      |       | 1,250                           |       | 3 years                  |       |
| Goodwill                             |       | 1,857                           |       | —                   |       |
| Assumed  liabilities                 |       | (2,097                          | )          | —                   |       |
|                                 |       |                            |       |                     |       |
|                                 |       | $                               | 8,815      |                     |       |   |

 

The acquisition wasfunded through available cash and by the issuance of 107 shares of Avocentcommon stock.  The common stock, valuedat approximately $3,500, was recorded as non-cash consideration for theacquisition of Crystal Link. On the closing of the Crystal Link transaction,the Company acquired $4 in cash held by Crystal Link.

 

The fair value of all ofthe IPR&D received in the acquisition was determined using a form of thediscounted cash flow method known as the multi-period excess earningsmethod.  These amounts were deemed to befor particular research and development projects that have no alternativefuture uses and were therefore expensed rather than capitalized at the time ofpurchase.

 

Crystal Link’s in-processresearch and development activities consisted of a second generation of the KVMwireless extender with significant enhancements to the developed KVM wirelessextender product and the development of a wireless KVM switch and an embeddedKVM switch solution.  The status of theseprojects varied from 10% complete to 60% complete.  The wireless KVM and the enhancements to theextender product have been completed as of the end of 2004.

 

The new generations ofproducts are projected to sell through sales channels and to customers that aresubstantially the same as current and historical sales channels and customers.Pricing and margins will not differ significantly from historical pricing andmargins.  Revenue for the projects underdevelopment was projected through 2013, with 100% of Crystal Link’s forecastedrevenue in 2005 expected to come from projects currently in development.   Net income attributable to IPR&D wascalculated by applying Crystal Link’s projected gross, operating and net profitmargins to IPR&D revenue, while considering Avocent’s historical resultsand industry prospects.

 

Revenue growth related tothe in-process research and development is embodied in products to be launchedin late 2004. These products have estimated economic lives ranging fromapproximately 7 to 10 years. The product life cycle is characterized by agradual 3 to 4 year ramp up period, followed by a 1 to 2 year plateau, followedby a 3 to 4 year decline period. Gross margins are projected to be belowoverall historical Avocent margins in the early years, but are expected toimprove for these products over their lives as the products mature, as costsare designed out of the products, and as sales volumes increase. The discountrate used to value IPR&D was 20%.

 

**Acquisition of Soronti -**On November 17, 2003, the Companyacquired the outstanding preferred and common shares of Soronti forapproximately $7,000 in cash and stock, plus the assumption of liabilities andpayment of certain acquisition costs.

** **

**46**

----

** **

**The results of Soronti’s operations have been includedin the consolidated financial statements since that date.  Soronti, headquartered in Draper, Utah, hasdeveloped server and system management products for the control of IT.  Soronti’s products included a virtualpresence PCI adaptor and a virtual presence stand alone unit.**

** **

The acquisition wasrecorded under the purchase method of accounting, and the purchase price wasallocated based on the fair value of the assets acquired and liabilitiesassumed. In accordance with generally accepted accounting principles, purchasedresearch and development costs allocated to patent-pending technology werecapitalized and will be amortized over the respective estimated usefullives.  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 theCompany’s annual review of goodwill for impairment.  A summary of the total purchase considerationis as follows:

 
| Cash paid for  outstanding shares                    |   | $      | 5,848  |   |
|------------------------------------------------------|--------|--------|--------|--------|
| Value of common  stock issued for outstanding shares |   | 1,152  |   |
| Acquisition  costs                                   |   | 207    |   |
|                                                 |   |   |   |
| Total purchase  consideration                        |   | $      | 7,207  |   |

 

The purchaseconsideration was allocated to the estimated fair values of the assets acquiredand liabilities assumed, as follows:

 
| ** **                           | ** ** | **Purchase  Price  Allocation** | ** ** | **Amortization  Period** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|--------------------------|------------|
| Tangible assets                      |       | $                               | 800        |                     | Various    |   |
| In-process  research and development |       | 3,940                           |       | —                   |       |
| Developed  technology                |       | 500                             |       | 3 years                  |       |
| International  marketing rights      |       | 668                             |       | 3 years                  |       |
| Goodwill                             |       | 2,412                           |       | —                   |       |
| Deferred taxes                       |       | (270                            | )          | 3 years                  |       |
| Assumed  liabilities                 |       | (843                            | )          | —                   |       |
|                                 |       |                            |       |                     |       |
|                                 |       | $                               | 7,207      |                     |       |   |

 

The acquisition wasfunded through available cash and by the issuance of 31 shares of Avocentcommon stock.  The common stock, valuedat approximately $1,152, was recorded as non-cash consideration for theacquisition of Soronti, Inc. On the closing of the Soronti transaction, theCompany acquired $535 in cash held by Soronti.

 

The fair value of all ofthe in-process research and development (“IPR&D”) received in theacquisition was determined using a form of the discounted cash flow methodknown as the multi-period excess earnings method.  These amounts were deemed to be forparticular research and development projects that have no alternative futureuses and were therefore expensed rather than capitalized at the time ofpurchase.

 

Soronti’s in-processresearch and development activities consisted of the development of the RemoteOffice Branch Office (“ROBO”) product, an appliance with both KVM and serialports that utilizes the SwitchView IP technology to provide the user access overIP, a mezzanine card based on the virtual presence technology that is a smallform factor card designed for integration into existing analog KVM switches,embedded KVM redirection circuitry for remote server management, whichessentially integrates the technology from the mezzanine card into the servermotherboard, and a PCI card which is an add-in card that provides remotemanagement of a server. The work remaining to be performed on these projectsvaried, but at the time of the acquisition, the projects were considered to bein early concept form, prototype form, or mid-design form.  The ROBO project essentially competed withproducts currently sold by Avocent and the project has been abandoned at thistime.  The results of our IPR&Dvaluation work yielded no value from the ROBO product.  The other projects were completed during2004.

 

The new generations ofproducts under development are projected to sell through sales channels and tocustomers that are substantially the same as current and historical saleschannels and customers. Pricing and margins will not differ significantly fromhistorical pricing and margins.  Revenuefor the projects under development was projected through 2013, with 90% ofSoronti’s forecasted revenue in 2005 coming from projects currently indevelopment.   Net income attributable toIPR&D was calculated by applying Soronti’s projected gross, operating andnet profit margins to IPR&D revenue, while considering Avocent’s historicalresults and industry prospects.

 

Revenue growth related tothe in-process research and development is embodied in products to be launchedin late 2004. These products have estimated economic lives ranging fromapproximately seven to ten years. The product life cycle is characterized by agradual 3 to 4 year ramp up period, followed by a 2 to 3 year plateau, followedby a 2 to 3 year decline

 

47

----

 

period. Gross margins areprojected to be below overall Avocent margins in the early years, but willimprove for these products over their lives as the products mature, as costsare designed out of the products, and as sales volumes increase. The discountrate used to value IPR&D was 25%.

 

**Acquisition of 2C -**On August 20, 2002, the Companyacquired the outstanding preferred and common shares of 2C for approximately$22.8 million in cash, plus the assumption of liabilities and stockoptions.  The results of 2C’s operationshave been included in the consolidated financial statements since thatdate.  2C, headquartered in Huntsville,Alabama, has developed digital extension technology that splits the PCI bus ofa PC and allows the PC motherboard, processor, hard drive, and other userdevices to be located at a distance from the user and connected using CAT 5 orfiber optic cable.

** **

The acquisition wasrecorded under the purchase method of accounting, and the purchase price wasallocated based on the fair value of the assets acquired and liabilitiesassumed. In accordance with generally accepted accounting principles, purchasedresearch and development costs allocated to patent-pending technology werecapitalized and will be amortized over the respective estimated usefullives.  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 theCompany’s annual review of goodwill for impairment.  A summary of the total purchase considerationis as follows:

 
| Cash paid for  outstanding shares |   | $      | 22,781 |   |
|-----------------------------------|--------|--------|--------|--------|
| Outstanding  options assumed      |   | 1,850  |   |
| Acquisition  costs                |   | 441    |   |
|                              |   |   |   |
| Total purchase  consideration     |   | $      | 25,072 |   |

 

The purchaseconsideration was allocated to the estimated fair values of the assets acquiredand liabilities assumed, as follows:

 
| ** **                           | ** ** | **Purchase  Price  Allocation** | ** ** | **Amortization  Period**   | ** ** |
|--------------------------------------|------------|---------------------------------|------------|----------------------------|------------|
| Tangible assets                      |       | $                               | 1,306      |                       | Various    |   |
| In-process  research and development |       | 6,000                           |       | —                     |       |
| Patents                              |       | 370                             |       | 5 years                    |       |
| Non-compete  agreements              |       | 3,273                           |       | 3 years (contract  period) |       |
| Trademarks                           |       | 2,030                           |       | 5 years                    |       |
| Customer base                        |       | 1,613                           |       | 3 years                    |       |
| Goodwill                             |       | 15,136                          |       | —                     |       |
| Deferred taxes                       |       | (2,733                          | )          | Various                    |       |
| Assumed  liabilities                 |       | (1,923                          | )          | —                     |       |
|                                 |       |                            |       |                       |       |
|                                 |       | $                               | 25,072     |                       |       |   |

 

The acquisition wasfunded through available cash.  On theclosing of the 2C transaction, the Company acquired $33 in cash held by 2C.

 

**Pro FormaFinancial Information –**The following unaudited pro forma summary combines the results ofoperations of Avocent, 2C, Soronti, Crystal Link, OSA and Sonic Mobility as ifthe acquisitions had at the beginning of each period presented.  Certain adjustments have been made to reflectthe impact of the purchase transactions. These pro forma results have beenprepared for comparative purposes only and do not purport to be indicative ofwhat would have occurred had the acquisitions been made at the beginning ofeach period presented, or of results which may occur in the future.

 
| ** **                       | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------|------------|------------------------------|------------|
| ** **                       | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
|                             |       |                         |       |   |   |   |   |
| Net sales                        |       | $                            | 366,155    |   | $ | 307,032 |   | $ | 262,830 |   |
| Net income  (loss)               |       | $                            | 44,844     |   | $ | 28,291 |   | $ | (93 | ) |
| Income (loss)  per basic share   |       | $                            | 0.92       |   | $ | 0.61 |   | $ | — |   |
| Income (loss)  per diluted share |       | $                            | 0.89       |   | $ | 0.59 |   | $ | — |   |

 

**The above amounts exclude acquired in-process researchand development expense of $789 (net of a $261 tax benefit) related to theSonic Mobility acquisition, $21,720 related to the OSA acquisition, $3,829 (netof a $2,661 tax benefit) related to the Crystal Link acquisition, $3,940related to the Soronti acquisition, and $6,000 related to the 2C acquisition.**

 

48

----

 

**4.**             Inventories

 

Inventories consist ofthe following at December 31, 2004 and 2003:

 
| ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
| Raw materials,  net   |       | $        | 4,411      |     | $          | 4,155 |   |
| Work in process,  net |       | 356      |       | 659      |       |
| Finished goods,  net  |       | 16,465   |       | 16,510   |       |
|                  |       |     |       |     |       |
| Inventories, net      |       | $        | 21,232     |     | $          | 21,324 |   |

 

Asof December 31, 2004 and 2003, inventories above have been reduced by reservesfor excess and obsolete inventories of $3,785 and $4,020, respectively.

 

**5.**             Investments

** **

All investments inpublicly traded securities at December 31, 2004 and 2003, are classified asavailable-for-sale and are carried at fair value.   The Company includes certain investmentswith original maturities of less than 90 days as short term investments whensuch investments are a part of our non-operating investment portfolio.  Investments at December 31, 2004 and 2003 areas follows:

 
| ** **                                                         | ** ** | **December 31, 2004**        | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| **Current investments:**                                           | ** ** | **Cost or  Amortized  Cost** | ** ** | **Gross**

**Unrealized**

**Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Corporate bonds                                                    |       | $                            | 32,459     |   | $ | 1 |   | $ | (133 | ) | $ | 32,327 |   |
| Municipal bonds                                                    |       | 93,409                       |       | 20 |   | (68 | ) | 93,361 |   |
| Mortgage-backed  securities guaranteed by U.S. government agencies |       | 14,209                       |       | 67 |   | (28 | ) | 14,248 |   |
| U.S. government  agency obligations                                |       | 14,704                       |       | — |   | (98 | ) | 14,606 |   |
| Time deposits                                                      |       | 40,533                       |       | — |   | — |   | 40,533 |   |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Total                                                              |       | $                            | 195,314    |   | $ | 88 |   | $ | (327 | ) | $ | 195,075 |   |

 
| ** **                                                         | ** ** | **December 31, 2004**        | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| **Non-current investments:**                                       | ** ** | **Cost or  Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Corporate bonds                                                    |       | $                            | 32,672     |   | $ | — |   | $ | (155 | ) | $ | 32,517 |   |
| Municipal bonds                                                    |       | 5,654                        |       | — |   | (33 | ) | 5,621 |   |
| Asset-backed  securities                                           |       | 1,222                        |       | — |   | (7 | ) | 1,215 |   |
| Mortgage-backed  securities guaranteed by U.S. government agencies |       | 33,154                       |       | 157 |   | (66 | ) | 33,245 |   |
| U.S agency  obligations                                            |       | 17,726                       |       | 3 |   | (110 | ) | 17,619 |   |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Totals                                                             |       | $                            | 90,428     |   | $ | 160 |   | $ | (371 | ) | $ | 90,217 |   |

 
| ** **                                                         | ** ** | **December 31, 2003**        | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| **Current investments:**                                           | ** ** | **Cost or  Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Corporate bonds                                                    |       | $                            | 40,944     |   | $ | 49 |   | $ | (30 | ) | $ | 40,963 |   |
| Municipal bonds                                                    |       | 56,316                       |       | 3 |   | (1 | ) | 56,318 |   |
| Asset-backed  securities                                           |       | 292                          |       | 7 |   | — |   | 299 |   |
| Mortgage-backed  securities guaranteed by U.S. government agencies |       | 13,762                       |       | 96 |   | (23 | ) | 13,835 |   |
| U.S. government  agency obligations                                |       | 17,508                       |       | 20 |   | (2 | ) | 17,526 |   |
| Time deposits                                                      |       | 17,959                       |       | — |   | — |   | 17,959 |   |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Total                                                              |       | $                            | 146,781    |   | $ | 175 |   | $ | (56 | ) | $ | 146,900 |   |

 

49

----

 
| ** **                                                         | ** ** | **December 31, 2003**        | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| **Non-current investments:**                                       | ** ** | **Cost or  Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Corporate bonds                                                    |       | $                            | 30,538     |   | $ | 43 |   | $ | (69 | ) | $ | 30,512 |   |
| Municipal bonds                                                    |       | 14,047                       |       | 11 |   | (31 | ) | 14,027 |   |
| Mortgage-backed  securities guaranteed by U.S. government agencies |       | 32,111                       |       | 225 |   | (54 | ) | 32,282 |   |
| U.S agency  obligations                                            |       | 2,607                        |       | 6 |   | — |   | 2,613 |   |
| Private equity  investments                                        |       | 3,450                        |       | — |   | — |   | 3,450 |   |
|                                                               |       |                         |       |   |   |   |   |   |   |
| Totals                                                             |       | $                            | 82,753     |   | $ | 285 |   | $ | (154 | ) | $ | 82,884 |   |

 

Scheduled maturities ofnon-current investments are as follows:

 
| ** **                  | ** ** | **December 31, 2004** | ** ** |
|-----------------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **Amortized  Cost**   | ** ** | **Estimated  Fair  Value** | ** ** |
| Due within two  years       |       | $                     | 45,936     |   | $ | 45,656 |   |
| Due two to three  years     |       | 11,338                |       | 11,316 |   |
| Mortgage-backed  securities |       | 33,154                |       | 33,245 |   |
|                        |       |                  |       |   |   |
| Totals                      |       | $                     | 90,428     |   | $ | 90,217 |   |

 

Investments inmortgage-backed securities are included under available-for-sale securities.The Company anticipates prepayments of approximately 25% per year in additionto the scheduled maturities on such securities.

 

As of December 31, 2004 substantially all of theCompany’s investments that had unrealized losses were in a loss position forless than twelve months.  The unrealizedlosses include 96 individual securities and have been caused by slight upwardvariations in interest rates in the particular securities since the time theywere acquired. Most of these investments have been acquired within the past 12months, are of high credit quality, or are guaranteed by an agency of the USgovernment, and Avocent anticipates that the Company will realize the full parvalue upon maturity of these securities.

 

Net realized gains (losses) forthe years ended December 31, 2004, 2003, and 2002 is comprised of thefollowing:

 
| ** **                              | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross realized  gains                   |       | $          | 31         |       | $          | 3,191      |       | $ | 36 |   |
| Gross realized  losses                  |       | (3,835     | )          | (572       | )          | (341       | )          |
| Net realized  investment gains (losses) |       | $          | (3,804     | )          | $          | 2,619      |       | $ | (305 | ) |

 

In the second quarter of2002, the Company made a $1,000 investment in Rymic Systems, Inc., aprivately-held company based in Huntsville, Alabama, that develops hardware andsoftware solutions for remote monitoring and control of vehicles and equipmentover the internet using standard desktop web browsers.  The Company purchased 400 shares of Rymic’scommon stock, giving Avocent approximately a 14% equity position in Rymic.  During 2004, as a result of Rymic’s decliningfinancial condition, the Company recorded an impairment charge of $450 againstits investment in Rymic, which was included in net realized investment lossesin the accompanying consolidated statements of operations and which reduced itsnet carrying value to nil.  During 2002, the Company recordedequity-method losses and an impairment charge totaling $550 against itsinvestment in Rymic.  The Companydid not recognize any gross realized losses in this investment in 2003.

 

In the second quarter of 2003 the Company made a$3,000 preferred stock investment in VIEO, Inc., a privately held company basedin Austin, Texas. VIEO provides management products for Adaptive ApplicationInfrastructure Management.  VIEO’sproducts combine application-aware networking hardware with intelligentinfrastructure management software in a secure, purpose-built appliance tomeasure, analyze and control application resources.  The Company’s investment, which representsless than 10% ownership in VIEO, is being accounted for on the cost method. During 2004, as a result of VIEO’s

 

50

----

 

declining financialcondition and its planned recapitalization, the Company recorded an impairmentcharge of $3,000 against its investment in VIEO, which was included in netrealized investment losses in the accompanying consolidated statements ofoperations, and which reduced the net carrying value of the investment to nil.

 

**6.**                                      Property Held for Lease

** **

The Company owns abuilding in Huntsville, Alabama and has executed a five-year agreement to leasethe building to an unrelated party. The five year agreement will expire in Mayof 2005; however the lease agreement contains renewal options for up to twothree-year extensions, subject to certain conditions. As of March 5, 2005, theCompany had not yet received a notice of extension under the lease.  Rental income totaled approximately $221 foreach of the years ended December 31, 2004, 2003 and 2002.

 

Property held for leaseconsists of the following at December 31, 2004 and 2003:

 
| ** **                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Building                      |       | $        | 2,306      |     | $          | 2,306 |   |
| Accumulated  depreciation     |       | (976     | )          | (780     | )          |
|                          |       |     |       |     |       |
| Property held  for lease, net |       | $        | 1,330      |     | $          | 1,526 |   |

 

Future minimum rentalincome remaining on this non-cancelable operating lease is approximately asfollows:

 

| **Years ending**

**December 31:** | ** ** |
|------------------------------------|------------|
| 2005                               |       | $ | 233 |
| 2006                               |       | 240 |
| 2007                               |       | 240 |
| 2008                               |       | 100 |
|                               | $          | 813 |

 

**7.**                                      Property and Equipment

** **

Property and equipmentconsists of the following at December 31, 2004 and 2003:

 
| ** **                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Land and land  improvements      |       | $        | 4,814      |     | $          | 4,947 |   |
| Buildings                        |       | 22,424   |       | 21,530   |       |
| Leasehold  improvements          |       | 2,433    |       | 2,403    |       |
| Computer  software and equipment |       | 21,330   |       | 15,014   |       |
| Other equipment                  |       | 13,244   |       | 11,539   |       |
| Construction in  progress        |       | 1,787    |       | 3,331    |       |
|                             |       |     |       |     |       |
|                             |       | 66,032   |       | 58,764   |       |
| Less accumulated  depreciation   |       | (26,136  | )          | (20,291  | )          |
|                             |       |     |       |     |       |
| Property and  equipment, net     |       | $        | 39,896     |     | $          | 38,473 |   |

** **

Depreciation expense was $6,222, $4,859 and $4,361 forthe years ended December 31, 2004, 2003 and 2002, respectively.

 

The Company implemented a new enterprise resourceplanning system in the fourth quarter of 2003 at its United States locationsand implemented the system at its international locations during the thirdquarter of 2004. The Company has capitalized the costs of the new system todate and has begun depreciating the costs for all locations.    The Company has capitalized approximately$12,065 of related costs as of December 31, 2004 and $9,867 of related costs asof December 31, 2003.

 

**8.**                                      Goodwill and Other Intangible Assets

** **

**Acquired other intangible assets subject toamortization, including the intangible assets from the Crystal Link, OSA, SonicMobility, Soronti and 2C acquisitions detailed in Note 3, are as follows:**

 
| ** **                       | ** ** | **December 31, 2004**        | ** ** | **December 31, 2003**         | ** ** |
|----------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **Gross  Carrying  Amounts** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amounts** | ** ** | **Accumulated  Amortization** | ** ** |
| Developed  technology            |       | $                            | 80,560     |                          | $          | 62,293 |   | $ | 66,240 |   | $ | 45,824 |   |
| Patents and  trademarks          |       | 21,508                       |       | 14,318                        |       | 17,657 |   | 9,566 |   |
| Customer base  and certification |       | 6,483                        |       | 1,961                         |       | 1,613 |   | 717 |   |
| Non-compete  agreements          |       | 5,793                        |       | 3,070                         |       | 3,273 |   | 1,455 |   |
| Other assets                     |       | 1,814                        |       | 535                           |       | 768 |   | 100 |   |
|                             |       | $                            | 116,158    |                          | $          | 82,177 |   | $ | 89,551 |   | $ | 57,662 |   |

 

51

----

 

**For the years ended December 31, 2004, 2003 and 2002,amortization expense for other intangible assets was $24,279, $21,805 and$22,189, respectively.  The approximatefuture annual amortization for other intangible assets is as follows:**

** **

| **Years  ending  December 31:** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------|------------|
| 2005                            |       | $          | 19,600     |   |
| 2006                            |       | 9,400      |       |
| 2007                            |       | 3,500      |       |
| 2008                            |       | 1,100      |       |
| 2009                            |       | 381        |       |
| Total                           |       | $          | 33,981     |   |

** **

**In 2003, the Company recorded $2,412 of goodwill asresult of the Soronti acquisition.  In2004, the Company recorded $5,203 of goodwill as result of the Sonic Mobilityacquisition, $57,131 of goodwill as result of the OSA acquisition and $1,857 ofgoodwill as a result of the acquisition of Crystal Link.**

** **

**In accordance with SFAS No. 142, the Company completeda transitional impairment test of all goodwill and intangible assets as ofJanuary 1, 2002.**  The test concluded that no adjustment was required uponadoption.  Additionally, the Companyperformed an annual impairment test of goodwill in the fourth quarter of 2004,2003 and 2002, as prescribed by this standard. The test in the fourth quarter of each year concluded that there hadbeen no impairment of goodwill and that no adjustments were required.

** **

**9.**                                      Product Warranties

** **

The activity within the liability for warranty returnsin 2004 and 2003 is as follows:

 

| ** **                                                | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                      |       |     |       |     |       |
| Balance,  beginning of year                               |       | $        | 2,652      |     | $          | 2,435 |   |
|                                                      |       |     |       |     |       |
| Accruals for  product warranties issued during the period |       | 528      |       | 597      |       |
| Settlements made  during the period                       |       | (420     | )          | (380     | )          |
|                                                      |       |     |       |     |       |
| Balance, end of  year                                     |       | $        | 2,760      |     | $          | 2,652 |   |

 

Deferred revenue related to the Company’s extendedwarranty program was $1,666 at December 31, 2004 and $1,046 at December 31,2003.  The Company recorded earnedrevenue from the amortization of deferred revenue related to extendedwarranties of $607 during 2004, $282 during 2003 and $90 during 2002.  In addition, the Company recorded newextended warranties of $1,227 during 2004, $710 during 2003 and $590 during2002.

 

**10.**                               Income Taxes

** **

The provision for incometaxes for the years ended December 31, 2004, 2003 and 2002 is comprised of thefollowing:

 
| ** **                              | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| U.S. operations:                        |       |     |       |     |       |     |       |
| Current:                                |       |     |       |     |       |     |       |
| Federal                                 |       | $        | 14,175     |     | $          | 13,356   |       | $ | 8,262 |   |
| State                                   |       | 1,582    |       | 1,198    |       | (1,468   | )          |
|                                    |       |     |       |     |       |     |       |
|                                    |       | 15,757   |       | 14,554   |       | 6,794    |       |
| Deferred:                               |       |     |       |     |       |     |       |
| Federal                                 |       | (6,367   | )          | (3,676   | )          | (4,615   | )          |
| State                                   |       | (1,092   | )          | (540     | )          | (677     | )          |
|                                    |       |     |       |     |       |     |       |
|                                    |       | (7,459   | )          | (4,216   | )          | (5,292   | )          |
|                                    |       |     |       |     |       |     |       |
| Total U.S.  operations tax provision    |       | 8,298    |       | 10,338   |       | 1,502    |       |
| Total foreign  operations tax provision |       | 4,154    |       | 4,161    |       | 3,000    |       |
|                                    |       |     |       |     |       |     |       |
| Total provision  for income taxes       |       | $        | 12,452     |     | $          | 14,499   |       | $ | 4,502 |   |

 

52

----

 

The provision for federal income taxes differs from the amount computedby applying the statutory rate of 35% to taxable income as follows:

 
| ** **                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                               |       |     |       |     |       |     |       |
| Expected federal  income tax provision                             |       | $        | 10,672     |     | $          | 18,566   |       | $ | 5,334 |   |
| Add (deduct):                                                      |       |     |       |     |       |     |       |
| Extraterritorial  income exclusion benefit                         |       | (35      | )          | (63      | )          | (29      | )          |
| State income tax                                                   |       | 318      |       | (642     | )          | (1,041   | )          |
| Tax effect  resulting from foreign operations taxed at lower rates |       | (7,848   | )          | (7,231   | )          | (6,154   | )          |
| Acquired  in-process research and development                      |       | 7,602    |       | 1,379    |       | 2,100    |       |
| Compensation  expense                                              |       | 1,984    |       | 1,488    |       | 3,897    |       |
| Municipal bond  interest income                                    |       | (602     | )          | (179     | )          | —   |       |
| Foreign stock  option incentive transfer                           |       | (848     | )          | —   |       | —   |       |
| Subpart F income                                                   |       | 1,110    |       | 449      |       | —   |       |
| R & E Credit                                                   |       | (325     | )          | (264     | )          | —   |       |
| Other                                                              |       | 425      |       | 996      |       | 395      |       |
|                                                               |       |     |       |     |       |     |       |
|                                                               |       | $        | 12,452     |     | 14,499     |     | $          | 4,502 |   |
|                                                                    |            |          |            |          |            |          |            |  |  |  |

 

The components of the netdeferred income tax assets and liabilities at December 31, 2004 and 2003, areas follows:

 
| ** **                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net current  deferred income tax assets:                        |       |     |       |     |       |
| Allowance for  doubtful accounts                                |       | $        | 454        |     | $          | 517 |   |
| Allowance for  sales returns and liability for warranty returns |       | 1,377    |       | 1,657    |       |
| Inventory  reserves                                             |       | 1,620    |       | 1,531    |       |
| Acquired  operating loss carryforwards                          |       | 2,013    |       | —   |       |
| Other                                                           |       | 1,256    |       | 911      |       |
|                                                            |       |     |       |     |       |
|                                                            |       | $        | 6,720      |     | $          | 4,616 |   |
|                                                            |       |     |       |     |       |
| Net noncurrent  deferred income tax liabilities:                |       |     |       |     |       |
| Accumulated  depreciation                                       |       | $        | (3,258     | )        | $          | (2,305 | ) |
| Foreign  subsidiary intangibles                                 |       | 2,039    |       | 2,039    |       |
| Acquired  developed technology                                  |       | 3,277    |       | 1,128    |       |
| Acquired  intangible assets                                     |       | (11,583  | )          | (11,988  | )          |
| Loss on  investments                                            |       | 30       |       | 521      |       |
| Acquired NOL  carryforwards                                     |       | 1,380    |       | 426      |       |
| Capital loss  carryforward                                      |       | 611      |       | —   |       |
| Allowance for  impairment on investments                        |       | 1,445    |       | —   |       |
| Other                                                           |       | (461     | )          | 1,760    |       |
|                                                            |       |     |       |     |       |
|                                                            |       | (6,520   | )          | (8,419   | )          |
| Less valuation  allowance                                       |       | (2,465   | )          | (2,465   | )          |
|                                                            |       |     |       |     |       |
|                                                            |       | $        | (8,985     | )        | $          | (10,884 | ) |

 

The Company has a fullvaluation allowance recorded against a deferred tax asset arising from aforeign subsidiary. The Company intends to fully reserve this asset until it isdetermined that it is more likely than not that the asset can be realizedthrough future taxable income from its acquired foreign operations.

 

It is currently management’s intent to permanentlyreinvest undistributed earnings of approximately $95,575 of its foreignsubsidiaries.  Additionally, because ofthe lack of clarification of certain provisions and the timing of theenactment, the Company continues to evaluate the effect of the American JobsCreation Act of 2004 on its plans for reinvestment or repatriation of foreignearnings.  Should the Company’s intentchange, additional income tax expense would likely be recorded due to thedifferential in tax rates between the U.S. and Ireland.

 

For U.S. Federal income tax purposes, at December 31,2004, the Company has approximately $7,417 of net operating loss carry forwardsavailable to offset future taxable income. These net operating loss carryforwards may be subject to certainlimitations under Internal Revenue Code Section 382.  If not utilized, the net operating loss carryforwards will expire from 2022 to 2024.

 

53

----

 

**11.**                               Stockholders’ Equity

 

**PreferredStock** - TheCompany has 5,000 shares of $0.001 par value preferred stock authorized and noshares issued and outstanding at December 31, 2004 and 2003.

 

**CommonStock** - TheCompany has 200,000 shares of $0.001 par value common stock authorized.  There were 50,332 and 47,350 shares issued atDecember 31, 2004 and 2003, respectively. There were 50,232 and 47,350 shares outstanding at December 31,2004 and 2003, respectively.

 

**TreasuryStock –**TheCompany’s Board of Directors approved a stock re-purchase program during thefourth quarter of 2004 whereby 2,000 of the Company’s shares of common stockcould be purchased from time-to-time on the open market or in negotiatedtransactions.  The Company purchased 100shares during the fourth quarter of 2004 under the approved repurchase program.

 

**12.**                               Earnings Per Share

** **

Asummary of the calculation of basic and diluted earnings per share (EPS) forthe years ended December 31, 2004, 2003 and 2002, is as follows:

 
| ** **                                    | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Earnings  Per-Share** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|---------------------------|------------|-------------------------|------------|
| **For the Year Ended December 31, 2004** |       |                    |       |                      |       |                    |       |
| **Basic EPS**                                 |       |                    |       |                      |       |                    |       |
| Net  income                                   |       | $                       | 18,040     |                      | 48,964     |                    | $          | 0.37 |   |
| **Effect of Dilutive Securities**             |       |                    |       |                      |       |                    |       |
| Stock  options                                |       |                    |       | 1,566                     |       |                    |       |
| **Diluted EPS**                               |       |                    |       |                      |       |                    |       |
| Net  income and assumed conversions           |       | $                       | 18,040     |                      | 50,530     |                    | $          | 0.36 |   |
|                                          |       |                    |       |                      |       |                    |       |
| **For the Year Ended December 31, 2003** |       |                    |       |                      |       |                    |       |
| **Basic EPS**                                 |       |                    |       |                      |       |                    |       |
| Net  income                                   |       | $                       | 38,547     |                      | 46,194     |                    | $          | 0.83 |   |
| **Effect of Dilutive Securities**             |       |                    |       |                      |       |                    |       |
| Stock  options                                |       |                    |       | 1,499                     |       |                    |       |
| **Diluted EPS**                               |       |                    |       |                      |       |                    |       |
| Net  income and assumed conversions           |       | $                       | 38,547     |                      | 47,693     |                    | $          | 0.81 |   |
|                                          |       |                    |       |                      |       |                    |       |
| **For the Year Ended December 31, 2002** |       |                    |       |                      |       |                    |       |
| **Basic EPS**                                 |       |                    |       |                      |       |                    |       |
| Net  income                                   |       | $                       | 10,738     |                      | 44,977     |                    | $          | 0.24 |   |
| **Effect of Dilutive Securities**             |       |                    |       |                      |       |                    |       |
| Stock  options                                |       |                    |       | 572                       |       |                    |       |
| **Diluted EPS**                               |       |                    |       |                      |       |                    |       |
| Net  income and assumed conversions           |       | $                       | 10,738     |                      | 45,549     |                    | $          | 0.24 |   |

 

Anti-dilutiveoptions to purchase common stock outstanding were excluded from thecalculations above.  At December 31,2004, 2003 and 2002, options to purchase 2,440, 1,941 and 5,470 shares ofcommon stock, respectively, were outstanding but were not included in thecomputation of diluted earnings per share because inclusion of such optionswould have been anti-dilutive.

 

**13.**                               Commitments and Contingencies

** **

TheCompany leases buildings and certain equipment under various operating leases.Rent expense under these leases totaled approximately $3,035, $2,559 and $2,882for the years ended December 31, 2004, 2003 and 2002, respectively.  Future minimum rental payments undernon-cancelable operating leases are approximately as follows:

 

| **Years  ending  December 31:** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
| 2005                                 |       | $          | 2,636      |   |
| 2006                                 |       | 1,788      |       |
| 2007                                 |       | 1,625      |       |
| 2008                                 |       | 1,088      |       |
| 2009                                 |       | 202        |       |
| Thereafter                           |       | —     |       |
|                                 |       |       |       |
|                                 |       | $          | 7,339      |   |

 

54

----

 

In the ordinary course of our business, the Company may atany point in time have a significant amount of contractual commitments not yetrecognized in our financial statements. These commitments totaled $26,941 as of December 31, 2004 and areall due within 2005. These commitments relate primarily to Avocent’s need to schedule thepurchase of inventories in advance of the related forecasted sales tocustomers. The Company also has at any point in time a variety of short-termcontractual commitments for services such as advertising, marketing,accounting, legal, and research and development activities. The liabilities forthese services and the related expenses are typically recognized upon thereceipt of the related services.

 

The Company has been involved from time to time in litigationin the normal course of business. Management is not aware of any pending orthreatened litigation matters that will have a material adverse effect on theCompany’s business, operations, financial condition or cash flows (*see Note 18*).

 

**14.**                               Stock Option and Stock Purchase Plans

** **

TheCompany has stock option plans covering substantially all of its employees anddirectors. Avocent assumed the stock option plans and the related underlyingoptions of Apex and Cybex at the merger effective July 1, 2000, of Equinoxat the acquisition effective January 3, 2001, of 2C at the acquisitioneffective August 20, 2002 and of OSA at the acquisition effective April 6,2004. With the exception of the assumed OSA plan, no additional options havebeen or will be granted under these pre-existing plans.

 

Apexhad adopted the Employee Stock Option Plan (the Apex Plan), which provided fornonqualified and incentive stock options for officers, directors and employees.At the time of the merger there were options to purchase 2,775 shares (afterconversion to Avocent options at 1.0905 per outstanding option) of common stockoutstanding under the Apex Plan. Options under the Apex Plan will generallyexpire 10 years from the date of grant, or 5 years in the case of an optioneeowning more than 10% of the voting power of all classes of stock. Purchaseprices for common stock subject to options issued under the Apex Plan generallyapproximate the fair market value of the related shares at the date of grant.Generally, options vest over four years.

 

Cybexhad adopted three plans, including the 1995 Employee Stock Option Plan (thePlan), the 1995 Outside Directors Option Plan (the 1995 Plan), and the 1998Employee Stock Incentive Plan (the 1998 Plan). The 1995 Employee Stock OptionPlan provided for nonqualified and incentive stock options for officers andemployees. At the time of the merger there were options to purchase 1,167shares of common stock outstanding under the Plan. Options under the Plan willgenerally expire 10 years from the date of grant. Purchase prices for commonstock subject to options issued under the Plan generally approximate the fairmarket value of the related shares at the date of grant. Generally, options vestover five years.

 

The1995 Outside Directors Plan provided for nonqualified options for outsidedirectors. At the time of the merger there were options to purchase 37 sharesof common stock outstanding under the 1995 Plan. Options under the 1995 Planwill generally expire 5 years from the date of grant. Purchase prices forcommon stock subject to options issued under the 1995 Plan generallyapproximate the fair market value of the related shares at the date of grant.Options vest and become exercisable immediately upon issuance.

 

The1998 Employee Stock Incentive Plan provided for nonqualified and incentivestock options for officers and employees. At the time of the merger there wereoptions to purchase 1,171 shares of common stock outstanding under the 1998Plan. Options under the 1998 Plan will generally expire 10 years from the dateof grant. Purchase prices for common stock subject to options issued under the1998 Plan generally approximate the fair market value of the related shares atthe date of grant. Generally, options vest over two to five years.

 

Equinoxhad adopted an option plan (the Equinox Plan) that provided for nonqualifiedstock options for officers, directors and employees.  At the time of the acquisition there wereoptions to purchase 675 shares (after conversion to Avocent options at 0.4575per outstanding option) of common stock outstanding under the EquinoxPlan.  Options under this plan generallyexpire 10 years from the date of grant. Purchase prices for common stocksubject to options issued under the Equinox Plan generally approximate the fairmarket value of the related shares at the date of grant. Generally, optionsvest quarterly over four years.

 

2C hadadopted an option plan (the 2C Plan) that provided for nonqualified stock optionsfor officers, directors and employees. At the time of the merger there were options to purchase 152 shares(after conversion to Avocent options at 0.3553 per outstanding option) ofcommon stock outstanding under the 2C Plan. Options under this plan generally expire 10 years from the date ofgrant.

 

55

----

 

Purchaseprices for common stock subject to options issued under the 2C Plan generallyapproximate the fair market value of the related shares at the date of grant.Generally, options vest annually over two years.

 

Avocenthas adopted four additional stock option plans, the 2000 Stock Option Plan (the2000 Plan), the 2000 Transition Nonstatutory Stock Option Plan (the TransitionPlan), the Avocent Corporation 2003 Stock Option Plan (the 2003 Plan), and theAvocent Corporation 2003 Inducement Plan (the Inducement Plan). The 2000 StockOption Plan, which provides for nonqualified and incentive stock options forofficers, directors and employees, reserved a total of 6,000 shares of commonstock for issuance pursuant to the 2000 Plan. Options under the 2000 Plan willgenerally expire 10 years from the date of grant. Purchase prices for commonstock subject to options issued under the 2000 Plan generally approximate thefair market value of the related shares at the date of grant. Generally,options vest over two to four years.

 

The2000 Transition Nonstatutory Stock Option Plan, which provides fornon-qualified and incentive stock options for employees, reserved a total of450 shares of common stock for issuance pursuant to the Transition Plan.Options under the Transition Plan will generally expire 10 years from the dateof grant. Purchase prices for common stock subject to options issued under theTransition Plan generally approximate the fair market value of the relatedshares at the date of grant. Generally, options vest over four years.

 

The2003 Plan, which provides for nonqualified and incentive stock options forofficers, directors and employees, reserved a total of 2,000 shares of commonstock for issuance pursuant to the 2003 Plan. The Inducement Plan, which provides for nonqualified and incentive stockoptions for new employees, reserved a total of 500 shares of common stock forissuance pursuant to the Inducement Plan. Options under the 2003 Plan and the Inducement Plan will generallyexpire 10 years from the date of grant. Purchase prices for common stocksubject to options issued under the 2003 Plan and the Inducement Plan generallyapproximate the fair market value of the related shares at the date of grant.Generally, options vest over two to four years.

 

OSAhad adopted an option plan (the OSA Plan) that provided for incentive optionsand nonqualified stock options for officers, directors and employees.  At the time of the acquisition there wereoptions to purchase 245 shares (after conversion to Avocent options atapproximately 0.038 per outstanding option) of common stock outstanding underthe OSA Plan.  An additional 144 optionswere available for issuance under the OSA plan at the time of theacquisition.  Options under this plangenerally expire 10 years from the date of grant. Purchase prices for commonstock subject to options issued under the OSA Plan generally approximate thefair market value of the related shares at the date of grant. Generally,options vest over four years.

 

Pertinentinformation regarding the Company’s plans is as follows:

 
| ** **                                   | ** ** | **Number of  Options** | ** ** | **Range of  Exercise  Prices** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|----------------------------------------------|------------|------------------------|------------|--------------------------------|------------|----------------------------------------|------------|
| Options  outstanding, December 31, 2001 |       | 7,183                  |       | $ 0.11 – $70.94      |       | $                                      | 26.88      |   |
| Options  assumed upon acquisition of 2C      |       | 152                    |       | $ 14.08                   |       | $                                      | 14.08      |   |
| Options  granted                             |       | 2,022                  |       | $12.86 – $27.30           |       | $                                      | 20.90      |   |
| Options  forfeited and cancelled             |       | (608                   | )          | $ 5.50 – $58.38      |       | $                                      | 36.40      |   |
| Options  exercised                           |       | (808                   | )          | $ 0.11 – $22.85      |       | $                                      | 12.85      |   |
|                                         |       |                   |       |                           |       |                                   |       |
| Options  outstanding, December 31, 2002 |       | 7,941                  |       | $ 0.11 – $70.94      |       | $                                      | 25.82      |   |
| Options  granted                             |       | 1,645                  |       | $21.79 – $38.20           |       | $                                      | 27.65      |   |
| Options  forfeited and cancelled             |       | (201                   | )          | $ 0.11 – $68.56      |       | $                                      | 25.26      |   |
| Options  exercised                           |       | (1,978                 | )          | $ 0.11 – $30.38      |       | $                                      | 16.59      |   |
|                                         |       |                   |       |                           |       |                                   |       |
| Options  outstanding, December 31, 2003 |       | 7,407                  |       | $ 0.11 – $70.94      |       | $                                      | 28.71      |   |
| Options  assumed upon acquisition of OSA     |       | 245                    |       | $ 1.31                    |       | $                                      | 1.31       |   |
| Options  granted                             |       | 1,330                  |       | $25.91 – $41.57           |       | $                                      | 34.28      |   |
| Options  forfeited and cancelled             |       | (111                   | )          | $ 1.28 – $68.56      |       | $                                      | 30.19      |   |
| Options  exercised                           |       | (1,442                 | )          | $ 1.31 – $37.28      |       | $                                      | 17.94      |   |
|                                         |       |                   |       |                           |       |                                   |       |
| Options  outstanding, December 31, 2004 |       | 7,429                  |       | $ 0.11 – $70.94      |       | $                                      | 30.87      |   |

 

Therewere no options with accelerated vesting outstanding as of December 31,2004 or 2003. However, in the first quarter of 2002, the Company allowed sharesissued upon the exercise of certain stock options by a former executive of theCompany to be traded as payment for the cost of the options and relatedtaxes.  Under applicable accountingrules, this cashless exercise required variable plan accounting for theseoptions.  As a result, the Companyrecorded approximately $2,000 of compensation expense in the first quarter of2002.

 

56

----

 

The following table summarizes information about stockoptions outstanding at December 31, 2004:

 
| ** **                   | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                           | ** ** |
|------------------------------|------------|-------------------------|------------|---------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual Life** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Number Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| $ 0.11 - $9.48          |       | 379                     |       | 5.45                                              |       | $ | 4.79 |   | 284 |   | $ | 5.95 |   |
| $ 10.06 - $20.00        |       | 555                     |       | 5.33                                              |       | $ | 14.29 |   | 465 |   | $ | 13.98 |   |
| $ 20.33 - $29.95        |       | 3,864                   |       | 7.59                                              |       | $ | 24.65 |   | 2,173 |   | $ | 23.92 |   |
| $ 30.02 - $44.25        |       | 982                     |       | 8.92                                              |       | $ | 38.48 |   | 228 |   | $ | 38.66 |   |
| $ 46.19 - $70.94        |       | 1,649                   |       | 5.72                                              |       | $ | 52.47 |   | 1,649 |   | $ | 52.47 |   |
|                         |       |                    |       |                                              |       |   |   |   |   |   |   |
|                         |       | 7,429                   |       |                                              |       |   |   | 4,799 |   |   |   |

 

The options above were issued with exercise pricesthat approximated fair value at the date of grant. At December 31, 2004, 1,163shares are available for grant under the Company’s stock option plans.

 

On December 6, 2000, the stockholders approved anemployee stock purchase plan for all Avocent employees (the AESPP), throughwhich qualified employees may participate in common stock ownership. The AESPPqualifies as a non-compensatory plan under Section 423 of the Internal RevenueCode. The Company has reserved 1,500 shares of common stock for issuance under theAESPP. The price of stock purchased under the AESPP is generally 85% of thelower of the fair market value of the common stock (i) at the beginning of theoffering period or (ii) at the end of the purchase period. In the event thefair market value at the end of a purchase period is less than the fair marketvalue at the beginning of the offering period, the participants will bewithdrawn from the current offering period following exercise and automaticallyre-enrolled in a new offering period. The new offering period will use thelower fair market value as of the first date of the new offering period todetermine the purchase price for future purchase periods. The AESPPadministrator administers and interprets all rules and regulations applicableto the AESPP.  Pursuant to the AESPP, 204shares were issued at a weighted average price of $15.76  per share for the year ended December 31,2004, 131 shares were issued at a weighted average price of $13.84 per sharefor the year ended December 31, 2003 and 78 shares were issued at a weightedaverage price of $16.01 per share for the year ended December 31, 2002.

 

**15.**                              Retirement Plans

 

The Company sponsors a 401(k) savings plan coveringsubstantially all U.S. employees and a profit-sharing plan covering substantiallyall international employees.  Under the401(k) savings plan, the Company makes discretionary contributions to match 50%of an employee’s contributions up to 6% of the employee’s compensation. TheCompany may also elect to make additional discretionary contributions asdetermined by its Board of Directors. No discretionary contributions were madeduring the years ended December 31, 2004, 2003 or 2002 under the 401(k) savingsplan. The Company’s expense for contributions under these plans totaled approximately$1,408, $1,072 and $907 for the years ended December 31, 2004, 2003 and 2002,respectively.

 

**16.**                              Segment Reporting

 

The Company has evaluated, and will at least annuallyre-evaluate, its business in light of the segment reporting requirements prescribedby SFAS No. 131, *Disclosures about Segments of an Enterpriseand Related Information.* Avocent has determined that it should report its operations as a singleoperating segment based on the requirements of the SFAS No. 131, including thereview of materials used by the chief operating decision maker to allocateresources and assess the performance of key executives and the functionaldepartments they lead.  However, theCompany supplementally reports sales by geographic region, as well as bycustomer type.  Following is apresentation of sales by geographic region for the years ended December 31,2004, 2003 and 2002:

 

| ** **    | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|---------------|------------|------------|------------|------------|------------|------------|------------|
| Net sales:    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States |       | $          | 216,687    |       | $          | 182,153    |       | $ | 155,589 |   |
| International |       | 148,568    |       | 122,085    |       | 105,011    |       |
|          |       |       |       |       |       |       |       |
|          |       | $          | 365,255    |       | $          | 304,238    |       | $ | 260,600 |   |

 

Following is a presentation of sales by customer typefor the years ended December 31, 2003, 2002 and 2001:

 

57

----

 

| ** ** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------|------------|----------|------------|----------|------------|----------|------------|
| Net sales: |       |     |       |     |       |     |       |
| Branded    |       | $        | 201,308    |     | $          | 164,684  |       | $ | 140,888 |   |
| OEM        |       | 163,947  |       | 139,554  |       | 119,712  |       |
|       |       |     |       |     |       |     |       |
|       |       | $        | 365,255    |     | $          | 304,238  |       | $ | 260,600 |   |
|            |            |          |            |          |            |          |            |  |  |  |  |

** **

**Morethan 90% of the Company’s revenue was derived from its KVM products during eachof 2004, 2003 and 2002.**

** **

**TheCompany sells its products internationally to customers in severalcountries.  Sales to customers in theNetherlands, including the European distribution facility for an OEM customer,accounted for $37,464 of sales in 2004. Sales to customers in the United Kingdom, including sales to theEuropean distribution center of an OEM customer, accounted for $30,334 and$38,559 in 2003 and 2002, respectively. No other country accounted for more than 10% of sales in 2004, 2003 or2002.**

** **

**Asof December 31, 2004, long-lived assets totaled $345,099, which includes$324,417 held in the U.S. and $20,682 held outside of the U.S.  As of December 31, 2003, long-lived assetstotaled $277,925, which includes $267,048 held in the U.S. and $10,877 heldoutside of the U.S.**

** **

**17.**                              Summarized Quarterly Financial Data(Unaudited)

 

The following table presents unaudited quarterlyoperating results for each of the Company’s last eight fiscal quarters. Thisinformation has been prepared by the Company on a basis consistent with theCompany’s audited financial statements and includes all adjustments, consistingonly of normal recurring adjustments, that the Company considers necessary fora fair presentation of the data.
| ** **                             | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **April 1,  2004**     | ** ** | **July 2,  2004** | ** ** | **October 1,  2004** | ** ** | **December 31,  2004** | ** ** |
| Net sales                              |       | $                      | 86,085     |   | $ | 87,796 |   | $ | 91,325 |   | $ | 100,049 |   |
| Gross profit                           |       | $                      | 50,102     |   | $ | 50,600 |   | $ | 53,125 |   | $ | 59,028 |   |
| Income (loss)  from operations (2) (3) |       | $                      | 9,087      |   | $ | (10,795 | ) | $ | 12,613 |   | $ | 18,235 |   |
| Net income  (loss) (2) (3)             |       | $                      | 8,543      |   | $ | (13,392 | ) | $ | 10,822 |   | $ | 12,067 |   |
| Net income  (loss) per share (1):      |       |                   |       |   |   |   |   |   |   |
| Basic                                  |       | $                      | 0.18       |   | $ | (0.27 | ) | $ | 0.22 |   | $ | 0.24 |   |
| Diluted                                |       | $                      | 0.17       |   | $ | (0.27 | ) | $ | 0.21 |   | $ | 0.23 |   |

 
| ** **                  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **March 28,  2003**    | ** ** | **June 27,  2003** | ** ** | **September 26,  2003** | ** ** | **December 31,  2003** | ** ** |
| Net sales                   |       | $                      | 71,162     |   | $ | 70,612 |   | $ | 76,482 |   | $ | 85,982 |   |
| Gross profit                |       | $                      | 39,597     |   | $ | 40,685 |   | $ | 43,573 |   | $ | 47,971 |   |
| Income from  operations (2) |       | $                      | 9,970      |   | $ | 8,751 |   | $ | 14,893 |   | $ | 12,276 |   |
| Net income (2)              |       | $                      | 8,167      |   | $ | 7,345 |   | $ | 13,476 |   | $ | 9,559 |   |
| Net income per  share (1):  |       |                   |       |   |   |   |   |   |   |
| Basic                       |       | $                      | 0.18       |   | $ | 0.16 |   | $ | 0.29 |   | $ | 0.20 |   |
| Diluted                     |       | $                      | 0.17       |   | $ | 0.16 |   | $ | 0.28 |   | $ | 0.20 |   |

 

----

(1)   The net income (loss) per share for eachquarter within a fiscal year does not equal the total net income (loss) per sharefor the particular fiscal year due to variations in the estimated value of theCompany’s Common stock during the year and the effect these variations had onthe shares outstanding calculation.

 

(2)   The loss from operations and net loss forthe quarter ended July 2, 2004 include a non-recurring charge of $21,720 foracquired in-process research and development related to the OSAacquisition.  Similar charges wereincurred in the quarter ended April 1, 2004, for Crystal Link and the quarterended October 1, 2004 for Sonic Mobility totaling $6,490 and $1,050respectively.  The quarter ended December31, 2003 included a similar charge of $3,940 related to Soronti.

 

(3)   The quarter ended December 31, 2004included impairment losses of $3,450 related to its investments in VIEO andRymic.

 

**18.****                               PatentLitigation**

 

In May 2001, the Companyfiled a complaint for patent infringement in the United States District Courtfor the Southern District of New York against Raritan Computer Inc. The Raritancomplaint sought injunctive relief, damages, attorneys’ fees and costs underthree patents.  After a seven day benchtrial in New York in January of 2002, U.S. District Judge Milton

 

58

----

 

Pollack found that therewas no infringement of these patents by Raritan and ordered that judgment beentered in favor of Raritan.

 

In April 2003, the United States Court of Appeals forthe Federal Circuit issued its ruling on the Company’s appeal in this patentlitigation.  The Court of Appeals ruledin the Company’s favor by vacating the non-infringement decision of theDistrict Court for the Southern District of New York and remanding the case forfurther proceedings consistent with the Court of Appeals’ opinion.

 

In September 2003, Raritan petitioned the United States Supreme Court fora Writ of Certiorari to review the Court of Appeals decision.  The Supreme Court declined to review Raritan’spetition in December 2003, and the case was sent back to the United StatesDistrict Court for the Southern District of New York. A Markman hearing onclaims construction was held in February 2005.

 

In October 2003, the Company filed a complaint for patent infringement inthe United States District Court for the Northern District of Alabama againstClearCube Technology, Inc.  The ClearCubecomplaint seeks injunctive relief, damages, attorneys’ fees, and costs underthree Avocent patents. ClearCube has filed counterclaims allegingnon-infringement, unenforceability, invalidity, and misuse of the Avocent patents.A Markman hearing on claims construction was originally set for February 2005,but in response to an inquiry from the Court, the Company recently agreed thatthe hearing should be postponed until the United States Court of Appeals forthe Federal Circuit issues its ruling on the issues raised in an unrelatedpatent case.

 

**19.****                               SubsequentEvents**

 

During the period from January 1, 2005 through March 7,2005, the Company purchased 350,000 additional shares of its common stock onthe open market under its Board approved treasury stock program, for a totalcost of $12,516.  Also during this period,the Company issued 386 additional shares of its common stock pursuant to stockoption exercises and purchases made through its employee stock purchase planfor total proceeds of $7,835.

 

59

----

 

**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 December31, 2004, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures (as defined in Rules13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) areeffective to ensure that information required to be disclosed by us in reportsthat we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in Securities andExchange Commission rules and forms.

 

(b) *Changes in internal controls*.    There were no significant changes in ourinternal controls or in other factors that could significantly affect thesecontrols subsequent to the date of their evaluation, including any correctiveactions with regard to significant deficiencies and material weaknesses.

 

Management’sReport on Internal Control over Financial Reporting and the Report ofIndependent Registered Public Accounting Firm is included in Part II,Item 8 of this Annual Report on Form 10-K.

 

**Item 9B. Other.**

 

None.

 

**PART III**

 

Information withrespect to Items 10 through 14 of this Part III may be found in thedefinitive proxy statement to be delivered to stockholders in connection withthe 2005 Annual Meeting of Stockholders. Such information is incorporatedherein by reference.

 

60

----

 

**PART IV**

 

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

 

**(a)Financial Statement Schedule**

 

**Scheduleof Valuation and Qualifying Accounts**

*For theyears ended December 31, 2004, 2003 and 2002 (in thousands)*

 
| ** **                            | ** ** | **Beginning Balance** | ** ** | **Assumed on  Acquisitions(1)** | ** ** | **Charged to  Income** | ** ** | **Deductions from  Reserves** | ** ** | **Ending Balance** | ** ** |
|---------------------------------------|------------|-----------------------|------------|---------------------------------|------------|------------------------|------------|-------------------------------|------------|--------------------|------------|
|                                  |       |                  |       |                            |       |                   |       |                          |       |               |       |
| Year ended  December 31, 2002:   |       |                  |       |                            |       |                   |       |                          |       |               |       |
| Allowance for  doubtful accounts      |       | $                     | 4,052      |                            | 2          |                   | (119       | )                             | (1,372     | )                  | $          | 2,563 |   |
| Allowance for  other receivables      |       | $                     | 1,772      |                            | —     |                   | (1,772     | )                             | —     |               | $          | — |   |
| Allowance for  inventory obsolescence |       | $                     | 15,279     |                            | 37         |                   | 5,118      |                          | (12,932    | )                  | $          | 7,502 |   |
| Allowance for  sales returns          |       | $                     | 2,607      |                            | —     |                   | 3,145      |                          | (1,983     | )                  | $          | 3,769 |   |
| Liability for  warranty returns       |       | $                     | 4,157      |                            | 12         |                   | 398        |                          | (2,132     | )                  | $          | 2,435 |   |
| Valuation  allowance for income taxes |       | $                     | 2,005      |                            | —     |                   | 34         |                          | —     |               | $          | 2,039 |   |
|                                  |       |                  |       |                            |       |                   |       |                          |       |               |       |
| Year ended  December 31, 2003:   |       |                  |       |                            |       |                   |       |                          |       |               |       |
| Allowance for  doubtful accounts      |       | $                     | 2,563      |                            | —     |                   | (386       | )                             | (186       | )                  | $          | 1,991 |   |
| Allowance for  inventory obsolescence |       | $                     | 7,502      |                            | —     |                   | 1,967      |                          | (5,449     | )                  | $          | 4,020 |   |
| Allowance for  sales returns          |       | $                     | 3,769      |                            | —     |                   | 5,461      |                          | (5,321     | )                  | $          | 3,909 |   |
| Liability for  warranty returns       |       | $                     | 2,435      |                            | —     |                   | 597        |                          | (380       | )                  | $          | 2,652 |   |
| Valuation  allowance for income taxes |       | $                     | 2,039      |                            | 426        |                   | —     |                          | —     |               | $          | 2,465 |   |
|                                  |       |                  |       |                            |       |                   |       |                          |       |               |       |
| Year ended  December 31, 2004:   |       |                  |       |                            |       |                   |       |                          |       |               |       |
| Allowance for  doubtful accounts      |       | $                     | 1,991      |                            | —     |                   | (265       | )                             | 14         |               | $          | 1,740 |   |
| Allowance for inventory  obsolescence |       | $                     | 4,020      |                            | —     |                   | 2,052      |                          | (2,287     | )                  | $          | 3,785 |   |
| Allowance for  sales returns          |       | $                     | 3,909      |                            | —     |                   | 6,366      |                          | (7,101     | )                  | $          | 3,174 |   |
| Liability for  warranty returns       |       | $                     | 2,652      |                            | —     |                   | 528        |                          | (420       | )                  | $          | 2,760 |   |
| Valuation  allowance for income taxes |       | $                     | 2,465      |                            | —     |                   | —     |                          | —     |               | $          | 2,465 |   |

 

----

(1)                                  Amountsrepresent balances assumed from the acquisition of 2C in 2002 and from theacquisition of Soronti in 2003.

 

61

----

 

**(b) Exhibits**

 
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                                                                       | ** ** | **Form**   | ** ** | **Incorporated by Reference** | ** ** | **Included** |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------------------------|------------|--------------|
| **Entity(1)**       | ** ** | **Date**                                                                                                                                                      | ** ** | **Number** |
| 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-K       |       | AVCT                          |       | 3/12/04      |   | Ex. 3.2 |   |   |
| 10.2                |       | Apex Inc. 1995 Employee  Stock Plan                                                                                                                           |       | SB-2       |       | Apex                          |       | 12/12/96     |   | Ex. 10.9 |   |   |
| 10.2.1              |       | Form of Nonstatutory  Stock Option Letter Agreement related to Apex Inc. 1995 Employee Stock Plan                                                             |       | SB-2       |       | Apex                          |       | 12/12/96     |   | Ex. 10.10 |   |   |
| 10.3                |       | Cybex Computer Products  Corporation 1995 Employee Stock Option Plan                                                                                          |       | S-1        |       | Cybex                         |       | 7/26/95      |   | Ex. 10.3 |   |   |
| 10.4                |       | Cybex Computer Products  Corporation 1995 Outside Directors Stock Option Plan                                                                                 |       | S-1        |       | Cybex                         |       | 7/26/95      |   | Ex. 10.4 |   |   |
| 10.5                |       | Cybex Computer Products  Corporation 1998 Employee Stock Incentive Plan                                                                                       |       | 10-K       |       | Cybex                         |       | 6/26/98      |   | Ex. 10.7 |   |   |
| 10.6                |       | Apex Inc. Employee  Stock Purchase Plan                                                                                                                       |       | SB-2       |       | Apex                          |       | 12/12/96     |   | Ex. 10.11 |   |   |
| 10.7                |       | Equinox Systems Inc.  1992 Non-Qualified Stock Option Plan                                                                                                    |       | S-8        |       | AVCT                          |       | 1/23/01      |   | Ex. 4.6 |   |   |
| 10.8                |       | Equinox Systems Inc.  1993 Stock Option Plan                                                                                                                  |       | S-8        |       | AVCT                          |       | 1/23/01      |   | Ex. 4.7 |   |   |
| 10.9                |       | Equinox Systems Inc.  Directors Stock Option Plan                                                                                                             |       | S-8        |       | AVCT                          |       | 1/23/01      |   | Ex. 4.8 |   |   |
| 10.10               |       | Equinox Systems Inc.  2000 Directors Stock Option Plan                                                                                                        |       | S-8        |       | AVCT                          |       | 1/23/01      |   | Ex. 4.9 |   |   |
| 10.11               |       | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Huntsville Corp., the Company, and John R. Cooper        |       | 10-K       |       | AVCT                          |       | 3-12-04      |   | Ex. 10.13 |   |   |
| 10.12               |       | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Huntsville Corp., the Company, and William A. Dambrackas |       | 10-K       |       | AVCT                          |       | 3-12-04      |   | Ex. 10.14 |   |   |
| 10.13               |       | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Huntsville Corp., the Company, and R. Byron Driver  |       | 10-K       |       | AVCT                          |       | 3-12-04      |   | Ex. 10.15 |   |   |
| 10.14               |       | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Huntsville Corp., the Company, and Gary R. Johnson       |       | 10-K       |       | AVCT                          |       | 3-12-04      |   | Ex. 10.16 |   |   |
| 10.15               |       | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  International Ltd., the Company, and Kieran MacSweeney   |       | 10-K       |       | AVCT                          |       | 3-12-04      |   | Ex. 10.17 |   |   |

 

62

----

 
| 10.16 |   | Employment and  Noncompetition Agreement dated January 5, 2004, among Avocent California  Corp., Avocent Huntsville Corp., the Company, and Rick Moore         |   | 10-K       |   | AVCT   |   | 3-12-04 |   | Ex. 10.18   |   |   |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|--------|--------|--------|---------|--------|-------------|--------|--------|
| 10.17 |   | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Texas, L.P., the Company, and C. David Perry    |   | 10-K       |   | AVCT   |   | 3-12-04 |   | Ex. 10.19   |   |   |
| 10.18 |   | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Huntsville Corp., the Company, and Douglas E. Pritchett   |   | 10-K       |   | AVCT   |   | 3-12-04 |   | Ex. 10.20   |   |   |
| 10.19 |   | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Redmond Corp., the Company, and Samuel F. Saracino        |   | 10-K       |   | AVCT   |   | 3-12-04 |   | Ex. 10.21   |   |   |
| 10.20 |   | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Huntsville Corp., the Company, and Christopher Thomas     |   | 10-K       |   | AVCT   |   | 3-12-04 |   | Ex. 10.22   |   |   |
| 10.21 |   | Amended and Restated  Employment and Noncompetition Agreement dated October 10, 2003, among Avocent  Huntsville Corp., the Company, and Doyle C. Weeks         |   | 10-K       |   | AVCT   |   | 3-12-04 |   | Ex. 10.23   |   |   |
| 10.22 |   | 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 |   |   |
| 10.23 |   | Form of Avocent  Corporation Indemnification Agreement for Officers and Directors                                                                              |   | 10-Q       |   | AVCT   |   | 9/29/00 |   | Ex. 10.11   |   |   |
| 10.24 |   | Avocent Corporation  2000 Transition Nonstatutory Stock Option Plan                                                                                            |   | 10-Q       |   | AVCT   |   | 9/29/00 |   | Ex. 10.12   |   |   |
| 10.25 |   | Avocent Corporation  2000 Stock Option Plan                                                                                                                    |   | Sched. 14A |   | AVCT   |   | 11/3/00 |   | App. A      |   |   |
| 10.26 |   | Avocent Corporation  2000 Employee Stock Purchase Plan                                                                                                         |   | Sched. 14A |   | AVCT   |   | 11/3/00 |   | App. B      |   |   |
| 10.27 |   | Avocent Corporation  2003 Employee Stock Option Plan                                                                                                           |   | Sched.14A  |   | AVCT   |   | 4/25/03 |   | Annex B     |   |   |
| 10.28 |   | Avocent Corporation  2003 Inducement Plan                                                                                                                      |   | 10-K       |   | AVCT   |   | 3/12/04 |   | Ex. 10.30   |   |   |
| 10.29 |   | Form of Amendment to  Option Agreement for Directors regarding Change of Control of the Company                                                                |   | 10-K       |   | AVCT   |   | 3/12/04 |   | Ex. 10.31   |   |   |
| 10.30 |   | Fourth Amendment to the  Net Lease Agreement dated October 17, 2002, by and between Avocent’s subsidiary,  Apex Inc., and Willows Redmond, L.L.C.         |   | 10-Q       |   | AVCT   |   | 9/27/02 |   | Ex. 10.37.1 |   |   |
| 21.1  |   | Subsidiaries of Avocent  Corporation                                                                                                                           |   |       |   |   |   |    |   |        |   | X      |
| 23.1  |   | Consent of  PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm                                                                          |   |       |   |   |   |    |   |        |   | X      |
| 24.1  |   | Power of Attorney(3)                                                                                                                                           |   |       |   |   |   |    |   |        |   | X      |

 

63

----

 
| 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; AGI = Aegean Sea Inc. (now known as AvocentCorporation); Apex = Apex Inc. (now Avocent Redmond Corp.); andCybex = Cybex Computer Products Corporation (now Avocent Huntsville Corp.)

 

(2)                                  Confidentialtreatment has previously been requested for portions of these documents.

 

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

 

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

 

On October 21, 2004, we furnished a Report on Form 8-K with the SEC regarding the publicdissemination of a press release announcing the financial results forour third quarter and nine months ended October 1, 2004.

 

On November 1, 2004, we filed a Report on Form 8-K with the SEC regarding the publicdissemination of a press release announcing a stock repurchase programof up to 2,000,000 shares of Common Stock.

 

On December 8, 2004, we filed a Report on Form 8-K with the SEC regarding the publicdissemination of a press release announcing that we expected it incur animpairment charge of up to $3 million during the fourth quarter of 2004 relatedto our stock investment in VIEO, a privately held company.

 

64

----

** **

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d)of the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|   | ** ** | **AVOCENT CORPORATION** | ** **                | ** ** |
|--------|------------|-------------------------|---------------------------|------------|
|   |       | By:                     | /s/ John R. Cooper        |       |   |   |
|   |       |                    | John R. Cooper            |       |   |
|   |       |                    | *Chief Executive Officer* |       |   |
|   |       |                    | Date: March 14, 2005      |       |   |
|        |            |                         |                           |            |  |  |

 

**POWER OFATTORNEY**

 

KNOW ALL PERSONS BY THESE PRESENTS:

 

That the undersigned officers and directors of AvocentCorporation do hereby constitute and appoint Douglas E. Pritchett, Samuel F.Saracino, and Doyle C. Weeks, and each of them, the lawful attorney and agentwith power and authority to do any and all acts and things and to execute anyand all instruments which said attorneys and agents, or either of them,determine may be necessary or advisable or required to enable AvocentCorporation to comply with the Securities Exchange Act of 1934, as amended, andany rules or regulations or requirements of the Securities Exchange Act of1934, as amended, and any rules or regulations or requirements of theSecurities and Exchange Commission in connection with this Form 10-KReport. Without limiting the generality of the foregoing power and authority,the powers granted include the power and authority to sign the names of theundersigned officers and directors in the capacities indicated below to thisForm 10-K Report of amendments or supplements thereto, and each of theundersigned hereby ratifies and confirms all that said attorneys and agents oreither of them, shall do or cause to be done by virtue hereof. This Power ofAttorney may be signed in several counterparts.

 

IN WITNESS WHEREOF, each of the undersigned hasexecuted this Power of Attorney as of the date indicated opposite his name.

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 
| **Signature**              | ** ** | **Title**                                                                              | ** ** | **Date**       |
|----------------------------|------------|----------------------------------------------------------------------------------------|------------|----------------|
|                       |       |                                                                                   |       |           |
| /s/ John R. Cooper         |       | Chief Executive Officer and Chairman of the Board  of Directors                        |       | March 14, 2005 |
| John R. Cooper             |       | (Principal Executive Officer)                                                          |       |           |
|                       |       |                                                                                   |       |           |
| /s/ Douglas E.  Pritchett  |       | Executive Vice President of Finance, Chief  Financial Officer, and Assistant Secretary |       |           |
| Douglas E. Pritchett       |       | (Principal Financial Officer)                                                          |       | March 14, 2005 |
|                       |       |                                                                                   |       |           |
| /s/ Edward H.  Blankenship |       | Vice President of Accounting and Chief  Accounting Officer                             |       | March 14, 2005 |
| Edward H. Blankenship      |       | (Principal Accounting Officer)                                                         |       |           |
|                       |       |                                                                                   |       |           |
| /s/ Harold D. Copperman    |       | Director                                                                               |       | March 14, 2005 |
| Harold D. Copperman        |       |                                                                                   |       |           |
|                       |       |                                                                                   |       |           |
| /s/ Francis A. Dramis, Jr. |       | Director                                                                               |       | March 14, 2005 |
| Francis A. Dramis, Jr.     |       |                                                                                   |       |           |
|                       |       |                                                                                   |       |           |
| /s/ Edwin L. Harper        |       | Director                                                                               |       | March 14, 2005 |
| Edwin L. Harper            |       |                                                                                   |       |           |
|                       |       |                                                                                   |       |           |
| /s/ William H. McAleer     |       | Director                                                                               |       | March 14, 2005 |
| William H. McAleer         |       |                                                                                   |       |           |
|                       |       |                                                                                   |       |           |
| /s/ Stephen F. Thornton    |       | Director                                                                               |       | March 14, 2005 |
| Stephen F. Thornton        |       |                                                                                   |       |           |

 

65

----

 
| /s/ David P. Vieau |   | Director               |   | March 14, 2005 |
|--------------------|--------|------------------------|--------|----------------|
| David P. Vieau     |   |                   |   |           |
|               |   |                   |   |           |
| /s/ Doyle C. Weeks |   | President and Director |   | March 14, 2005 |
| Doyle C. Weeks     |   |                   |   |           |

 

66

----