** **

**U.S. SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

** **

# **FORM 10-Q**

# ** **

| **(Mark  One)**                                                                                                                                         |                                                                                                |
|---------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------|
|                                                                                                                                                    |                                                                                                |
| **ý**                                                                                                                                              | **Quarterly  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**  |
|                                                                                                                                                    |                                                                                                |
| **For the quarterly period ended October 1, 2004  or**                                                                                             |
|                                                                                                                                                    |                                                                                                |
| **o**                                                                                                                                                   | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|                                                                                                                                                    |                                                                                                |
| **For the period from             to            /** |
|                                                                                                                                                    |                                                                                                |
| **Commission file number: 000-30575**                                                                                                                   |

 

**AVOCENTCORPORATION**

(Exact Name of Registrant asSpecified in Its Charter)

 
| **Delaware**                                                    | ** ** | **91-2032368**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or  Other Jurisdiction of Incorporation or Organization) |       | (I.R.S.  Employer Identification Number) |
|                                                            |       |                                     |
| **4991 Corporate Drive  Huntsville, Alabama**                   | ** ** | **35805**                                |
| (Address of  Principal Executive Offices)                       |       | (Zip Code)                               |
|                                                            |       |                                     |
| **256-430-4000**                                                |
| (Registrant’s  Telephone Number, Including Area Code)      |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934, as amended, during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports) and (2) has been subject to such filing requirements for the past 90days.

 

ýYes  oNo

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended).

 

ýYes  oNo

 

As of November 5, 2004, the number ofoutstanding shares of the Registrant’s Common Stock was 49,823,291.

 

 

----

 

**AVOCENTCORPORATION**

**FORM 10-Q**

**October 1,2004**

 

**INDEX**

 
| Part I     |   | Financial Information |   |
|------------|--------|-----------------------|--------|
|       |   |                  |   |   |   |
|       |   | Item 1.               |   | Financial Statements (unaudited) |   |
|       |   |                  |   |   |   |
|       |   |                  |   | Condensed Consolidated Statements of  Operations for the Three and Nine Months Ended October 1, 2004 and September 26,  2003 |   |
|       |   |                  |   | Condensed Consolidated Balance Sheets at October 1,  2004 and December 31, 2003 |   |
|       |   |                  |   | Condensed Consolidated Statements of Cash  Flows for the Nine Months Ended October 1, 2004 and September 26,  2003 |   |
|       |   |                  |   | Notes to Condensed Consolidated Financial  Statements |   |
|       |   |                  |   |   |   |
|       |   | Item 2.               |   | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|       |   |                  |   |   |   |
|       |   | Item 3.               |   | Quantitative and Qualitative Disclosures  about Market Risks |   |
|       |   |                  |   |   |   |
|       |   | Item 4.               |   | Controls and Procedures |   |
|       |   |                  |   |   |   |
| Part II    |   | Other Information     |   |
|       |   |                  |   |   |   |
|       |   | Item 1.               |   | Legal Proceedings |   |
|       |   |                  |   |   |   |
|       |   | Item 6.               |   | Exhibits |   |
|       |   |                  |   |   |   |
| Signatures |   |
|            |        |                       |        |  |  |  |  |  |

 

2

----

 

**Item1.  Financial Statements**

 

**AVOCENTCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited, in thousands,except per share data)

#### ** **

| ** **                                                     | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|----------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                     | ** ** | **October 1,  2004**      | ** ** | **September 26,  2003**  | ** ** | **October 1,  2004** | ** ** | **September 26,  2003** | ** ** |
|                                                           |       |                           |       |                          |       |   |   |   |   |
| Net sales                                                      |       | $                              | 91,325     |                          | $          | 76,482 |   | $ | 265,206 |   | $ | 218,256 |   |
| Cost of  sales                                                 |       | 38,200                         |       | 32,909                        |       | 111,379 |   | 94,401 |   |
| Gross profit                                                   |       | 53,125                         |       | 43,573                        |       | 153,827 |   | 123,855 |   |
|                                                           |       |                           |       |                          |       |   |   |   |   |
| Research and  development expenses                             |       | 11,774                         |       | 7,103                         |       | 32,428 |   | 21,569 |   |
| Acquired  in-process research and development expense          |       | 1,050                          |       | —                        |       | 29,260 |   | — |   |
| Selling,  general and administrative expenses                  |       | 21,206                         |       | 16,838                        |       | 63,578 |   | 51,621 |   |
| Amortization  of intangible assets                             |       | 6,482                          |       | 4,739                         |       | 17,656 |   | 17,051 |   |
| Total operating  expenses                                      |       | 40,512                         |       | 28,680                        |       | 142,922 |   | 90,241 |   |
|                                                           |       |                           |       |                          |       |   |   |   |   |
| Income from  operations                                        |       | 12,613                         |       | 14,893                        |       | 10,905 |   | 33,614 |   |
|                                                           |       |                           |       |                          |       |   |   |   |   |
| Net  investment income                                         |       | 1,297                          |       | 1,182                         |       | 3,594 |   | 3,689 |   |
| Net realized  investment gains (losses)                        |       | (101                           | )          | 3,014                         |       | (269 | ) | 2,804 |   |
| Other income  (expense), net                                   |       | 26                             |       | 1                             |       | (122 | ) | (417 | ) |
|                                                           |       |                           |       |                          |       |   |   |   |   |
| Income  before provision for income taxes                      |       | 13,835                         |       | 19,090                        |       | 14,108 |   | 39,690 |   |
| Provision  for income taxes                                    |       | 3,013                          |       | 5,614                         |       | 8,135 |   | 10,701 |   |
|                                                           |       |                           |       |                          |       |   |   |   |   |
| Net income                                                     |       | $                              | 10,822     |                          | $          | 13,476 |   | $ | 5,973 |   | $ | 28,989 |   |
|                                                           |       |                           |       |                          |       |   |   |   |   |
| Earnings per  share:                                           |       |                           |       |                          |       |   |   |   |   |
| Basic                                                          |       | $                              | 0.22       |                          | $          | 0.29 |   | $ | 0.12 |   | $ | 0.63 |   |
| Diluted                                                        |       | $                              | 0.21       |                          | $          | 0.28 |   | $ | 0.12 |   | $ | 0.61 |   |
|                                                           |       |                           |       |                          |       |   |   |   |   |
| Weighted  average shares used in computing earnings per share: |       |                           |       |                          |       |   |   |   |   |
| Basic                                                          |       | 49,323                         |       | 46,347                        |       | 48,663 |   | 45,900 |   |
| Diluted                                                        |       | 50,502                         |       | 47,770                        |       | 50,283 |   | 47,261 |   |

 

See notes accompanying thesecondensed consolidated financial statements

 

3

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**AVOCENTCORPORATION**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

(Unaudited, in thousands,except per share data)

 
| ** **                                                                                                                                                                        | ** ** | **October 1,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                        |       |                      |       |                        |       |
| **ASSETS**                                                                                                                                                                        |       |                      |       |                        |       |
| Current  assets:                                                                                                                                                                  |       |                      |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                        |       | $                         | 52,518     |                        | $          | 76,492 |   |
| Investments  maturing within one year                                                                                                                                             |       | 161,690                   |       | 146,900                     |       |
| Accounts  receivable, net                                                                                                                                                         |       | 55,664                    |       | 45,011                      |       |
| Inventories,  net                                                                                                                                                                 |       | 21,075                    |       | 21,324                      |       |
| Other  current assets                                                                                                                                                             |       | 5,949                     |       | 4,891                       |       |
| Deferred tax  assets                                                                                                                                                              |       | 6,751                     |       | 4,616                       |       |
| Total  current assets                                                                                                                                                             |       | 303,647                   |       | 299,234                     |       |
| Investments                                                                                                                                                                       |       | 85,299                    |       | 82,884                      |       |
| Property  held for lease, net                                                                                                                                                     |       | 1,379                     |       | 1,526                       |       |
| Property and  equipment, net                                                                                                                                                      |       | 39,792                    |       | 38,473                      |       |
| Goodwill                                                                                                                                                                          |       | 268,035                   |       | 206,037                     |       |
| Other  intangible assets, net                                                                                                                                                     |       | 40,598                    |       | 31,889                      |       |
| Other assets                                                                                                                                                                      |       | 837                       |       | 720                         |       |
|   Total  assets                                                                                                                                                         |       | $                         | 739,587    |                        | $          | 660,763 |   |
|                                                                                                                                                                              |       |                      |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                    |       |                      |       |                        |       |
| Current  liabilities:                                                                                                                                                             |       |                      |       |                        |       |
| Accounts  payable                                                                                                                                                                 |       | $                         | 7,849      |                        | $          | 10,034 |   |
| Accrued  wages and commissions                                                                                                                                                    |       | 9,434                     |       | 9,120                       |       |
| Accrued  liabilities                                                                                                                                                              |       | 17,924                    |       | 16,866                      |       |
| Income taxes  payable                                                                                                                                                             |       | 13,239                    |       | 6,702                       |       |
| Total  current liabilities                                                                                                                                                        |       | 48,446                    |       | 42,722                      |       |
| Other  liabilities                                                                                                                                                                |       | 477                       |       | —                      |       |
| Deferred tax  liabilities                                                                                                                                                         |       | 10,584                    |       | 10,884                      |       |
| Total  liabilities                                                                                                                                                                |       | 59,507                    |       | 53,606                      |       |
|                                                                                                                                                                              |       |                      |       |                        |       |
| Commitments  and contingencies                                                                                                                                                    |       |                      |       |                        |       |
|                                                                                                                                                                              |       |                      |       |                        |       |
| Stockholders’  equity:                                                                                                                                                       |       |                      |       |                        |       |
| Preferred  stock, $0.001 par value; 5,000 shares authorized, no shares issued and  outstanding as of October 1, 2004 and December 31, 2003,  respectively               |       | —                    |       | —                      |       |
| Common  stock, $0.001 par value; 200,000 shares authorized, 49,212 and 47,350 shares  issued and outstanding as of October 1, 2004 and December 31, 2003,  respectively |       | 49                        |       | 47                          |       |
| Additional  paid-in capital                                                                                                                                                       |       | 1,051,305                 |       | 982,218                     |       |
| Accumulated  other comprehensive income                                                                                                                                           |       | 153                       |       | 227                         |       |
| Deferred  compensation                                                                                                                                                            |       | (3,508                    | )          | (1,443                      | )          |
| Accumulated  deficit                                                                                                                                                              |       | (367,919                  | )          | (373,892                    | )          |
| Total  stockholders’ equity                                                                                                                                                  |       | 680,080                   |       | 607,157                     |       |
| Total  liabilities and stockholders’ equity                                                                                                                                  |       | $                         | 739,587    |                        | $          | 660,763 |   |

 

See notes accompanying thesecondensed consolidated financial statements.

 

4

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**AVOCENTCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited, in thousands)

 
| ** **                                                                         | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                         | ** ** | **October 1,  2004**     | ** ** | **September 26,  2003** | ** ** |
|                                                                               | * *   | * *                      | * *   | * * | * * |
| Cash flows  from operating activities:                                             | * *   | * *                      | * *   | * * | * * |
| Net income:                                                                        |       | $                             | 5,973      |   | $ | 28,989 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                          |       |   |   |
| Depreciation                                                                       |       | 4,565                         |       | 3,445 |   |
| Amortization  of intangible assets                                                 |       | 17,656                        |       | 17,051 |   |
| Stock-based  compensation                                                          |       | 4,286                         |       | 3,994 |   |
| Acquired  in-process research and development expenses                             |       | 29,260                        |       | — |   |
| Amortization  of premiums on investments                                           |       | 2,660                         |       | 2,574 |   |
| Net (gain)  loss on sales of investments                                           |       | 269                           |       | (2,804 | ) |
| Income tax  benefit from exercise of stock options                                 |       | 2,510                         |       | 5,537 |   |
| Changes in  operating assets and liabilities (net of effects of acquisitions):     |       |                          |       |   |   |
| Accounts  receivable, net                                                          |       | (10,384                       | )          | (11,074 | ) |
| Inventories,  net                                                                  |       | 395                           |       | 3,893 |   |
| Other assets                                                                       |       | 142                           |       | (1,270 | ) |
| Accounts  payable                                                                  |       | (2,769                        | )          | 622 |   |
| Accrued  wages and commissions                                                     |       | (578                          | )          | (413 | ) |
| Accrued  liabilities                                                               |       | 274                           |       | 1,020 |   |
| Income  taxes, current and deferred                                                |       | (3,027                        | )          | (307 | ) |
| Net cash  provided by operating activities                                         |       | 51,232                        |       | 54,257 |   |
| ** **                                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| Cash flows  from investing activities:                                             |       |                          |       |   |   |
| Purchase of  Sonic Mobility, net of cash received                                  |       | (9,141                        | )          | — |   |
| Purchase of  OSA, net of cash received (1)                                         |       | (47,179                       | )          | — |   |
| Purchase of  Crystal Link, net of cash received (1)                                |       | (3,311                        | )          | — |   |
| Purchases of  property and equipment                                               |       | (5,377                        | )          | (15,447 | ) |
| Purchases of  investments                                                          |       | (212,883                      | )          | (157,858 | ) |
| Proceeds  from sales and maturities of investments                                 |       | 192,555                       |       | 98,479 |   |
| Net cash  used in investing activities                                             |       | (85,336                       | )          | (74,826 | ) |
| ** **                                                                         | ** ** | ** **                    | ** ** | ** ** | ** ** |
| Cash flows  from financing activities:                                             | ** ** | ** **                    | ** ** | ** ** | ** ** |
| Repayment of  debt assumed at the acquisition of Crystal Link                      |       | (1,798                        | )          | — |   |
| Proceeds  from employee stock option exercises                                     |       | 8,598                         |       | 16,215 |   |
| Proceeds  from employee stock purchase plan                                        |       | 3,211                         |       | 1,809 |   |
| Net cash  provided by financing activities                                         |       | 10,011                        |       | 18,024 |   |
|                                                                               |       |                          |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                      |       | 119                           |       | 110 |   |
|                                                                               |       |                          |       |   |   |
| Net decrease  in cash and cash equivalents                                         |       | (23,974                       | )          | (2,435 | ) |
| Cash and  cash equivalents at beginning of period                                  |       | 76,492                        |       | 61,699 |   |
| Cash and  cash equivalents at end of period                                        |       | $                             | 52,518     |   | $ | 59,264 |   |

 

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

 

See notes accompanying thesecondensed consolidated financial statements.

 

5

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**AVOCENT CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, in thousands)

 

Note 1.          Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in conformity with generally accepted accounting principlesand reflect all adjustments consisting of normal recurring adjustments which,in the opinion of management, are necessary for a fair presentation of theresults for the three and nine months ended October 1, 2004 and September 26,2003.  The results of operations forthese periods are not necessarily indicative of the results expected for thefull fiscal year or for any future periods. The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates and assumptions.

 

The accompanying unaudited condensed consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements and the related notes contained in our Annual Report on Form 10-Kfor the year ended December 31, 2003, which is on file with the Securitiesand Exchange Commission and is available at our website, www.avocent.com. Thebalance sheet presented in the accompanying financial statements for December 31,2003, was derived from the audited financial statements filed in our 10-K forthe period ended December 31, 2003.

 

We report our annual results based on years ending December 31.  We report our quarterly results for the firstthree interim periods based on 13 week periods ending on Fridays and for thefourth interim period ending on December 31.

 

Our financial statements are consolidated and include the accounts ofAvocent Corporation and our wholly owned subsidiaries.  Significant inter-company transactions andbalances have been eliminated in consolidation.

 

Note 2.          Inventories

 

Inventoriesconsisted of the following at:

 
| ** **        | ** ** | **October 1,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **        | ** ** | ** **                | ** ** | ** **                  | ** ** |
| Raw  materials    |       | $                         | 4,857      |                        | $          | 4,155 |   |
| Work-in-process   |       | 523                       |       | 659                         |       |
| Finished  goods   |       | 15,695                    |       | 16,510                      |       |
| Inventories,  net |       | $                         | 21,075     |                        | $          | 21,324 |   |

 

Inventories above have been reduced by reserves for excess and obsoleteinventories of $4,081 and $4,020 as of October 1, 2004 and December 31,2003, respectively.

 

Note 3.          StockOptions and Deferred Compensation

 

Deferred compensation — We recorded $41,165 of deferredcompensation related to Cybex employee stock options at the time of the mergerof Apex and Cybex on July 1, 2000, $2,752 of deferred compensation relatedto the Equinox employee stock options at the time of the acquisition on January 3,2001 and $6,350 of deferred compensation related to the OSA employee stockoptions at the time of the acquisition on April 6, 2004.  The deferred compensation is being amortizedover the vesting period of the options for which it was recorded. Amortizationof deferred compensation totaled $1,421 for the three months ended October 1,2004 and $769 for the three months ended and September 26, 2003.  Amortization of deferred compensation totaled$4,286 for the nine months ended October 1, 2004 and $3,994 for the ninemonths ended September 27, 2003.

 

Stock optionexercises — Shares of our common stock issued as a result of option exercisestotaled 492 shares during the nine months ended October 1, 2004 and 1,124shares during the nine months ended September 26, 2003.  Total proceeds received from these optionexercises were $8,598 for the nine months ended October 1, 2004 and$16,215 for the nine months ended September 26, 2003. Common stock issuedunder our Employee Stock Purchase Plan totaled 204 shares during the ninemonths ended October 1, 2004 and 131 shares during the nine months ended September 26,2003.  Total proceeds received from theshares issued under the ESPP were $3,211 for the nine months ended October 1,2004 and $1,809 

 

6

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for the nine months ended September 26,2003.

 

Note 4.          AccumulatedOther Comprehensive Income

 

Werecord, net of tax, unrealized gains and losses on our foreign currencytranslation adjustments and unrealized holding gains or losses on ouravailable-for-sale securities as accumulated other comprehensive income, whichis included as a separate component of stockholders’ equity.  Comprehensive income for the first ninemonths of 2004 of $5,900 consists of $5,973 of net income, $193 of unrealizedlosses on investments (net of deferred income taxes) and $119 of foreigncurrency translation gain (net of deferred income taxes).  Comprehensive income for the firstnine months of 2003 of $29,194 consists of $28,989 of net income, $95 ofunrealized gains on investments (net of deferred income taxes) and $110 offoreign currency translation gain (net of deferred income taxes).  As of October 1, 2004 and December 31,2003, total accumulated other comprehensive income was $153 and $227,respectively.

 

Note 5.          Earningsper Share

 
| ** **                                                           | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per-Share  Amount** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|---------------------------|------------|-----------------------|------------|
| ** **                                                           | ** ** | ** **              | ** ** | ** **                | ** ** | ** **            | ** ** |
| **For the  three months ended October 1, 2004**                 |       |                    |       |                      |       |                  |       |
| **Basic  EPS**                                                       |       |                    |       |                      |       |                  |       |
| Net income  available to common stockholders                         |       | $                       | 10,822     |                      | 49,323     |                  | $          | 0.22 |   |
| **Effect  of Dilutive Securities**                                   |       |                    |       |                      |       |                  |       |
| Stock  options                                                       |       | —                  |       | 1,179                     |       | —                |       |
| **Diluted  EPS**                                                     |       |                    |       |                      |       |                  |       |
| Net income  available to common stockholders and assumed conversions |       | $                       | 10,822     |                      | 50,502     |                  | $          | 0.21 |   |
|                                                                 |       |                    |       |                      |       |                  |       |
| **For the  three months ended September 26, 2003**              |       |                    |       |                      |       |                  |       |
| **Basic  EPS**                                                       |       |                    |       |                      |       |                  |       |
| Net income  available to common stockholders                         |       | $                       | 13,476     |                      | 46,347     |                  | $          | 0.29 |   |
| **Effect  of Dilutive Securities**                                   |       |                    |       |                      |       |                  |       |
| Stock  options                                                       |       | —                  |       | 1,423                     |       | —                |       |
| **Diluted  EPS**                                                     |       |                    |       |                      |       |                  |       |
| Net income  available to common stockholders and assumed conversions |       | $                       | 13,476     |                      | 47,770     |                  | $          | 0.28 |   |
|                                                                 |       |                    |       |                      |       |                  |       |   |   |
| **For the  nine months ended October 1, 2004**                  |       |                    |       |                      |       |                  |       |
| **Basic  EPS**                                                       |       |                    |       |                      |       |                  |       |
| Net income  available to common stockholders                         |       | $                       | 5,973      |                      | 48,663     |                  | $          | 0.12 |   |
| **Effect  of Dilutive Securities**                                   |       |                    |       |                      |       |                  |       |
| Stock  options                                                       |       | —                  |       | 1,620                     |       | —                |       |
| **Diluted  EPS**                                                     |       |                    |       |                      |       |                  |       |
| Net income  available to common stockholders and assumed conversions |       | $                       | 5,973      |                      | 50,283     |                  | $          | 0.12 |   |
| ** **                                                           | ** ** | ** **              | ** ** | ** **                | ** ** | ** **            | ** ** |
| **For the  nine months ended September 26, 2003**               |       |                    |       |                      |       |                  |       |
| **Basic  EPS**                                                       |       |                    |       |                      |       |                  |       |
| Net income  available to common stockholders                         |       | $                       | 28,989     |                      | 45,900     |                  | $          | 0.63 |   |
| **Effect  of Dilutive Securities**                                   |       |                    |       |                      |       |                  |       |
| Stock  options                                                       |       | —                  |       | 1,361                     |       | —                |       |
| **Diluted  EPS**                                                     |       |                    |       |                      |       |                  |       |
| Net income  available to common stockholders and assumed conversions |       | $                       | 28,989     |                      | 47,261     |                  | $          | 0.61 |   |

 

Anti-dilutive options to purchase commonstock outstanding were excluded from the calculations above.  Anti-dilutive options totaled 2,656 and 2,428for the three and nine months ended October 1, 2004, respectively.  Anti-dilutive options totaled 1,955 and 2,278for the three and nine months ended September 26, 2003, respectively.

 

7

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Note 6.          Salesby Geographic Region

 

We haveevaluated, and will periodically re-evaluate, our business in light of thesegment reporting requirements prescribed by SFAS No. 131, *Disclosuresabout Segments of an Enterprise and Related Information.*  We have determined that we should report ouroperations as a single operating segment. However, we supplementally report sales by geographic region, as well asby customer type.  Following is apresentation of sales by geographic region and by customer type for the threeand nine months ended October 1, 2004 and September 26, 2003:

 
| ** **         | ** ** | **For the Three Months  Ended** | ** ** | **For the Nine Months  Ended** | ** ** |
|--------------------|------------|---------------------------------|------------|--------------------------------|------------|
| ** **         | ** ** | **Oct. 1,  2004**               | ** ** | **Sept. 26,  2003**            | ** ** | **Oct. 1,  2004** | ** ** | **Sept. 26,  2003** | ** ** |
| ** **         | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales:         | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| United  States     |       | $                               | 56,026     |                           | $          | 48,870 |   | $ | 160,076 |   | $ | 135,361 |   |
| Rest of the  World |       | 35,299                          |       | 27,612                         |       | 105,130 |   | 82,895 |   |
|               |       | $                               | 91,325     |                           | $          | 76,482 |   | $ | 265,206 |   | $ | 218,256 |   |

 
| ** ** | ** ** | **For the Three Months  Ended** | ** ** | **For the Nine Months  Ended** | ** ** |
|------------|------------|---------------------------------|------------|--------------------------------|------------|
| ** ** | ** ** | **Oct. 1,  2004**               | ** ** | **Sept. 26  2003**             | ** ** | **Oct. 1,  2004** | ** ** | **Sept. 26  2003** | ** ** |
| ** ** | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales: | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Branded    |       | $                               | 49,170     |                           | $          | 43,117 |   | $ | 149,869 |   | $ | 119,989 |   |
| OEM        |       | 42,155                          |       | 33,365                         |       | 115,337 |   | 98,267 |   |
|       |       | $                               | 91,325     |                           | $          | 76,482 |   | $ | 265,206 |   | $ | 218,256 |   |

 

We sell ourproducts internationally to customers in several countries. Sales to customersin the Netherlands, including the European distribution facility for one of ourOEM customers, accounted for 10% of sales in the first nine months of2004.  Sales to customers in the UnitedKingdom, including the European distribution facility for one of our OEMcustomers, accounted for 11% of sales in the first nine months of 2003.  No other country accounted for more than 10%of sales in the first nine months of either 2004 or 2003.

 

**As of October 1,2004, long-lived assets totaled $349,804, which includes $336,918 held in theU.S. and $12,886 held outside of the U.S. As of December 31, 2003, long-lived assets totaled $277,925, whichincludes $267,048 held in the U.S. and $10,877 held outside of the U.S.**

** **

**Note 7.**          Acquisitions of Sonic MobilityInc., OSA Technologies, Inc. and Crystal Link Technologies

** **

**SonicMobility Inc.**

 

On August 31,2004, we acquired all of the outstanding stock of Sonic Mobility Inc. (SonicMobility), headquartered in Calgary, Canada. Sonic Mobility has developed (i)software solutions that allow for management of network and data centerinfrastructure from mobile devices, (ii) security software for intranet andextranet resource access from mobile handheld devices and (iii) softwaresolutions for managing mobile devices centrally by IT administrators. Ourcurrent management solutions primarily provide management and access solutionsfor fixed place IT devices.  The additionof Sonic Mobility’s proprietary products expands our markets to include bothintegrated and stand-alone solutions for the expanding mobile IT device market.The results of Sonic Mobility’s operations have been included in theconsolidated financial statements since the date of acquisition.

 

Theacquisition was recorded under the purchase method of accounting, and thepurchase price was allocated based on the fair value of the assets acquired andliabilities assumed. In accordance with generally accepted accountingprinciples, purchased research and development costs allocated topatent-pending technology were capitalized and will be amortized over therespective estimated useful lives.  Theremaining amounts of purchased research and development were expensed upon the

 

8

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closing of the transaction.  The goodwill recorded as a result of theacquisition will not be amortized but will be included in our review ofgoodwill for impairment. The goodwill is amortizable for tax purposes.  A summary of the total purchaseconsideration, excluding cash received, is as follows:

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

 

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

 

The purchase consideration wasallocated, on a preliminary basis, to the estimated fair values of the assetsacquired 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      |                     |       |   |

 

The fair value of all of thein-process research and development (“IPR&D”) received in the acquisitionwas determined using a form of the discounted cash flow method known as themulti-period excess earnings method. These amounts were deemed to be for particular research and developmentprojects that have no alternative future uses and were therefore expensedrather than capitalized at the time of purchase.

 

Sonic Mobility’s in-process researchand development activities consisted of an upgrade of its Sonic Sentry product,software that allows for managing mobile devices centrally by ITadministrators.  The upgrade will rollout in two stages, one in the fall of 2004 and the second in 2005.  These projects were still in process at theend of the third quarter of 2004.

 

The new generation of Sonic Sentryupgrades under development is 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 over 90% ofSonic Mobility’s forecasted revenue in 2006 coming from projects currently indevelopment.  Net income attributable toIPR&D was calculated by applying Sonic Mobility’s projected gross,operating and net profit margins to IPR&D revenue, while consideringAvocent’s historical results and industry prospects.

 

Revenue growth related to thein-process research and development is embodied in products to be launched inlate 2004 and during 2005. The Sonic Sentry product has an estimated economiclife of approximately nine years. The product life cycle is characterized by a4 to 5 year ramp up period, followed by a 2 to 3 year plateau, followed by a 1to 2 year decline period. Operating margins are projected to be well abovehistorical Avocent margins as these products are primarily software. Thediscount rate used to value IPR&D was 41%.

 

**OSATechnologies, Inc.**

 

On April 6,2004, we acquired the outstanding stock of OSA Technologies, Inc. (“OSA”).  OSA is headquartered in

 

9

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San Jose, California and has additionaloffices in Shanghai, China and Taipei, Taiwan. OSA has developed embeddedmanageability firmware and software using Intelligent Platform ManagementInterface (“IPMI”) solutions. The acquisition of OSA will enhance our positionin the embedded management market and OSA’s embedded management solutions forthe IPMI market complements our core KVM business and builds upon prioracquisitions.  The results of OSA’soperations have been included in the consolidated financial statements sincethe date of acquisition.

 

Theacquisition was recorded under the purchase method of accounting, and thepurchase price was allocated based on the fair value of the assets acquired andliabilities assumed. In accordance with generally accepted accountingprinciples, purchased research and development costs allocated topatent-pending technology were capitalized and will be amortized over therespective estimated useful lives.  Theremaining amounts of purchased research and development were expensed upon theclosing of the transaction.  The goodwillrecorded as result of the acquisition will not be amortized but will beincluded in our review of goodwill for impairment. Additionally, the goodwillrecorded upon the OSA acquisition 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 vestedOSA options at the date of consummation have been included in the purchase consideration.A summary of the total purchase consideration, excluding cash received, is asfollows:

 
| 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 |   |

 

We 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, we acquired $5,618in cash held by OSA.

 

The purchase consideration wasallocated, on a preliminary basis, to the estimated fair values of the assetsacquired 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,we recorded $6,350 of deferred compensation related to the unvested OSAemployee stock options at the time of the acquisition on April 6,2004.  The deferred compensation is beingamortized straight-line over the vesting period of the options for which it wasrecorded.

 

The fair value of all of thein-process research and development (“IPR&D”) received in the acquisitionwas determined using a form of the discounted cash flow method known as themulti-period excess earnings method. These amounts were deemed to be for particular research and developmentprojects that have no alternative future uses and were therefore expensedrather than capitalized at the time of purchase.

 

10

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OSA’s in-process research anddevelopment activities consisted of an upgrade of its Firmware Suite to Version2.0 and an embedded server management product. The status of these projects varied, however, it is anticipated that theproducts will be completed during 2005 and 2006.  These projects were still in process at theend of the third quarter of 2004.

 

The new generations of products underdevelopment are projected to sell through sales channels and to customers thatare substantially the same as current and historical sales channels andcustomers. Pricing and margins will not differ significantly from historicalpricing and margins.  Revenue for theprojects 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 to thein-process research and development is embodied in products to be launchedduring 2005. 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. Operating margins are projected to be wellabove historical Avocent margins as these products are primarily software. Thediscount rate used to value IPR&D was 24%.

 

**CrystalLink Technologies**

** **

**On January 6,2004, we acquired the outstanding common shares of Crystal Link Technologies (“CrystalLink”) for approximately $6,652 in cash and common stock, plus the assumptionof liabilities 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, we paid $2,000 of theearn-out consideration based on achieving the specified technologyenhancements.  The remaining $3,000 ofpotential earn-out consideration will not be paid as the goals specified werenot met.  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 wireless technology for KVMswitching and extension products, which is incorporated into our LongViewWireless product.**

** **

Theacquisition was recorded under the purchase method of accounting, and thepurchase price was allocated based on the fair value of the assets acquired andliabilities assumed. In accordance with generally accepted accountingprinciples, purchased research and development costs allocated topatent-pending technology were capitalized and will be amortized over therespective estimated useful lives.  Theremaining amounts of purchased research and development were expensed upon theclosing of the transaction.  Thevaluation resulted in an excess of acquired nets assets over cost, or negativegoodwill in the amount of $143. As prescribed under FAS 141, *Business Combinations*, the negative goodwill was recorded asa contingent liability due to the potential future earn-outs.  Goodwill will be recorded for the additionalearn-out paid in October 2004.  Thegoodwill will not be amortized but will be included in our review of goodwillfor impairment.  A summary of the totalinitial purchase consideration is as follows:

 
| Cash paid  for outstanding shares                    |   | $      | 3,152  |   |
|------------------------------------------------------|--------|--------|--------|--------|
| Value of  common stock issued for outstanding shares |   | 3,500  |   |
| Acquisition  costs                                   |   | 163    |   |
|                                                 |   |   |   |
| Total  purchase consideration                        |   | $      | 6,815  |   |

 

The purchase consideration wasallocated, on a preliminary basis, to the estimated fair values of the assetsacquired and liabilities assumed, as follows:

 

11

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| ** **                           | ** ** | **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                  |       |
| Contingent  consideration liability  |       | (143                            | )          | —                   |       |
| Assumed  liabilities                 |       | (2,097                          | )          | —                   |       |
|                                 |       |                            |       |                     |       |
|                                 |       | $                               | 6,815      |                     |       |   |

 

Theacquisition was funded through available cash and by the issuance of 107 sharesof Avocent common stock.  The commonstock, valued at approximately $3,500, was recorded as non-cash considerationfor the acquisition of Crystal Link. On the closing of the Crystal Linktransaction, we acquired $4 in cash held by Crystal Link.

 

The fair value of all of theIPR&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-process researchand development activities consisted of a second generation of the KVM wirelessextender with significant enhancements to the developed KVM wireless extenderproduct and the development of a wireless KVM switch and an embedded KVM switchsolution.  The status of these projectsvaried from 10% complete to 60% complete. The KVM switch solution has been completed, the remaining projects werestill in process at the end of the third quarter of 2004.

 

The new generations of products underdevelopment are projected to sell through sales channels and to customers thatare substantially the same as current and historical sales channels andcustomers. Pricing and margins will not differ significantly from historicalpricing and margins.  Revenue for theprojects under development was projected through 2013, with 100% of CrystalLink’s forecasted revenue in 2005 expected to come from projects currently indevelopment.   Net income attributable toIPR&D was calculated by applying Crystal Link’s projected gross, operatingand net profit margins to IPR&D revenue, while considering Avocent’shistorical results and industry prospects.

 

Revenue growth related to thein-process research and development is embodied in products to be launched inlate 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. Operating 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%.

 

**Pro Forma Financial Information -**The following unaudited pro forma summary combines theresults of operations of Avocent, Soronti (acquired in November of 2003), CrystalLink, OSA and Sonic Mobility as if the acquisitions had occurred at thebeginning of each period presented. Certain adjustments have been made to reflect the impact of the purchasetransactions. These pro forma results have been prepared for comparativepurposes only and do not purport to be indicative of what would have occurredhad the acquisitions been made at the beginning of 2003, or of results whichmay occur in the future.

 

12

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| ** **                | ** ** | **Three Months Ended,**  | ** ** | **Nine Months Ended,**      | ** ** |
|---------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **October 1, 2004** | ** ** | **September 26, 2003** | ** ** | **October 1, 2004** | ** ** | **September 26, 2003** | ** ** |
|                      |       |                     |       |                        |       |   |   |   |   |
| Net sales                 |       | $                        | 91,404     |                        | $          | 77,343 |   | $ | 266,105 |   | $ | 217,333 |   |
| Net income                |       | $                        | 11,196     |                        | $          | 8,696 |   | $ | 26,742 |   | $ | 14,689 |   |
| Income per  basic share   |       | $                        | 0.23       |                        | $          | 0.18 |   | $ | 0.54 |   | $ | 0.31 |   |
| Income per  diluted share |       | $                        | 0.22       |                        | $          | 0.18 |   | $ | 0.53 |   | $ | 0.30 |   |

** **

**The aboveamounts exclude acquired in-process research and development expense of $789(net of a $261 tax benefit) related to the Sonic Mobility acquisition, $21,720related to the OSA acquisition, $3,829 (net of a $2,661 tax benefit) related tothe Crystal Link acquisition and $3,940 related to the Soronti acquisition.**

** **

**Note 8.**          Goodwill and Other IntangibleAssets

** **

**Acquired otherintangible assets subject to amortization were as follows:**

** **
| ** **                       | ** ** | **October 1, 2004**     | ** ** | **December 31, 2003**    | ** ** |
|----------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                       | ** ** | **Gross  Carrying  Amounts** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Amounts** | ** ** | **Accumulated  Amortization** | ** ** |
| Developed  technology            |       | $                            | 80,560     |                          | $          | 57,870 |   | $ | 66,240 |   | $ | 45,824 |   |
| Patents and trademarks           |       | 21,400                       |       | 13,057                        |       | 17,657 |   | 9,566 |   |
| Customer  base and certification |       | 6,483                        |       | 1,563                         |       | 1,613 |   | 717 |   |
| Non-compete  agreements          |       | 5,793                        |       | 2,587                         |       | 3,273 |   | 1,455 |   |
| Other                            |       | 1,814                        |       | 375                           |       | 768 |   | 100 |   |
|                             |       | $                            | 116,050    |                          | $          | 75,452 |   | $ | 89,551 |   | $ | 57,662 |   |

** **

**For the threemonths ended October 1, 2004 and September 26, 2003, amortizationexpense for other intangible assets was $6,482 and $4,739, respectively. Forthe nine months ended October 1, 2004 and September 26, 2003,amortization expense for other intangible assets was $17,656 and $17,051,respectively. The approximate estimated annual amortization for otherintangibles is as follows:**

** **
| **Years ending December 31:** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| 2004,  remaining                   |       | $          | 6,500      |   |
| 2005                               |       | $          | 18,200     |   |
| 2006                               |       | $          | 10,100     |   |
| 2007                               |       | $          | 4,300      |   |
| 2008                               |       | $          | 1,100      |   |
| Thereafter                         |       | $          | 400        |   |

** **

**In accordancewith Statement of Financial Accounting Standards No. 142, *Goodwill andOther Intangible Assets*, we test goodwill at least annually forimpairment.  Unless conditions warrantearlier review, we perform our annual impairment test in the fourth quarter ofeach year.**

** **

**We recordedapproximately $5,203 of goodwill as result of the Sonic Mobility acquisition inthe third quarter of 2004 and approximately $57,131 of goodwill as result ofthe OSA acquisition in the second quarter of 2004 (see Note 8 for a discussionof goodwill and for a discussion of contingent consideration).**

** **

**13**

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** **

**Note 9.  ProductWarranties**

** **

**The activitywithin the liability for warranty returns for the nine months ended October 1,2004 was as follows:**

 
| ** **                                                | ** ** | **2004** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|
|                                                      |       |     |       |
| Balance, December 31,  2003                          |       | $        | 2,652      |   |
|                                                      |       |     |       |
| Accruals for  product warranties issued during the period |       | 363      |       |
| Settlements  made during the period                       |       | (334     | )          |
| Other                                                     |       | 26       |       |
|                                                      |       |     |       |
| Balance, October 1,  2004                            |       | $        | 2,707      |   |
|                                                           |            |          |            |  |  |

 

Deferredrevenue related to our extended warranty program was $1,379 for the nine monthsended October 1, 2004.  We recordedearned revenue from the amortization of deferred revenue related to extendedwarranties of $419 for the nine months ended October 1, 2004.  In addition, we recorded new extendedwarranties of $752 during the nine months ended October 1, 2004.

 

Note 10.  Income Taxes

 

The provisionfor income taxes was approximately $8,135 for the nine months ended October 1,2004, compared to $10,701 for the nine months ended September 26, 2003. The increase in the effective tax rate is primarily attributable to theimpact of $21,720 of acquired in-process research and development expense,which is not deductible for tax purposes, and $2,843 of additional deferredcompensation expense (related to assumed incentive stock options which have notax benefit to the Company) recorded during the second and third quarters as aresult of the acquisition of OSA.   These amounts were partially offset bythe tax impact of a higher mix of pre-tax income contributed by our Shannonoperations that is taxed at a lower rate.

 

Note 11.  Patent Dispute

 

In May 2001, we filed a complaint for patent infringement in the UnitedStates District Court for the Southern District of New York against RaritanComputer Inc. The Raritan complaint sought injunctive relief, damages,attorneys’ fees and costs under three of our patents.  After a seven day bench trial in New York in January 2002,U.S. District Court Judge Milton Pollack found that there was no infringementof these patents by Raritan and ordered that judgment be entered in favor ofRaritan.

 

In April 2003,the United States Court of Appeals for the Federal Circuit issued its ruling onour 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 SupremeCourt for a 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.  With the recent death of Judge Pollack, thecase has now been assigned to U.S. District Court Judge Kevin Castel.

 

In October 2003, we 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 undertwo of our patents. ClearCube filed counterclaims alleging non-infringement,unenforceability, invalidity, and misuse of the Avocent patents.

 

14

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**Note 12. Stock-Based Compensation [2004 calculation open]**

** **

**We applyAccounting Principles Board Opinion No. 25, *Accounting for StockIssued to Employees*, and related Interpretations in accounting forour stock plans. Had compensation cost for our stock-based compensation plansbeen determined based on the fair value at the grant dates for awards underthose plans consistent with the method prescribed in SFAS No. 123, *Accounting for Stock-Based Compensation*, our net income andearnings per share would have been reduced to the pro forma amounts indicatedbelow.**

 
| ** **                                                                                                                              | ** ** | **Three Months ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                              | ** ** | **Oct. 1, 2004**       | ** ** | **Sept. 26, 2003**    | ** ** | **Oct. 1, 2004** | ** ** | **Sept. 26, 2003** | ** ** |
| Net income —  as reported                                                                                                          |       | $                      | 10,822     |                  | $          | 13,476 |   | $ | 5,973 |   | $ | 28,989 |   |
| Add:  Stock-based employee compensation expense included in reported net income,  net of related tax effects                            |       | 1,421                  |       | 709                   |       | 4,196 |   | 3,706 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  method for all awards, net of related tax effects |       | 7,966                  |       | 6,700                 |       | 26,043 |   | 22,053 |   |
| Net income  (loss) — pro forma                                                                                                     |       | $                      | 4,277      |                  | $          | 7,485 |   | $ | (15,874 | ) | $ | 10,642 |   |
|                                                                                                                                    |       |                   |       |                  |       |   |   |   |   |
| Basic  earnings per share — as reported                                                                                            |       | $                      | 0.22       |                  | $          | 0.29 |   | $ | 0.12 |   | $ | 0.63 |   |
| Basic  earnings (loss) per share — pro forma                                                                                       |       | $                      | 0.09       |                  | $          | 0.16 |   | $ | (0.33 | ) | $ | 0.23 |   |
| Diluted  earnings per share — as reported                                                                                          |       | $                      | 0.21       |                  | $          | 0.28 |   | $ | 0.12 |   | $ | 0.61 |   |
| Diluted  earnings (loss) per share — pro forma                                                                                     |       | $                      | 0.09       |                  | $          | 0.16 |   | $ | (0.33 | ) | $ | 0.23 |   |

 

The pro forma amounts reflected aboveare not representative of the effects on reported net income (loss) in futureyears because, in general, the 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:

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **Oct. 1, 2004**       | ** ** | **Sept. 26, 2003**    | ** ** | **Oct. 1, 2004** | ** ** | **Sept. 26, 2003** | ** ** |
| Dividend  yield          |       | 0.0                    | %          | 0.0                   | %          | 0.0 | % | 0.0 | % |
| Expected  life (years)   |       | 1.0-4.5                |       | 4.5                   |       | 1.0-4.5 |   | 4.5 |   |
| Expected  volatility     |       | 33.0                   | %          | 60.0                  | %          | 33.0–55.0 | % | 60.0 | % |
| Risk-free  interest rate |       | 3.36                   | %          | 2.88                  | %          | 1.17–3.54 | % | 2.38–2.88 | % |

 

**Note 13. Subsequent Event**

** **

OnOctober 4, 2004, the Working Families Tax Relief Act of 2004 was signedinto law.  This legislation, among other things, extended the research anddevelopment (R&D) tax credit for 18 months, from July 1, 2004 to December 31,2005, allowing U.S. companies conducting qualifying research and developmentactivities to receive a tax credit of up to 10 percent of R&D spending. We are currently reviewing the impact of this new legislation but do notexpect the new legislation to have a material impact to our effective tax rateor provision for taxes.

 

OnOctober 22, 2004, the American Jobs Creation Act of 2004 was signed intolaw. This legislation repeals export tax benefits, which have historicallyreduced our effective tax rate. This legislation transitions the repeal byallowing 100 percent of 2004, 80 percent of 2005 and 60 percent of 2006 exportbenefits.  The legislation also transitions in a new tax deduction forqualifying U.S. manufacturing activities and provides for the repatriation of earningsfrom foreign subsidiaries at reduced federal income tax rates. The provisionsof the new legislation are expected to benefit us in future periods.  Wedo not expect the legislation to have a material effect on our 2004 taxliability; however, we are evaluating the impact on future years.

 

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**Note 14. Recently Issued Accounting Standards**

** **

In March 2004, the Financial AccountingStandards Board (“FASB”) reached consensus on the guidance provided by EmergingIssues Task Force (“EITF”) Issue 03-1, *TheMeaning of Other-Than-Temporary Impairment and its Application to CertainInvestments*. EITF 03-1 specifies that an impairment would beconsidered other-than-temporary unless (a) the investor has the ability andintent to hold an investment for a reasonable period of time sufficient for therecovery of the fair value up to (or beyond) the cost of the investment and (b)evidence indicating the cost of the investment is recoverable within a reasonableperiod of time outweighs evidence to the contrary. The disclosure provisions ofEITF 03-1 were effective for annual reporting periods ending after December 15,2003. In September 2004, the EITF delayed the effective date for themeasurement and recognition guidance included in paragraphs 10 through 20 ofEITF 03-1. We continue to evaluate our investment portfolio in order todetermine the applicability of EITF 03-1.

 

During September 2004, the EITF releasedIssue 04-08, *“The Effect of ContingentlyConvertible Debt on Diluted Earnings per Share.”*Issue 04-08provides guidance on when the dilutive effect of contingently convertible debtsecurities with a market price trigger should be included in the computation ofdiluted earnings per share (“EPS”). The guidance is expected to be effective asof December 31, 2004 and would be applied by retrospectively restatingpreviously reported EPS. We anticipate that the adoption of this guidance willnot have a material effect on the computation of EPS as we do not havecontingently convertible debt.  In addition, the FASB is consideringamending SFAS No. 128 to make it consistent with International AccountingStandard 33, and to make EPS computations comparable on a global basis. The amended standard is expected to be effective for all periods endingafter December 15, 2004.  We anticipate that the adoption of Issue04-08 and the amendment to SFAS No. 128 will not have a material impact on thecomputation of our EPS.

 

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** **

**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

** **

*THE INFORMATION IN THIS ITEM 2**“MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”**CONTAINS FORWARD-LOOKINGSTATEMENTS, INCLUDING, WITHOUT LIMITATION, STATEMENTS RELATING TO OUR FUTUREBUSINESS PROSPECTS AND ECONOMIC CONDITIONS IN GENERAL, STATEMENTS REGARDING OURENGINEERING AND DESIGN ACTIVITIES, PRODUCT DEVELOPMENT, AND NEW PRODUCTINTRODUCTIONS, STATEMENTS RELATING TO FUTURE PRODUCT DEMAND, DESIGN WINS, ANDOUR FUTURE SALES, EARNINGS, GROSS PROFIT, INCOME, AND EXPENSES, STATEMENTSREGARDING INTERNATIONAL SALES, STATEMENTS REGARDING THE INTEGRATION OF OURACQUISTIONS, ACQUISITION ACCOUNTING, ACQUISITION AND TRANSACTION COSTS ANDADJUSTMENTS, STATEMENTS ABOUT THE RATIO OF SALES AMONG OUR DISTRIBUTIONCHANNELS, STATEMENTS REGARDING FUTURE INVENTORY LEVELS, AND STATEMENTS ABOUTTHE TIMING, IMPLEMENTATION, AND BENEFITS OF OUR NEW ERP SYSTEM AND STATEMENTSRELATING TO ANTICIPATED CAPITAL NEEDS AND USES.*

 

*THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS ANDUNCERTAINTIES THAT COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROMTHOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS.  FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCEINCLUDE, BUT ARE NOT LIMITED TO, THE RISKS ASSOCIATED WITH GENERAL ECONOMICCONDITIONS, RISKS ATTRIBUTABLE TO FUTURE PRODUCT DEMAND, SALES, AND EXPENSES,RISKS ASSOCIATED WITH PRODUCT DESIGN EFFORTS, RISKS ASSOCIATED WITH RELIANCE ONA LIMITED NUMBER OF COMPONENT SUPPLIERS AND SINGLE SOURCE COMPONENTS, THE LOSSOF ONE OF OUR OEM CUSTOMERS, A REDUCTION OR FLUCTUATIONS IN SALES OF OUR OEM ORBRANDED PRODUCTS, INTENSE COMPETITION AND NEW PRODUCTS AND TECHNOLOGIES FROMEXISTING AND NEW COMPETITORS, RISKS RELATED TO PROTECTING OUR INTELLECTUALPROPERTY RIGHTS, FLUCTUATIONS IN FOREIGN CURRENCIES, RISKS RELATED TOACQUISITIONS AND THEIR SUBSEQUENT INTEGRATION, AND OTHER RISKS DETAILED IN OURANNUAL REPORT ON FORM 10-K, WHICH WAS FILED WITH THE SECURITIES AND EXCHANGECOMMISSION ON MARCH 12, 2004.*

 

**Overview**

 

Avocent Corporation was formed as a result ofthe merger transaction in July 2000 between Apex Inc. and Cybex ComputerProducts Corporation, which was accounted for as an acquisition of Cybex byApex.  Our subsequent acquisitionsinclude Equinox Systems Inc. in January 2001, 2C Computing, Inc. in August 2002,Soronti, Inc. in November 2003, Crystal Link Technologies in January 2004,and OSA Technologies, Inc. in April 2004. In August 2004 we closedthe acquisition of Sonic Mobility Inc., a leading provider of integrated andstand alone solutions for the mobile IT device market.

 

We design, manufacture, sell, and licenseanalog and digital KVM (keyboard, video and mouse) switching systems, serialconnectivity devices, extension, wireless extension, remote access andmanagement products, Intelligent Platform Management Interface (“IPMI”)  firmware and software, and relatedtechnologies for the computer industry. Data center managers and networkadministrators have increasingly complex and growing server populations andother network appliances and devices, and our analog, digital, and serialswitching solutions, as well as our IPMI, extension, remote access andmanagement products and technologies, help them manage multiple servers,serially controlled devices, and mobile devices from a single local or remoteconsole consisting of a keyboard, video monitor, and mouse.  Specifically, our products can providesignificant cost reductions including lower initial investment, reduced utilitycosts, and space savings, as well as more efficient technical supportcapabilities.

 

We provide “plug and play” switching systemsfor many network administration, management, and storage problems faced bycorporate customers, data centers, and server farms. Our switching solutionsinclude products and technologies sold or licensed under the Avocent, Apex,Cybex, Equinox brands, including our *AMX*TM,*AutoViewTM, DS SeriesTM, SwitchView®,OutLook®, LongViewTM,*and*XP®4000Series* products. Our switching systems and solutions help facilitiesmanagers and network administrators access multiple servers serially controlleddevices, and mobile devices from one or more centralized or remote consoles,consolidate hardware requirements, and provide direct hardwired connectionsbetween the switch and the attached servers to facilitate access to thoseservers, even when the network is down. Our Equinox branded products addhigh-performance, reliable, and affordable server-based products for serial anddial-up access applications.  The Equinox*SuperSerialTM* product line providesserial communications for security, commercial point-of-sale, process control,industrial automation, data collection, remote access, fax servers, Internetaccess, and custom applications. Our Digital Desktops product line includes the*CstationTM* product.  Initial applications for Cstation includefinancial trading floors where space is at a premium, industrial plant controlenvironments that benefit from remote computers due to harsh or unsecuredenvironments, and healthcare and government installations that require highsecurity afforded through the remote location of the computer and hard disk. Inlate 2003, we introduced *LongView*TM*Wireless,*which allows for wirelesscontrol of monitors, keyboards, mice, and audio devices on a computer up to 100feet away.  We offer our KVM, Equinox,and LongView solutions through external 

 

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appliances and embedded solutions within products sold by others.

 

The combination of OSA’s technology andexpertise with our current embedded KVM solutions builds on our strategy ofproviding a common management interface to enable automation of the monitoring,configuration, and provisioning of server room devices.  We believe these embedded technologies willextend Avocent’s growth opportunities beyond our traditional KVM products.

 

Avocent’s 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 IT device market.

 

A substantial portion of our revenue isderived from sales to a limited number of OEMs who purchase our solutions 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 for43% of sales in the first nine months of 2004 and 45% of sales in the firstnine months of 2003.  Sales to ourbranded customers accounted for 57% of sales in the first nine months of 2004and 55% of sales in the first nine months of 2003. We do not have contractswith many of our OEM and branded customers, and in general, they are obligatedto purchase products from us only pursuant to binding purchase orders.  The loss of, or material decline in ordersfrom, our OEM or certain branded customers would have a material adverse effecton our business, financial condition, results of operations, and cashflows.  Our top five customers includeboth OEM and branded customers, and accounted for 64% of sales in the firstnine months of 2004 and 63% of sales in the first nine months of 2003.

 

We sell products to dealers, end-users, andOEMs in the United States, Canada, Europe, and Asia as well as in other foreignmarkets.  Sales within the United Statesaccounted for approximately 60% of sales in the first nine months of 2004 and62% of sales in the first nine months of 2003. Sales outside of the United States accounted for 40% of sales in thefirst nine months of 2004 and 38% of sales in the first nine months of2003.  Sales to customers in the Netherlands,including the European distribution facility for one of our OEM customers,accounted for 10% of our sales in the first nine months of 2004.  Sales to customers in the United Kingdom,including the European distribution facility for one of our OEM customers,accounted for 11% of our sales in the first nine months of 2003.  No other country accounted for more than 10%of sales in the first nine months of either 2004 or 2003.

 

With continued industry-wide initiatives toreduce all channel inventories and to shorten lead times, trends with our majorcustomers are, generally, to reduce the number of weeks of forward-committedfirm orders. This trend continues to affect our business with certaindistributors, OEMs, and other server manufacturers, and we believe that itwill continue to make our future sales difficult to predict and inventorylevels more difficult to manage.

 

We continue to experience significant pricecompetition in the market for all of our products, and we expect that pricingpressures will continue in the future. In addition, general economic conditions continue to be unpredictable,and we expect our revenue growth rate to fluctuate in relation to economicconditions and IT related spending trends. Depending on future general economic conditions and other factors, our revenuecould decline in the future.

 

We implemented a new enterpriseresource planning system in the fourth quarter of 2003 at our United Stateslocations, and we implemented the system at our international locations at thebeginning of the third quarter 2004. We have capitalized the development andimplementation costs of the new system to date and have begun depreciating thecosts for the system used in the United States and internationally.  As of October 1, 2004, $12.1 million hadbeen capitalized for the new system for all our locations.  We expect the new system to provide manybenefits, including more detailed information to improve the ways we manageinventory, customer relationships, and operating expenses on a more timelybasis.

 

Many of our executive officers and directorsare vested in significant amounts of options to purchase shares of our commonstock and continue to vest in additional shares on a regular basis.  These officers and directors have informed usthat they have sold, and may sell additional, shares of our common stock toprovide liquidity and diversify their portfolios.

 

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Results of Operations

 

The following table sets forth, for theperiods indicated, selected statement of operations data expressed as apercentage of net sales: 

 
| ** **                                            | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------|------------|---------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **October 1,  2004** | ** ** | **Sept. 26,  2003**   | ** ** | **October 1,  2004** | ** ** | **Sept. 26,  2003** | ** ** |
|                                                  |       |                      |       |                  |       |   |   |   |   |
| Net sales                                             |       | 100.0                     | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |
| Cost of  sales                                        |       | 41.8                      |       | 43.0                  |       | 42.0 |   | 43.3 |   |
| Gross profit                                          |       | 58.2                      |       | 57.0                  |       | 58.0 |   | 56.7 |   |
| Operating  expenses:                                  |       |                      |       |                  |       |   |   |   |   |
| Research and  development expenses                    |       | 12.9                      |       | 9.3                   |       | 12.2 |   | 9.9 |   |
| Acquired  in-process research and development expense |       | 1.1                       |       | —                |       | 11.0 |   | — |   |
| Selling,  general and administrative expenses         |       | 23.2                      |       | 22.0                  |       | 24.0 |   | 23.6 |   |
| Amortization  of intangible assets                    |       | 7.1                       |       | 6.2                   |       | 6.7 |   | 7.8 |   |
| Total  operating expenses                             |       | 44.3                      |       | 37.5                  |       | 53.9 |   | 41.3 |   |
| Income from  operations                               |       | 13.9                      |       | 19.5                  |       | 4.1 |   | 15.4 |   |
| Net  investment income                                |       | 1.4                       |       | 1.5                   |       | 1.4 |   | 1.7 |   |
| Net realized  investment gains (losses)               |       | (0.1                      | )          | 3.9                   |       | (0.1 | ) | 1.3 |   |
| Other income  (expense), net                          |       | 0.0                       |       | 0.1                   |       | (0.1 | ) | (0.2 | ) |
| Income  before income taxes                           |       | 15.2                      |       | 25.0                  |       | 5.3 |   | 18.2 |   |
| Provision  for income taxes                           |       | 3.4                       |       | 7.4                   |       | 3.0 |   | 4.9 |   |
| Net income                                            |       | 11.8                      | %          | 17.6                  | %          | 2.3 | % | 13.3 | % |

 

*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 extension, remoteaccess and management solutions. Net sales increased 19% to $91.3 million forthe third quarter of 2004 from $76.5 million for the third quarter of2003.  The increase in sales resultedfrom the strength of our OEM sales in the third quarter of 2004 as compared tothe third quarter of 2003 and reflects our historical seasonal increase in OEMsales we typically see in the second half of our calendar year.   OEM sales grew 26% from $33.4 million in thethird quarter of 2003 to $42.1 million in the third quarter of 2004.  OEM sales were 46% of sales for the thirdquarter of 2004, compared to 43% of sales for the third quarter of 2003.  An increase in sales from our OEM customersin the U.S. and Europe contributed to our sales growth.  As compared to the third quarter of lastyear, our branded sales also performed well, particularly in the U.S. and inAsia.  Overall, branded sales grew 14%from $43.1 million in the third quarter of 2003 to $49.2 million in the thirdquarter of 2004.  As a percentage ofsales, branded revenue accounted for 54% of sales in the third quarter of 2004and 57% of revenue in the third quarter of 2003.  Sales of our digital products continued toincrease and represented 49% of our revenue in the third quarter of 2004 ascompared to 38% of our revenue in the third quarter of 2003.  Additionally, sales of our productsintroduced within the last twelve months contributed to revenue growth in thethird quarter of 2004.  These productsinclude our embedded solutions, which is comprised of our embedded KVMofferings and our IPMI management solutions. Two of our OEM customers began shipping servers containing our IPMItechnologies in the third quarter of 2004.

 

We experienced an increase in sales bothwithin the United States and internationally. Sales within the United Statesincreased 15% to $56.0 million in the third quarter of 2004 from $48.9 millionin the third quarter of 2003. International sales increased 28%, to $35.3 million in the third quarterof 2004 from $27.6 million in the third quarter of 2003.  Sales within the United States were 61% ofsales for the third quarter of 2004 and 64% of sales for the third quarter of2003.  International sales were 39% ofsales for the third quarter of 2004 and 36% of sales for the third quarter of2003. We believe the increase in international sales resulted from our pastinvestments in international sales and marketing programs.

 

Net sales increased 22% to $265.2 million forthe first nine months of 2004 from $218.3 million for the first nine months of2003.  As with the third quarter, theincrease in sales resulted from new product introductions and from increasedsales of our digital products.  Thestrength in sales on a year-to-date basis was evident both in U.S. andinternational sales.  Sales within theUnited States increased by approximately 18% to $160.1 million in the firstnine months of 2004 from $135.4 million in the first nine months of 2003.  International sales increased approximately27% to $105.1 million in the first nine months of 2004 from $82.9 million in thefirst nine months of 2003.  In addition,sales to our branded customers increased 25% to $149.9 million in the firstnine months of 2004 from $120.0 in the first six months of 2003, while sales toour OEM customers increased 17% to $115.3 million in the first nine months of2004 from $98.3 in the first nine months of 2003.

 

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Revenue for the third quarter of 2004 was inthe middle of the range we expected at the beginning of the quarter, and ouroutlook for the fourth quarter of 2004 remains positive.  We have seen mixed economic indicators duringthe past year, but believe the overall tone of our business remainspositive.  Product introductionscurrently planned for the remainder of the year, combined with expected revenuecontributions from our recent acquisitions, should allow us to continue ourpositive revenue growth trend for the fourth quarter of 2004.  We expect revenue from our embedded productsto continue to contribute to sales growth in the fourth quarter of 2004.  Based on internal sales forecasts from thevarious organizations within our sales groups, we expect to achieve our first$100 million quarter in the history of Avocent during the fourth quarter of2004.

 

*Gross profit.* Grossprofit is affected by a variety of factors, including the ratio of sales amongour distribution channels, as OEM sales have lower gross margins than ourbranded sales; absorption of fixed costs as sales levels fluctuate; productmix, raw materials, and labor costs; new product introductions by us and by ourcompetitors; and the level of our outsourcing of manufacturing and assemblyservices.  Gross margin increased to58.2% in the third quarter of 2004 as compared to 57.0% in the third quarter of2003.  The increase is attributable tohigher sales contribution of our digital, AMX, and SwitchView product lines andincreased royalty revenue all of which have higher than average margins.  Each of these factors combined to more thanoffset the impact of higher OEM sales, which typically have lower margins than ourbranded products.  Our engineering andoperations teams continue to work to lower product costs through productredesign to replace costly components and through negotiations with ourcontract manufacturers to reduce costs in our supply chain.  Gross margin increased to 58.0% for the firstnine months of 2004 from 56.7% for the first nine months of 2003, primarily asa result of the factors mentioned above and the higher mix of branded sales inthe first quarter of 2004 when compared to the first quarter of 2003.

 

We expect gross margins to be between 57.5%and 58.5% in the fourth quarter of 2004. We expect that a higher mix of OEM sales will somewhat offset theexpected higher sales volume, cost reductions and slightly higher contributionfrom embedded technology revenue in the fourth quarter of 2004.

 

*Research and development expenses.*  Research and development expenses includecompensation for engineers, support personnel, outside contracted services andmaterials costs, and are expensed as they are incurred.  Research and development expenses were $11.8million, or 12.9% of net sales, in the third quarter of 2004 compared to $7.1million, or 9.3% of net sales, for the third quarter of 2003.  The increase in the amount spent on researchand development can be attributed to an increase in headcount, primarily as aresult of the Soronti purchase in November 2003, the Crystal Linkacquisition in early 2004, the OSA acquisition early in the second quarter of2004 and the Sonic Mobility acquisition during the third quarter of 2004.  Other factors related to the increase includeadding additional test labs and increasing the amount spent for materials,certification, and testing of products as we accelerate the speed and number ofour product introductions.  We continueto invest heavily in new technologies such as embedded KVM, digital desktopextension, IPMI solutions, mobile device management, and wireless KVMsolutions. Research and development expenses for the first nine months of 2004increased to $32.4 million from $21.6 million for the first nine months of 2003for the reasons listed above.  As apercentage of net sales, research and development expenses in the first ninemonths of 2004 increased to 12.2% from 9.9%. We believe that the timely development of innovative products andenhancements to existing products is essential to maintaining our competitiveposition.

 

In the fourth quarter of 2004, we expectresearch and development expense to increase sequentially by $400,000 to$700,000 but be down slightly as a percentage of sales due to the expectedincreased sales volume.

 

*Acquired in-process research and developmentexpenses.* Acquisition related expenses in the third quarter of 2004 are comprisedsolely of the non-recurring write-off of $1.1 million of in-processresearch and development expense related to the acquisition of Sonic Mobility.Acquisition related expenses in the first nine months of 2004 also include thenon-recurring write-off of $6.5 million of in-process research anddevelopment expense related to the acquisition of Crystal Link and $21.7million of in-process research and development expense related to theacquisition of OSA . There were no such charges in the first nine months of2003.

 

***Selling,general and administrative expenses.*** Selling, general and administrative expenses include personnel costs foradministration, finance, information systems, human resources, sales andmarketing and general management, certain merger and acquisition relatedexpenses, rent, utilities, legal and accounting expenses, bad debts,advertising, promotional material, trade show expenses and related travelcosts.  Selling, general andadministrative expenses were $21.2 million, or 23.2% of net sales, for the thirdquarter of 2004 compared to $16.8 million, or 22.0% of net sales, for the thirdquarter of 2003.  The increase inselling, general and administrative expenses is primarily related to increasedheadcount as a result of the Soronti, Crystal Link, OSA and Sonic Mobilityacquisitions.  We also continue to expandour international sales infrastructure. Other factors contributing to higher selling, general and administrativeexpenses were higher depreciation expenses related to the SAP implementation,costs of compliance with the Sarbanes-Oxley Act of 2002, and higher legal feesassociated with protecting our intellectual property rights.  Sequentially, selling, general and

** **

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administrative expenses decreased 4% over the second quarter of 2004due to lower marketing costs for the third quarter of 2004.  In the first nine months of 2004 selling,general, and administrative expenses increased to $63.6 million, or 24.0% ofnet sales for 2004, from $51.6 million, or 23.6% of year-to-date net sales in2003, as a result of the factors mentioned above.

** **

**We expect our selling, general andadministrative expenses to increase by $500,000 to $600,000 in the fourthquarter of 2004 when compared sequentially to the third quarter of 2004.  We expect patent litigation expense andSarbanes-Oxley compliance and audit costs to increase slightly in the fourthquarter of 2004 and we expect an increase in marketing expense related toadditional trade shows and new product launches planned for early in 2005.**

** **

***Amortizationof intangible assets***.  Amortization of$6.5 million in the third quarter of 2004 is comprised of the amortization ofthe identifiable intangible assets created as a result of the mergertransaction between Apex and Cybex and the acquisitions of Equinox, 2C, Soronti,Crystal Link, OSA and Sonic Mobility. Amortization of $4.7 million in 2003 was comprised of the amortizationof the identifiable intangible assets created as a result of the mergertransaction between Apex and Cybex and the acquisitions of Equinox and 2C.  The increase in amortization expense relatesprimarily to the additional amortization of intangibles from the Soronti,Crystal Link, OSA, and Sonic Mobility acquisitions, which were offset by thecompletion of amortization during 2003 of several significant intangible assetsrecorded on the merger of Apex and Cybex and the acquisition of Equinox.Amortization expense increased slightly from $17.1 million in the first ninemonths of 2003 to $17.7 million in the first nine months of 2004 as a result ofthe factors mentioned above. Amortization expense in the fourth quarter of 2004 is expected to beslightly higher when compared to the amount from the third quarter of 2004 as aresult of recognizing a full quarter of amortization related to the intangiblesrecorded as a result of the acquisition of Sonic Mobility on August 31,2004.

** **

*Net investment income**.** *Net******investment income increasedslightly to $1.3 million in the third quarter of 2004 from $1.2 million in thethird quarter of 2003.  Net investmentincome decreased slightly from $3.7 million in the first nine months of 2003 to$3.6 million in the first nine months of 2004.

 

*Net realized investment gains ( losses). *Net realizedinvestment gains (losses) declined significantly from a $3.0 million net gainin the third quarter of 2003 to a $101,000 net loss in the third quarter of2004 almost entirely as a result of a recognized gain on the disposition of anequity investment in the third quarter of 2003. For the same reason, net realized investment gains (losses) declinedsignificantly for the first nine months of the year as well, from a net gain of$2.8 million in the first nine months of 2003 to a net loss of $269,000 in thefirst nine months of 2004.

 

*Other income (expense), net.*  Net other income (expense) improved slightlyfrom a net income of $1,000 in the third quarter of 2003, to a net income of$26,000 in the third quarter of 2004. Net other income (expense) improved froma net expense of $417,000 in the first nine months of 2003 to a net expense of$122,000 in the first nine months of 2004. The improvement for the nine monthperiod related primarily to a lower level of foreign exchange losses.

 

*Provision for income taxes**.***** **The provision for income taxes wasapproximately $8.1 million for the nine months ended October 1, 2004,compared to $10.7 million for the nine months ended September 26, 2003. The increase in the effective tax rate is primarily attributable to theimpact of $21.7 million of acquired in-process research and development expense,which is not deductible for tax purposes, and $2.8 million of additionaldeferred compensation expense (related to assumed incentive stock options whichhave no tax benefit to the company) recorded as a result of the acquisition ofOSA.   These amounts were partially offset by the tax impact of a highermix of pre-tax income contributed by our Shannon operations that is taxed at alower rate. Including these items, we expect our effective tax rate to be inthe 40% to 42% range for the year ended December 31, 2004.

 

*Net income.*  Net income for the third quarter of 2004 was$10.8 million compared to net income of $13.5 million for the third quarter of2003, as a result of the above factors, including increases in research anddevelopment expenses and the write-off of acquired research and developmentexpense as a result of the Sonic Mobility acquisition, offset somewhat by theincrease in our revenues.  As apercentage of sales, net income for the third quarter of 2004 was 11.8%,compared to net income of 17.6% for the third quarter of 2003. For the firstnine months of the year,  net income was$6.0 million, or 2.3%, in 2004 as compared to net income of $29.0 million, or13.3% of net sales, in 2003 as a result of the factors mentioned above.

 

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**Liquidity and Capital Resources**

 

As of October 1, 2004, our principalsources of liquidity consisted of over $300 million in cash, cash equivalents,and investments.  We have no outstandingdebt or available credit facilities as of this filing.

 

Our operating activities generated cash ofover $51.2 million in the first nine months of 2004, as compared toapproximately $54.3 million in the first nine months of 2003.  The reduction in positive cash flow is primarilythe result of an increase in accounts receivable and higher operating expensesfrom our acquisitions.  We experienced anincrease in receivables as a result of the timing and volume of sales in thethird quarter of 2004.  Additionally, ourdays sales outstanding (“DSOs”) increased to 55 days from 50 days from the sameperiod last year.  The DSOs are betterthan our goal of 60 days.  A decline inaccounts payable and in accrued compensation also affected cash flow fromoperations for the first nine months of 2004. Although net inventories decreased slightly at the end of the thirdquarter and were not a large factor in determining cash from operations, we doanticipate modestly higher inventory levels at the end of the fourth quarter of2004 due to expected new product launches.

 

We implemented a new enterpriseresource planning system in the fourth quarter of 2003 at our United Stateslocations, and in our international locations, except for OSA, during July 2004.We have capitalized the costs of the new system to date and have begundepreciating the costs for the system. As of October 1, 2004, $12.1 million had been capitalized for thisnew system.

 

In the ordinary course of our business, wemay at any point in time have a significant amount of contractual commitmentsnot yet recognized in our financial statements. These commitments relateprimarily to our need to schedule the purchase of inventories in advanceof the related forecasted sales to customers. We have longer lead times for theproducts we purchase from suppliers based in Asia than those from our U.S.based and European suppliers. Our actual contractual commitments are typicallylimited to products needed for one to three months of forecasted sales. Theliabilities for these inventory purchases along with the related inventoryassets are typically recognized upon our receipt of the products. We also haveat any point in time a variety of short term contractual commitments forservices such as advertising, marketing, accounting, legal, and research anddevelopment activities. The liabilities for these services and the relatedexpenses are typically recognized upon our receipt of the relatedservices.  As of October 1, 2004, wehad $26.7 million of such commitments. None of our expected purchase commitments required payment beyond thenext year.

 

We intend to use a portion of our cash andinvestments for strategic acquisitions of technologies and companies that willenhance and complement our existing technologies and help increase oursales.  Also, on October 28, 2004our board of directors approved a stock repurchase program whereby we may, fromtime to time, purchase up to 2 million shares of our common stock in the openmarket, in privately negotiated transactions or otherwise, at prices that we deemappropriate.

 

**Investments**

 

Our investments consist primarily of bankdeposits, money market funds, corporate bonds, municipal bonds, commercialpaper, mortgage backed securities guaranteed by U.S. government agencies, andcommon stock. We classify our debt and equity securities as available-for-salesecurities and report them at fair value, with unrealized gains and lossesexcluded from earnings and reported as a separate component of stockholders’equity. We periodically review our investment portfolio for investmentsconsidered to have sustained an other-than-temporary decline in value.   Upon review of our investment portfolio asof October 1, 2004, no investments were considered to have sustained another-than-temporary decline, and no impairment charge was recorded.

 

**Certain Transactions**

 

***Acquisition of Crystal Link Technologies***

** **

On January 6, 2004, we acquired CrystalLink Technologies for an initial payment of cash and common stock ofapproximately $6.7 million, plus assumed liabilities of approximately $2.1million and acquisition costs of approximately $163,000. The purchase agreementcalled for possible additional earn-out payments of up to $5.0 million based onfuture technical enhancements and sales goals. The technology enhancement milestones were met subsequent to October 1,2004, and we paid $2 million of earn-out consideration in October 2004.  The remaining earn-out consideration will notbe paid as the other milestones were not met. Crystal Link, based in Escondido, California, has developed wirelesstechnology for KVM switching and extension products, which is incorporated intoour LongView Wireless product.

 

We recorded the acquisition under thepurchase method of accounting, and allocated the purchase price based on thefair value of the assets acquired and liabilities assumed. In accordance withgenerally accepted accounting principles, purchased research and developmentcosts allocated to patent-pending technology were capitalized and will beamortized 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

 

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FAS 141, *Business Combinations*, thenegative goodwill was recorded as a contingent liability due to the potentialfuture earn-outs.  Goodwill will berecorded 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, we acquired OSATechnologies, Inc. (OSA) for cash and common stock of $97.5 million, plusassumed liabilities of approximately $1.7 million, employee stock options ofapproximately $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 on April 6, 2004.  OSA is headquartered in San Jose, Californiaand has additional research and development offices in Shanghai, China andTaipei, Taiwan. OSA has developed embedded manageability firmware and softwareusing Intelligent Platform Management Interface (IPMI) solutions. The resultsof OSA’s operations have been included in the consolidated financial statementssince the date of acquisition.

 

The acquisition was recorded under thepurchase method of accounting, and the purchase price was allocated based onthe fair value of the assets acquired and liabilities assumed. In accordancewith generally accepted accounting principles, purchased research anddevelopment costs allocated to patent-pending technology were capitalized andwill 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 the acquisitionwill not be amortized but will be included in our review of goodwill forimpairment. The excess of the fair value over the intrinsic value of theunvested OSA options and the fair value of the vested OSA options at the dateof consummation have been included in the purchase consideration.

 

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

** **

On August 31, 2004, we acquired theoutstanding stock of Sonic Mobility Inc. (Sonic Mobility), 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 IT device market. The results of SonicMobility’s operations have been included in the consolidated financialstatements since the date of acquisition.

 

The acquisition was recorded under thepurchase method of accounting, and the purchase price was allocated based onthe fair value of the assets acquired and liabilities assumed. In accordancewith generally accepted accounting principles, purchased research anddevelopment costs allocated to patent-pending technology were capitalized andwill 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 our review ofgoodwill for impairment.

 

**Critical Accounting Policies**

 

We believe the following critical accountingpolicies affect the more significant judgments and estimates used in thepreparation of our 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, and productreturns are reasonably estimable.  Wegenerally ship products upon receipt of a purchase order from a customer.  We record revenue in accordance with theapplicable terms of each respective customer contract.  Accordingly, revenue on products shipped FOBdestination is recorded when the customer takes possession of the goods, andrevenue on products shipped FOB shipping point is recorded when the goods leaveour facilities.  Shipping and handlingfees are included in net sales, and the related costs are included in cost ofsales in the accompanying consolidated statements of operations.

 

We accrue for sales returns as a reduction ofsales and cost of sales based on our experience from historical customerreturns, which we believe provides a reasonable estimate of futurereturns.  Our sales agreements generallyinclude a one-month unconditional return policy.  We also allow additional rights of return tocertain distributors, which

 

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generally extend the return period to 90days.  If actual future customer returnsare less favorable than those projected by management, additional sales returncosts may be incurred.   The reserve isincluded as a reduction in the carrying value of accounts receivable in the accompanyingconsolidated balance sheets.

 

We record royalty revenue upon shipment byOEMs of the related products within which our technologies are embedded or uponrelease of our software which we license. Revenue from our maintenance and support agreements is deferred andrecognized ratably over the term of the agreements.

 

Prior to extending credit to a new customer, weperform a detailed credit review of the customer and establish credit limitsbased on the results of our credit review. We review collection experience periodically to determine if thecustomer’s payment terms and credit limits need to be revised.  We maintain allowances for doubtful accountsfor estimated losses resulting from the inability of our customers to makerequired payments.  If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir 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.

 

We participate in cooperative advertising and marketdevelopment programs with certain distributors and OEMs. We use these programsto reimburse distributors and OEMs for certain forms of advertising, and ingeneral, allow distributors and OEMs credits up to a specified percentage ofnet purchases. Our costs associated with these programs are estimated andaccrued at the time of sale, and are included in sales and marketing expensesin the accompanying consolidated statements of operations.  Payments of invoices submitted by ourcustomers are deducted from the accrued liability.

 

•                                          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 inventorywrite-downs may be required.

 

•                                          Weprovide for the estimated cost of product warranties at the time revenue is recognized.  While we engage in extensive product qualityprograms and processes, including actively monitoring and evaluating thequality of our component suppliers and contract manufacturers, our warrantyobligation is affected by product failure rates, failure rates of purchasedcomponents integrated into our products, material usage, and other rework costsincurred in correcting a product failure. Should actual product failure rates, material usage, or other reworkcosts differ from our estimates, revisions to our estimated warranty liabilitymay be required.

 

•                                          Wehold investments in various publicly traded debt securities, includingmortgaged-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 investments in 2004 or 2003.

 

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 initialinvestment.  We record impairment chargeson investments having a carrying value that is greater than the value that wewould reasonably expect to receive in an arm’s length sale of theinvestment.  There were no impairmentcharges recorded against privately-held investments in 2004 or 2003.

 

**•**                                          Ourgoodwill recognized upon acquisitions is not amortized but is subject to annualimpairment testing during the fourth quarter of each year, or more frequentlyif certain impairment indicators occur. Our annual test for goodwillimpairment, performed in the fourth quarter of 2003, determined that noadjustment for impairment was required. Our testing indicated that the implied fair value of our goodwillexceeded its carrying value; accordingly, no further 

 

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impairment analysis wasrequired.  We will perform our annualtest for goodwill impairment for 2004 during the fourth quarter.  If economic conditions deteriorate andindicators of impairment become present, an adjustment to the carrying value ofgoodwill and other intangible assets may be required.

 

**•****                                         **We recognizeimpairment losses on long-lived assets used in operations when indicators ofimpairment are present and the undiscounted cash flows estimated to begenerated by those assets are less than the assets’ carrying values. Animpairment loss would be recognized in the amount by which the recorded valueof the asset exceeds the fair value of the asset, measured by the quoted marketprice of an asset or an estimate based on the best information available in thecircumstances.  There were no such lossesrecognized during 2004 or 2003.

 

**•****                                         **We accountfor income taxes using the asset and liability method. We provide for incometaxes currently payable and, in addition, provide deferred income taxes fortemporary differences between the tax bases of assets and liabilities and theirreported amounts in the financial statements and for known contingencies.Temporary differences relate principally to the allowance for doubtfulaccounts, allowance for sales returns, liability for warranty claims,unrealized gain (loss) on investments, acquired intangible assets, accumulateddepreciation, loss on write-down of investments, and inventory reserves.Valuation allowances are established when necessary to reduce deferred taxassets to the amount expected to be realized.

 

We undergo various tax authority audits in the ordinary courseof business and reserve for known tax contingencies as they arise.  If tax audit adjustments differ from theamounts we have provided, we record differences as changes in estimates in theperiod in which they become known.

 

**Recently Issued Accounting Standards and Recent TaxLegislation**

** **

In March 2004, the FASB reachedconsensus on the guidance provided by EITF 03-1, *The Meaning of Other-Than-Temporary Impairment and its Application toCertain Investments*. EITF 03-1 specifies that an impairment would beconsidered other-than-temporary unless (a) the investor has the ability andintent to hold an investment for a reasonable period of time sufficient for therecovery of the fair value up to (or beyond) the cost of the investment and (b)evidence indicating the cost of the investment is recoverable within areasonable period of time outweighs evidence to the contrary. The disclosureprovisions of EITF 03-1 were effective for annual reporting periods endingafter December 15, 2003. In September 2004, the EITF delayed theeffective date for the measurement and recognition guidance included inparagraphs 10 through 20 of EITF 03-1. We continue to evaluate our investmentportfolio in order to determine the applicability of EITF 03-1.

 

During September 2004, the EITF releasedIssue 04-08, *“The Effect of ContingentlyConvertible Debt on diluted Earnings per Share.”*Issue 04-08provides guidance on when the dilutive effect of contingently convertible debtsecurities with a market price trigger should be included in the computation ofdiluted earnings per share (“EPS”). The guidance is expected to be effective asof December 31, 2004 and would be applied by retrospectively restatingpreviously reported EPS. We anticipate that the adoption of this guidance willnot have a material effect on the computation of EPS as we do not havecontingently convertible debt.  In addition, the FASB is consideringamending SFAS No. 128 to make it consistent with International AccountingStandard 33, and to make EPS computations comparable on a global basis. The amended standard is expected to be effective for all periods endingafter December 15, 2004.  We anticipate that the adoption of Issue04-08 and the amendment to SFAS No. 128 will not have a material impact on thecomputation of our EPS.

 

OnOctober 4, 2004, the Working Families Tax Relief Act of 2004 was signedinto law.  This legislation, among other things, extended the research anddevelopment (R&D) tax credit for 18 months, from July 1, 2004 to December 31,2005, allowing U.S. companies conducting qualifying research and developmentactivities to receive a tax credit of up to 10 percent of R&D spending. We are currently reviewing the impact of this new legislation but do notexpect the new legislation to have a material impact to our effective tax rateor provision for taxes.

 

OnOctober 22, 2004, the American Jobs Creation Act of 2004 was signed intolaw. This legislation repeals export tax benefits, which have historicallyreduced our effective tax rate. This legislation transitions the repeal byallowing 100 percent of 2004, 80 percent of 2005 and 60 percent of 2006 exportbenefits.  The legislation also transitions in a new tax deduction forqualifying U.S. manufacturing activities and provides for the optional repatriationof earnings from foreign subsidiaries. The provisions of the new legislation areexpected to benefit us in future periods.  We do not expect thelegislation to have a material effect on our 2004 tax liability; however, weare evaluating the impact on future years.

 

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**Item 3.****Quantitative andQualitative Disclosures About Market Risks.**

 

Our primary market risk is the potential lossarising from increases in interest rates, which could have an adverse impact onthe fair value of our investment securities. Our investment policy is to manageour investment portfolio to preserve principal and liquidity while maximizingthe return on our investment portfolio through the investment of availablefunds. We diversify our investment portfolio by investing in a variety ofhighly-rated investment-grade securities and through the use of differentinvestment managers. Our investment securities portfolio is primarily investedin securities with maturities (or interest rate resets) of two years or lesswith at least an investment grade rating to minimize interest rate and creditrisk as well as to provide for an immediate source of funds. Market risk,calculated as the potential change in fair value in our investment portfolioresulting from a hypothetical 10% change in interest rates, was not material atOctober 1, 2004. We generally hold investment securities until maturity.

 

We also face foreign currency exchange raterisk to the extent that the value of certain foreign currencies relative to theU.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. As of October 1,2004, we had no open forward contracts.

 

**Item 4.****Controls and Procedures.**

 

(a) *Evaluationof disclosure controls and procedures.*   Based on their evaluation as of October 1,2004, our Chief Executive Officer and Chief Financial Officer have concludedthat our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934) are effective to ensurethat information required to be disclosed by us in reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in Securities and Exchange Commission rulesand forms.

 

(b) *Changesin internal control over financial reporting*.   There were no significant changes in ourinternal control over financial reporting identified in management’s evaluationduring the period covered by this quarterly report on Form 10-Q that havematerially affected or are reasonably likely to materially affect our internalcontrol over financial reporting.

 

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### **PART II — OTHERINFORMATION**

### ** **

**Item 1.****           LegalProceedings.**

 

In May 2001, wefiled 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 of our patents.  After a seven daybench trial in New York in January 2002, U.S. District Court Judge MiltonPollack found that there was no infringement of these patents by Raritan andordered that judgment be entered in favor of Raritan.

 

In April 2003, the United States Courtof Appeals for the Federal Circuit issued its ruling on our appeal in thispatent litigation.  The Court of Appealsruled in our favor by vacating the non-infringement decision of the DistrictCourt for the Southern District of New York and remanding the case for furtherproceedings consistent with the Court of Appeals’ opinion.

 

In September 2003,Raritan petitioned the United States Supreme Court for a Writ of Certiorari toreview the Court of Appeals decision. The Supreme Court declined to review Raritan’s petition in December 2003,and the case was sent back to the United States District Court for the SouthernDistrict of New York.  Withthe recent death of Judge Pollack, the case has now been assigned to U.S.District Court Judge Kevin Castel.

 

In October 2003,we filed a complaint for patent infringement in the United States DistrictCourt for the Northern District of Alabama against ClearCube Technology,Inc.  The ClearCube complaint seeksinjunctive relief, damages, attorneys’ fees, and costs under two of ourpatents. ClearCube filed counterclaims alleging non-infringement,unenforceability, invalidity, and misuse of the Avocent patents.

 

**Item 6.****           Exhibits.**

 

 

**31.1**                           Sarbanes-Oxley Act of 2002 Section 302(a)Certification of the Chief Executive Officer

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**31.2**                           Sarbanes-Oxley Act of 2002 Section 302(a)Certification of the Chief FinancialOfficer

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32.1                           Certification of the Chief Executive Officerand the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

ITEMS 2, 3, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.

 

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### **SIGNATURES**

### ** **

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   |   |                    |   | AVOCENT CORPORATION                                  |   |   |
|--------|--------|-------------------------|--------|------------------------------------------------------|--------|--------|
|   |   |                    |   | (Registrant)                                         |   |
|   |   |                    |   |                                                 |   |
|   |   |                    |   |                                                 |   |
| Date:  |   | November 10,  2004 |   | /s/ Douglas E.  Pritchett                            |   |   |
|   |   |                    |   | Douglas E. Pritchett                                 |   |
|   |   |                    |   | Senior Vice President of Finance, Chief  Financial   |   |
|   |   |                    |   | Officer and Treasurer (Principal Financial  Officer) |   |
|        |        |                         |        |                                                      |        |        |  |

 

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