Tableof Contents

 

 

 

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

**WASHINGTON,D.C.  20549**

** **

# **FORM 10-Q**

 
| **(Mark  One)**                                                                                                                                                    |       |                                                                                                     |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                                                               |       |                                                                                                     |
| **x**                                                                                                                                                              | ** ** | **Quarterly  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934**  |
|                                                                                                                                                               |       |                                                                                                     |
| **For  the quarterly period ended September 26, 2008 or**                                                                                                     |
|                                                                                                                                                               |       |                                                                                                     |
| **o**                                                                                                                                                              | ** ** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934** |
|                                                                                                                                                               |       |                                                                                                     |
| **For  the transition period from             to            ** |
|                                                                                                                                                               |       |                                                                                                     |
| **Commission  file number: 000-30575**                                                                                                                             |

 

**AVOCENTCORPORATION**(Exact Name of Registrant as Specified in Its Charter)

 

| **Delaware**                                                    | ** ** | **91-2032368**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or Other  Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer  Identification 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 checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934, asamended, during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days.

 

xYes  oNo

 

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

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct): Yes o   No x

 

As of October 30,2008, the number of outstanding shares of the Registrant’s Common Stock was 44,795,691.

 

 

 

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Table of Contents

 

**AVOCENTCORPORATION**

**FORM 10-Q**

**September 26,2008**

 

**INDEX**

 
| ** **   | ** **            | **Page(s)**                                                                                                                           |
|--------------|-----------------------|---------------------------------------------------------------------------------------------------------------------------------------|
| Part I  | Financial Information |                                                                                                                                  |
|         |                  |                                                                                                                                  |
|         | Item 1.          | Financial Statements (unaudited)                                                                                                      |   |
|         |                  |                                                                                                                                  |   |
|         |                  | Condensed Consolidated  Statements of Income for the Three and Nine Months Ended September 26,  2008 and September 28, 2007 | 3 |
|         |                  | Condensed  Consolidated Balance Sheets at September 26, 2008 and December 31,  2007                                         | 4 |
|         |                  | Condensed Consolidated Statements of Cash Flows for  the Nine Months Ended September 26, 2008 and September 28, 2007        | 5 |
|         |                  | Notes to Condensed Consolidated Financial Statements                                                                                  | 6-18 |
|         |                  |                                                                                                                                  |   |
|         | Item 2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                           | 19-29 |
|         |                  |                                                                                                                                  |   |
|         | Item 3.               | Quantitative  and Qualitative Disclosures about Market Risks                                                                          | 30 |
|         |                  |                                                                                                                                  |   |
|         | Item 4.               | Controls and  Procedures                                                                                                              | 30 |
|         |                  |                                                                                                                                  |   |
| Part II | Other Information     |                                                                                                                                  |
|         |                  |                                                                                                                                  |
|         | Item 1.               | Legal Proceedings                                                                                                                     | 30 |
|         |                  |                                                                                                                                  |   |
|         | Item 1A.              | Risk Factors                                                                                                                          | 31 |
|         |                  |                                                                                                                                  |   |
|         | Item 2.               | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                          | 48 |
|         |                  |                                                                                                                                  |   |
|         | Item 5.               | Other Information                                                                                                                     | 48 |
|         |                  |                                                                                                                                  |   |
|         | Item 6.               | Exhibits                                                                                                                              | 48 |
|         |                  |                                                                                                                                  |
| Signature    | 49                    |

 

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**PART I —FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**AVOCENT CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited, in thousands, except per share data)**

** **
| ** **                                                                                                                                                                                                                                     | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                     | ** ** | **Sept. 26,**                                 | ** ** | **Sept. 28,**                                | ** ** | **Sept. 26,** | ** ** | **Sept. 28,** | ** ** |
| ** **                                                                                                                                                                                                                                     | ** ** | **2008**                                           | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales:                                                                                                                                                                                                                                     | * *   | * *                                           | * *   | * *                                          | * *   | * * | * * | * * | * * |
| Products and  services                                                                                                                                                                                                                         |       | $                                                  | 152,175    |                                              | $          | 136,492 |   | $ | 402,941 |   | $ | 375,475 |   |
| Licenses and  royalties                                                                                                                                                                                                                        |       | 30,873                                             |       | 25,580                                            |       | 80,688 |   | 69,973 |   |
| Total net sales                                                                                                                                                                                                                                |       | 183,048                                            |       | 162,072                                           |       | 483,629 |   | 445,448 |   |
|                                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Cost of sales:                                                                                                                                                                                                                                 |       |                                               |       |                                              |       |   |   |   |   |
| Products and  services                                                                                                                                                                                                                         |       | 64,217                                             |       | 55,151                                            |       | 166,871 |   | 156,023 |   |
| Licenses and  royalties                                                                                                                                                                                                                        |       | 566                                                |       | 564                                               |       | 1,935 |   | 1,521 |   |
| Amortization of  intangibles related to licenses and royalties                                                                                                                                                                                 |       | 4,218                                              |       | 2,767                                             |       | 9,753 |   | 8,217 |   |
| Total cost of sales (including stock compensation of $298 and  $797 for the three and nine months ended September 26, 2008; $373 and  $853 for the three and nine months ended September 28, 2007)                                   |       | 69,001                                             |       | 58,482                                            |       | 178,559 |   | 165,761 |   |
|                                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Gross profit                                                                                                                                                                                                                                   |       | 114,047                                            |       | 103,590                                           |       | 305,070 |   | 279,687 |   |
|                                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Research and development expenses (including stock compensation  of $1,523 and $3,878 for the three and nine months ended September 26, 2008;  $1,916 and $4,422 for the three and nine months ended September 28,  2007)            |       | 24,398                                             |       | 22,751                                            |       | 72,126 |   | 64,821 |   |
| Acquired  in-process research and development expenses                                                                                                                                                                                         |       | 700                                                |       | —                                            |       | 700 |   | — |   |
| Selling, general and administrative expenses (including stock compensation  of $3,986 and $9,288 for the three and nine months ended September 26,  2008; $4,021 and $9,799 for the three and nine months ended  September 28, 2007) |       | 60,266                                             |       | 52,820                                            |       | 172,830 |   | 153,922 |   |
| Restructuring, integration and retirement expenses (including  stock compensation of $480 and $2,999 for the three and nine months ended  September 26, 2008)                                                                             |       | 5,926                                              |       | —                                            |       | 13,627 |   | — |   |
| Amortization of  intangible assets                                                                                                                                                                                                             |       | 8,971                                              |       | 7,581                                             |       | 24,123 |   | 24,124 |   |
| Total operating  expenses                                                                                                                                                                                                                      |       | 100,261                                            |       | 83,152                                            |       | 283,406 |   | 242,867 |   |
|                                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Income from  operations                                                                                                                                                                                                                        |       | 13,786                                             |       | 20,438                                            |       | 21,664 |   | 36,820 |   |
|                                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Net investment  income                                                                                                                                                                                                                         |       | 295                                                |       | 1,074                                             |       | 1,863 |   | 2,857 |   |
| Interest expense                                                                                                                                                                                                                               |       | (2,268                                             | )          | (1,853                                            | )          | (5,915 | ) | (6,355 | ) |
| Other income  (expense), net                                                                                                                                                                                                                   |       | 2,362                                              |       | 207                                               |       | 2,722 |   | (95 | ) |
|                                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Income before  provision for income taxes                                                                                                                                                                                                      |       | 14,175                                             |       | 19,866                                            |       | 20,334 |   | 33,227 |   |
| Provision for  income taxes                                                                                                                                                                                                                    |       | 3,214                                              |       | 3,749                                             |       | 5,199 |   | 1,364 |   |
|                                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Net income                                                                                                                                                                                                                                     |       | $                                                  | 10,961     |                                              | $          | 16,117 |   | $ | 15,135 |   | $ | 31,863 |   |
|                                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Earnings per  share:                                                                                                                                                                                                                           |       |                                               |       |                                              |       |   |   |   |   |
| Basic                                                                                                                                                                                                                                          |       | $                                                  | 0.24       |                                              | $          | 0.32 |   | $ | 0.33 |   | $ | 0.63 |   |
| Diluted                                                                                                                                                                                                                                        |       | $                                                  | 0.24       |                                              | $          | 0.32 |   | $ | 0.33 |   | $ | 0.62 |   |
| Weighted average  shares used in computing earnings per share:                                                                                                                                                                                 |       |                                               |       |                                              |       |   |   |   |   |
| Basic                                                                                                                                                                                                                                          |       | 44,792                                             |       | 50,310                                            |       | 45,241 |   | 50,506 |   |
| Diluted                                                                                                                                                                                                                                        |       | 45,467                                             |       | 51,149                                            |       | 45,868 |   | 51,399 |   |

 

See notesaccompanying these condensed consolidated financial statements.

 

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**AVOCENT CORPORATIONCONDENSED CONSOLIDATED BALANCE SHEET**

**(Unaudited,in thousands, except per share data)**

 
| ** **                                                                                                                                                                                                                    | ** ** | **September 26,  2008** | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                    | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                               |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                    |       | $                            | 114,901    |                        | $          | 105,183 |   |
| Investments  maturing within one year                                                                                                                                                                                         |       | —                       |       | 5,943                       |       |
| Accounts  receivable, less allowance for doubtful accounts of $2,837 and $2,481 at  September 26, 2008 and December 31, 2007, respectively                                                                          |       | 127,400                      |       | 109,851                     |       |
| Other  receivables                                                                                                                                                                                                            |       | 13,318                       |       | 10,799                      |       |
| Inventories                                                                                                                                                                                                                   |       | 28,813                       |       | 30,103                      |       |
| Other current  assets                                                                                                                                                                                                         |       | 6,912                        |       | 4,399                       |       |
| Deferred tax  assets, net                                                                                                                                                                                                     |       | 3,707                        |       | 5,928                       |       |
| Total current  assets                                                                                                                                                                                                         |       | 295,051                      |       | 272,206                     |       |
|                                                                                                                                                                                                                          |       |                         |       |                        |       |
| Property and  equipment, net                                                                                                                                                                                                  |       | 36,984                       |       | 37,298                      |       |
| Goodwill                                                                                                                                                                                                                      |       | 613,610                      |       | 584,949                     |       |
| Other intangible  assets, net                                                                                                                                                                                                 |       | 192,440                      |       | 167,982                     |       |
| Deferred tax  asset, non-current                                                                                                                                                                                              |       | 14,152                       |       | 13,297                      |       |
| Other assets                                                                                                                                                                                                                  |       | 3,927                        |       | 2,701                       |       |
| Total assets                                                                                                                                                                                                                  |       | $                            | 1,156,164  |                        | $          | 1,078,433 |   |
|                                                                                                                                                                                                                          |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                 | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current  liabilities:                                                                                                                                                                                                         |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                                                              |       | $                            | 18,590     |                        | $          | 20,031 |   |
| Accrued wages  and commissions                                                                                                                                                                                                |       | 30,197                       |       | 25,072                      |       |
| Accrued  liabilities                                                                                                                                                                                                          |       | 43,121                       |       | 30,630                      |       |
| Income taxes  payable                                                                                                                                                                                                         |       | 19,559                       |       | 14,950                      |       |
| Deferred  revenue, current                                                                                                                                                                                                    |       | 65,346                       |       | 54,738                      |       |
| Total current  liabilities                                                                                                                                                                                                    |       | 176,813                      |       | 145,421                     |       |
|                                                                                                                                                                                                                          |       |                         |       |                        |       |
| Long-term debt                                                                                                                                                                                                                |       | 180,000                      |       | 95,000                      |       |
| Deferred  revenue, non-current                                                                                                                                                                                                |       | 9,250                        |       | 11,325                      |       |
| Other  non-current liabilities                                                                                                                                                                                                |       | 580                          |       | 1,025                       |       |
| Total  liabilities                                                                                                                                                                                                            |       | 366,643                      |       | 252,771                     |       |
|                                                                                                                                                                                                                          |       |                         |       |                        |       |
| Commitments and  contingencies*(see Note 13)*                                                                                                                                                                                 |       |                         |       |                        |       |
|                                                                                                                                                                                                                          |       |                         |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                                                   |       |                         |       |                        |       |
| Preferred stock,  par value $0.001 per share; 5,000 shares authorized; no shares issued and  outstanding                                                                                                                      |       | —                       |       | —                      |       |
| Common stock,  par value $0.001 per share; 200,000 shares authorized; September 26,  2008 —54,486 shares issued and 44,859 outstanding; December 31, 2007 —  53,910 shares issued and 48,283 outstanding; |       | 54                           |       | 54                          |       |
| Additional  paid-in capital                                                                                                                                                                                                   |       | 1,223,288                    |       | 1,208,674                   |       |
| Accumulated  other comprehensive income                                                                                                                                                                                       |       | 689                          |       | 2,130                       |       |
| Accumulated  deficit                                                                                                                                                                                                          |       | (203,584                     | )          | (218,719                    | )          |
| Treasury stock,  at cost; September 26, 2008 — 9,627 shares; December 31, 2007 —  5,627 shares;                                                                                                           |       | (230,926                     | )          | (166,477                    | )          |
| Total  stockholders’ equity                                                                                                                                                                                              |       | 789,521                      |       | 825,662                     |       |
|                                                                                                                                                                                                                          |       |                         |       |                        |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                              |       | $                            | 1,156,164  |                        | $          | 1,078,433 |   |

 

See notesaccompanying these condensed consolidated financial statements.

 

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**AVOCENTCORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited, inthousands)

 
| ** **                                                                         | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **September 26,**                            | ** ** | **September 28,** | ** ** |
| ** **                                                                         | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| ** **                                                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                             | * *   | * *                                          | * *   | * * | * * |
| Net income                                                                         |       | $                                                 | 15,135     |   | $ | 31,863 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                              |       |   |   |
| Depreciation                                                                       |       | 7,027                                             |       | 7,232 |   |
| Amortization of  intangible assets                                                 |       | 34,416                                            |       | 32,677 |   |
| Stock-based  compensation                                                          |       | 16,957                                            |       | 15,074 |   |
| Acquired  in-process research and development expense                              |       | 700                                               |       | — |   |
| Amortization of  discounts on investments                                          |       | —                                            |       | (155 | ) |
| Net loss on  disposition of property and equipment                                 |       | 548                                               |       | 277 |   |
| Excess tax benefit from stock-based  compensation                                  |       | (85                                               | )          | (907 | ) |
| Changes in  operating assets and liabilities (net of effects of acquisitions):     |       |                                              |       |   |   |
| Accounts  receivable, net                                                          |       | (8,214                                            | )          | 11,159 |   |
| Inventories                                                                        |       | 4,521                                             |       | 10,846 |   |
| Other assets                                                                       |       | (3,127                                            | )          | (1,394 | ) |
| Accounts payable                                                                   |       | (4,252                                            | )          | 6,562 |   |
| Accrued wages  and commissions                                                     |       | 4,170                                             |       | (5,860 | ) |
| Accrued other  liabilities and deferred revenue                                    |       | 3,532                                             |       | 1,007 |   |
| Income taxes,  current and deferred                                                |       | (5,167                                            | )          | (9,497 | ) |
| Net cash  provided by operating activities                                         |       | 66,161                                            |       | 98,884 |   |
| ** **                                                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Cash flows from  investing activities:                                             |       |                                              |       |   |   |
| Purchase of  Ergo, net of cash received                                            |       | (28,443                                           | )          | — |   |
| Purchase of  Touchpaper, net of cash received                                      |       | (47,113                                           | )          | — |   |
| Purchase of  other intangible assets                                               |       | (674                                              | )          | (3,841 | ) |
| Purchases of  property and equipment                                               |       | (6,773                                            | )          | (7,027 | ) |
| Purchases of  investments                                                          |       | —                                            |       | (70,568 | ) |
| Maturities and  proceeds from sales of investments                                 |       | 5,942                                             |       | 72,458 |   |
| Net cash used in  investing activities                                             |       | (77,061                                           | )          | (8,978 | ) |
| ** **                                                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Cash flows from  financing activities:                                             | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Borrowings under  term loan                                                        |       | 90,000                                            |       | — |   |
| Borrowings  (repayments) under line of credit, net                                 |       | (5,000                                            | )          | (55,000 | ) |
| Proceeds from  employee stock option exercises                                     |       | 1,484                                             |       | 4,294 |   |
| Excess tax benefit from stock-based  compensation                                  |       | 85                                                |       | 907 |   |
| Purchases of  treasury stock                                                       |       | (64,449                                           | )          | (26,469 | ) |
| Net cash  provided by (used in) financing activities                               |       | 22,120                                            |       | (76,268 | ) |
|                                                                               |       |                                              |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                      |       | (1,502                                            | )          | 1,141 |   |
|                                                                               |       |                                              |       |   |   |
| Net increase in  cash and cash equivalents                                         |       | 9,718                                             |       | 14,779 |   |
| Cash and cash  equivalents at beginning of period                                  |       | 105,183                                           |       | 81,301 |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                 | 114,901    |   | $ | 96,080 |   |

 

See notesaccompanying these condensed consolidated financial statements.

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

Note 1.   Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in conformity with accounting principles generally acceptedin the United States and reflect all adjustments consisting of normal recurringadjustments which, in the opinion of management, are necessary for a fairstatement of the results for the periods shown. The results of operations for these periods are not necessarilyindicative of the results expected for the full fiscal year nor for any futureperiod.  The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenue and expenses during the reporting period.  Actual results could differ from thoseestimates 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, 2007, which is on file with the Securitiesand Exchange Commission and is available at our website, www.avocent.com. Theconsolidated balance sheet presented in the accompanying condensed consolidatedfinancial statements for December 31, 2007, was derived from the auditedfinancial statements filed in our 10-K for the period ended December 31,2007, but does not include all disclosures required by accounting principlesgenerally accepted in the United States of America.

 

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.  Beginning January 1, 2009 we will reportour quarterly periods based on the calendar month end.

 

Our financial statements are consolidated and include the accounts ofAvocent Corporation and our wholly owned subsidiaries.  All significant inter-company transactionsand balances have been eliminated in consolidation.

 

Note 2.   Inventories

 

Inventoriesconsisted of the following at:

 

| ** **      | ** ** | **September 26, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **      | ** ** | ** **                       | ** ** | ** **                      | ** ** |
| Raw materials   |       | $                                | 1,270      |                            | $          | 1,394 |   |
| Work-in-process |       | 300                              |       | 1,058                           |       |
| Finished goods  |       | 27,243                           |       | 27,651                          |       |
| Inventories     |       | $                                | 28,813     |                            | $          | 30,103 |   |

 

Inventories above have been reduced by reserves forexcess and obsolete inventories of $7,227 and $7,328 as of September 26,2008 and December 31, 2007, respectively.

 

Note 3.   Equity and Treasury Stock

 

We issued commonstock as a result of stock option exercise activity during the three and ninemonths ended September 26, 2008 and September 28, 2007 as follows:

 

| ** **              | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **              | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
|                    |       |                                               |       |                                              |       |   |   |   |   |
| Stock option  exercises |       | 73,235                                             |       | 40,225                                            |       | 137,607 |   | 225,974 |   |

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

We issued commonstock as a result of restricted stock unit (RSU) vesting activity during thethree and nine months ended September 26, 2008 and September 28, 2007as follows:

 

| ** **               | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|--------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **               | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
| Net RSUs issued          |       |                                               |       |                                              |       |   |   |   |   |
| RSU’s vested        |       | 27,961                                             |       | 1,434                                             |       | 617,145 |   | 350,553 |   |
| Shares withheld  for tax |       | (4,121                                             | )          | (377                                              | )          | (178,676 | ) | (104,099 | ) |
| Net shares  issued       |       | 23,840                                             |       | 1,057                                             |       | 438,469 |   | 246,454 |   |

 

Share repurchaseactivity during the three and nine months ended September 26, 2008 and September 28,2007 was as follows:

 

| ** **          | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|---------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **          | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
|                |       |                                               |       |                                              |       |   |   |   |   |
| Shares  repurchased |       | —                                             |       | 300,000                                           |       | 4,000,000 |   | 886,267 |   |

 

RSUsgranted — During the first nine months of 2008, our Compensation Committeeapproved the grant of 963,000 time-based and 588,000 market condition-based andperformance conditioned-based restricted stock units to our employees, officersand directors.

 

RSUsaccelerated — During the three and nine months ended September 26, 2008,we accelerated 27,000 and 184,000 RSUs, respectively, in relation to ourrestructuring program (*see note 14*).

 

Note 4.   Accumulated Other Comprehensive Income

 

Werecord unrealized gains and losses on our foreign currency translationadjustments, unrealized gains and losses on derivatives accounted for as cashflow hedges, and unrealized holding gains or losses on our available-for-salesecurities, net of tax, as accumulated other comprehensive income, which isincluded as a separate component of stockholders’ equity.  Comprehensive income for the nine monthsended September 26, 2008 and September 28, 2007 is as follows:

 

| ** **                               | ** ** | **Nine months ended** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **September 26,  2008**    | ** ** | **September 28,  2007** | ** ** |
|                                     |       |                            |       |   |   |
| Net income                               |       | $                               | 15,135     |   | $ | 31,863 |   |
| Unrealized gains  on investments         |       | —                          |       | 87 |   |
| Unrealized gains  on cash flow hedges    |       | 430                             |       | 142 |   |
| Foreign currency  translation adjustment |       | (1,871                          | )          | 1,228 |   |
| Total  comprehensive income              |       | $                               | 13,694     |   | $ | 33,320 |   |

 

Asof September 26, 2008 and December 31, 2007, total accumulated othercomprehensive income was $689 and $2,130, respectively.

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

Note 5.   Earnings Per Share (*share datain thousands*)

 
| ** **                                                           | ** ** | **Income (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per-Share  Amount** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|-----------------------|------------|
| ** **                                                           | ** ** | ** **                  | ** ** | ** **                | ** ** | ** **            | ** ** |
| **For the  three months ended September 26, 2008**              |       |                        |       |                      |       |                  |       |
| **Basic  EPS**                                                       |       |                        |       |                      |       |                  |       |
| Net income  available to common stockholders                         |       | $                           | 10,961     |                      | 44,792     |                  | $          | 0.24 |   |
| **Effect  of Dilutive Securities**                                   |       |                        |       |                      |       |                  |       |
| Stock options  and unvested restricted stock awards                  |       | —                      |       | 675                       |       | —                |       |
| **Diluted  EPS**                                                     |       |                        |       |                      |       |                  |       |
| Net income  available to common stockholders and assumed conversions |       | $                           | 10,961     |                      | 45,467     |                  | $          | 0.24 |   |
|                                                                 |       |                        |       |                      |       |                  |       |
| **For the  three months ended September 28, 2007**              |       |                        |       |                      |       |                  |       |
| **Basic  EPS**                                                       |       |                        |       |                      |       |                  |       |
| Net income  available to common stockholders                         |       | $                           | 16,177     |                      | 50,310     |                  | $          | 0.32 |   |
| **Effect  of Dilutive Securities**                                   |       |                        |       |                      |       |                  |       |
| Stock options  and unvested restricted stock awards                  |       | —                      |       | 839                       |       | —                |       |
| **Diluted  EPS**                                                     |       |                        |       |                      |       |                  |       |
| Net income available  to common stockholders and assumed conversions |       | $                           | 16,177     |                      | 51,149     |                  | $          | 0.32 |   |
|                                                                 |       |                        |       |                      |       |                  |       |
| **For the  nine months ended September 26, 2008**               |       |                        |       |                      |       |                  |       |
| **Basic  EPS**                                                       |       |                        |       |                      |       |                  |       |
| Net income  available to common stockholders                         |       | $                           | 15,135     |                      | 45,241     |                  | $          | 0.33 |   |
| **Effect  of Dilutive Securities**                                   |       |                        |       |                      |       |                  |       |
| Stock options  and unvested restricted stock awards                  |       | —                      |       | 627                       |       | —                |       |
| **Diluted  EPS**                                                     |       |                        |       |                      |       |                  |       |
| Net income  available to common stockholders and assumed conversions |       | $                           | 15,135     |                      | 45,868     |                  | $          | 0.33 |   |
|                                                                 |       |                        |       |                      |       |                  |       |
| **For the  nine months ended September 28, 2007**               |       |                        |       |                      |       |                  |       |
| **Basic  EPS**                                                       |       |                        |       |                      |       |                  |       |
| Net income  available to common stockholders                         |       | $                           | 31,863     |                      | 50,506     |                  | $          | 0.63 |   |
| **Effect  of Dilutive Securities**                                   |       |                        |       |                      |       |                  |       |
| Stock options  and unvested restricted stock awards                  |       | —                      |       | 893                       |       | —                |       |
| **Diluted  EPS**                                                     |       |                        |       |                      |       |                  |       |
| Net income  available to common stockholders and assumed conversions |       | $                           | 31,863     |                      | 51,399     |                  | $          | 0.62 |   |

 

Anti-dilutive options to purchase commonstock outstanding and anti-dilutive RSUs were excluded from the calculationsabove. Anti-dilutive options and anti-dilutive RSUs totaled 3,871 and 4,074 forthe three and nine months ended September 26, 2008, respectively.  Anti-dilutive options and anti-dilutive RSUstotaled 2,192 and 2,203 for the three and nine months ended September 28,2007, respectively.

 

Note 6.   Segment Reporting

 

In thefirst quarter of 2008, we dissolved our Desktops Solutions Business Unit (DS)and transferred some of its personnel and a portion of its technology intoManagement Systems.  DS’ results werepreviously reported within our Other Business Units segment.  The related revenue and expenses of DS havenot been material to our consolidated results, and this business unit wasdissolved rather than being merged into another business unit.  Accordingly, we will continue to report historicalresults for DS within our Other Business Units segment.  In addition, no goodwill was allocated tothis business unit 

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

and all relatedintangible assets were fully amortized prior to the dissolution of the businessunit. Accordingly, there was no related write-off of goodwill or write-down ofintangible assets as a result of the dissolution of this business unit. Costsassociated with the dissolution of DS are included in retirement andrestructuring expenses for the first quarter of 2008 (*see note 14*).

 

In July 2008,we announced our intention to sell (or license the technology of) the majorityof our emerging Connectivity and Control Business Unit.  We have divided this entrepreneurial businessunit into its three product lines, the Equinox branded serial business, theBroadcast business and the Pro Audio Visual business.  We have folded our Broadcast product lineinto Management Systems and intend to sell (or license the technology of) theremaining two parts of this business. All revenues and costs associated with the Broadcast business areincluded within Management Systems and historical results have been adjusted toinclude the Broadcast business in Management Systems.

 

We evaluate theperformance of our segments based on revenue and operating income, which iscalculated before corporate and unallocated costs, amortization of intangibles,acquired in-process research and development expense, restructuring,integration and  retirement costs, andstock compensation costs.  We do nottrack or use assets by segment as a measure of performance, therefore, we havenot presented assets by segment.  Thefollowing is a presentation of information for our two reportable segments,Management Systems and LANDesk:

** **
| ** **                                                         | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                         | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
| Net revenue:                                                       |       |                                               |       |                                              |       |   |   |   |   |
| Management  Systems                                                |       | $                                                  | 138,011    |                                              | $          | 129,222 |   | $ | 370,434 |   | $ | 351,580 |   |
| LANDesk                                                            |       | 41,559                                             |       | 28,648                                            |       | 102,594 |   | 80,065 |   |
| Other business  units                                              |       | 2,972                                              |       | 3,819                                             |       | 8,561 |   | 11,788 |   |
| Corporate and  unallocated                                         |       | 506                                                |       | 981                                               |       | 2,040 |   | 3,889 |   |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | —                                             |       | (598                                              | )          | — |   | (1,874 | ) |
| Total net  revenue                                                 |       | $                                                  | 183,048    |                                              | $          | 162,072 |   | $ | 483,629 |   | $ | 445,448 |   |

** **
| ** **                                                         | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                         | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
| Operating income  (loss):                                          |       |                                               |       |                                              |       |   |   |   |   |
| Management  Systems                                                |       | $                                                  | 39,649     |                                              | $          | 43,821 |   | $ | 97,415 |   | $ | 105,304 |   |
| LANDesk                                                            |       | 7,620                                              |       | 885                                               |       | 12,161 |   | 969 |   |
| Other business  units                                              |       | (1,015                                             | )          | (3,154                                            | )          | (4,064 | ) | (9,360 | ) |
| Corporate and  unallocated costs                                   |       | (6,844                                             | )          | (3,856                                            | )          | (21,515 | ) | (10,779 | ) |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | —                                             |       | (598                                              | )          | — |   | (1,874 | ) |
| Acquired  research and development expense                         |       | (700                                               | )          | —                                            |       | (700 | ) | — |   |
| Amortization of  intangibles and other expenses                    |       | (13,191                                            | )          | (10,350                                           | )          | (34,043 | ) | (32,366 | ) |
| Restructuring,  integration and retirement expenses                |       | (5,446                                             | )          | —                                            |       | (10,628 | ) | — |   |
| Stock-based  compensation expense                                  |       | (6,287                                             | )          | (6,310                                            | )          | (16,962 | ) | (15,074 | ) |
| Total income  from operations                                      |       | $                                                  | 13,786     |                                              | $          | 20,438 |   | $ | 21,664 |   | $ | 36,820 |   |
|                                                               |       |                                               |       |                                              |       |   |   |   |   |
| Other income  (expense)                                            |       | 389                                                |       | (572                                              | )          | (1,330 | ) | (3,593 | ) |
| Income before  provision for income taxes                          |       | $                                                  | 14,175     |                                              | $          | 19,866 |   | $ | 20,334 |   | $ | 33,227 |   |

** **

Sales by productline for Management Systems and LANDesk for the three and nine months ended September 26,2008 and September 28, 2007 are as follows:

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 
| ** **                            | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|---------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                            | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
| Management  Systems net revenue:      |       |                                               |       |                                              |       |   |   |   |   |
| KVM                                   |       | $                                                  | 97,101     |                                              | $          | 99,181 |   | $ | 268,350 |   | $ | 268,917 |   |
| Serial  management                    |       | 13,517                                             |       | 13,387                                            |       | 39,572 |   | 37,425 |   |
| Embedded  software and solutions      |       | 10,229                                             |       | 8,662                                             |       | 26,981 |   | 24,136 |   |
| Other                                 |       | 17,164                                             |       | 7,992                                             |       | 35,531 |   | 21,102 |   |
| Total Management  Systems net revenue |       | $                                                  | 138,011    |                                              | $          | 129,222 |   | $ | 370,434 |   | $ | 351,580 |   |

 
| ** **                 | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
| LANDesk net  revenue:      | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Licenses and  royalties    |       | $                                                  | 22,092     |                                              | $          | 16,741 |   | $ | 57,919 |   | $ | 46,912 |   |
| Maintenance and  services  |       | 19,467                                             |       | 11,907                                            |       | 44,675 |   | 33,153 |   |
| Total LANDesk  net revenue |       | $                                                  | 41,559     |                                              | $          | 28,648 |   | $ | 102,594 |   | $ | 80,065 |   |

 

We sell ourproducts internationally to customers in several countries; however no foreigncountry accounted for more than 10% of sales in the first nine months of 2008or 2007.

 

Followingis a presentation of long-lived tangible assets by geography as of September 26,2008 and December 31, 2007:

 

| ** **                   | ** ** | **September 26,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Long-lived  tangible assets: |       |                         |       |                        |       |
| United States                |       | $                            | 26,187     |                        | $          | 26,266 |   |
| International                |       | 10,797                       |       | 11,032                      |       |
| Total                        |       | $                            | 36,984     |                        | $          | 37,298 |   |

** **

**Note 7.   ForwardContracts and Interest Rate Swap**

** **

We use forward contracts to reduce our foreigncurrency exposure related to the net cash flows from our internationaloperations.  The majority of thesecontracts are short-term contracts (three months or less) and aremarked-to-market each quarter and included in trade payables, with theoffsetting gain or loss included in other income (expense) in the accompanyingconsolidated statements of income.  As ofSeptember 26, 2008, we had 4 open forward contracts with an approximatefair value of $(14).  As of December 31,2007, we had three open forward contracts with an approximate fair value of $8.

 

As of September 26,2008 we have two interest rate swaps, which are recorded on our balancesheet.  In 2006, we entered into aninterest rate swap agreement with a notional amount of $125,000.  The notional amount of the interest rate swapwas $20,000 as of September 26, 2008.   The swap was effective on August 31, 2006 and terminates on December 31,2008.  The swap calls for us to make fixed rate payments of 5.42% over theterm of the hedge and to receive floating rate payments based on LIBOR(matching the LIBOR rate in the line of credit above) from thecounter-party.   On May 1, 2008, weentered into an interest rate swap agreement with a notional amount of $80,000.  The notional amount of the interest rate swapwas $80,000 as of September 26, 2008. The swap was effective on May 1, 2008 and terminates on December 31,2009.  The swap calls for us to make fixed rate payments of 3.05% over theterm of the hedge and to receive floating rate payments based on LIBOR(matching the LIBOR rate in the line of credit above) from the counter-party.

 

Theobjective of the rate swap agreements is to provide a hedge against risingLIBOR interest rates that would have a negative effect on our cash flows due tochanges in interest rates on our credit agreements. We anticipate these hedgeswill be settled upon maturity and are being accounted for as a cash flowhedges.  The interest rate swaps arerecorded at fair value 

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

each reportingperiod with the changes in the fair value of the hedge that take place throughthe date of maturity recorded in accumulated other comprehensive income (OCI).

 

At September 26,2008, we recorded a net unrealized gain on the interest rate swaps, net of tax,of $430 in accumulated OCI. There was no significant ineffectiveness in thenine months of 2008, and we anticipate no significant ineffectivenessthroughout the remainder of 2008.

 

**Note 8.   Acquisitions**

** **

**TouchpaperGroup Limited** — On June 30, 2008, we acquired TouchpaperGroup Limited, a privately-held company based in Woking, U.K.(Touchpaper).  Touchpaper employedapproximately 200 people, located primarily in the UK.  We acquired Touchpaper for $45,740 in cashconsideration plus assumed liabilities and acquisitions costs.   The Touchpaper product lines includesoftware for incident management, problem management and service deskmanagement.  We believe the acquisition ofTouchpaper and its products will enhance and expand our IT Operations Managementsolutions and products.  The results ofTouchpaper’s operations have been included in the consolidated financialstatements since the date of acquisition.

 

The acquisition was recorded under the purchase methodof accounting, and the purchase cost was allocated based on the fair value ofthe assets acquired and liabilities assumed. In accordance with generally accepted accounting principles, purchasedresearch and development costs allocated to patented and patent-pendingtechnology were capitalized and will be amortized over the respective estimateduseful lives.  The remaining amounts ofpurchased research and development were expensed upon the closing of thetransaction.  The goodwill recorded as aresult of the acquisition will not be amortized but will be allocated to ourLANDesk business unit (see Note 9) and will be included in Avocent’s annualreview of goodwill for impairment.  Amortizationof the other intangible assets acquired and the goodwill recorded is not taxdeductible. Our preliminary allocation of the purchase consideration, excludingcash received, is as follows:

 

| Cash paid for  outstanding shares  |   | $      | 45,740 |   |
|------------------------------------|--------|--------|--------|--------|
| Acquisition  costs paid by Avocent |   | 4,248  |   |
|                               |   |   |   |
| Total purchase  consideration      |   | $      | 49,988 |   |

 

We funded theacquisition through available cash and through borrowings on the line ofcredit.  On the closing of the Touchpapertransaction, we acquired $2,875 in cash held by Touchpaper.

 

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                 |       | $                               | 14,583     |                     | —     |   |
| In-process  research and development |       | 700                             |       | —                   |       |
| Developed  technology                |       | 29,000                          |       | 5 years                  |       |
| Maintenance  contracts               |       | 8,000                           |       | 5 years                  |       |
| Customer base                        |       | 2,000                           |       | 5 years                  |       |
| Trademarks                           |       | 100                             |       | 3 years                  |       |
| Non-compete  agreements              |       | 125                             |       | 3 years                  |       |
| Goodwill                             |       | 23,630                          |       | —                   |       |
| Deferred taxes                       |       | (10,921                         | )          | —                   |       |
| Assumed  liabilities                 |       | (17,229                         | )          | —                   |       |
|                                 |       |                            |       |                     |       |
|                                 |       | $                               | 49,988     |                     |       |   |

 

The capitalizedamounts will be amortized on a straight-line basis over the estimated life ofthe intangibles.  An escrow account withapproximately $11,200 in cash is held for indemnifiable claims for a period of24 months after the acquisition.

 

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** **

**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

The $700 in fair value of all of the in-processresearch and development (“IPR&D”) received in the acquisition wasdetermined using a form of the discounted cash flow method known as themulti-period excess earnings method. These amounts were for particular research and development projects thathave no alternative future uses and were therefore expensed rather thancapitalized at the time of purchase.

 

Touchpaper’s in-process research and developmentactivities consisted of the development of its ITBM Version 7.2.6software product. This product was completedduring October 2008.

 

The new generations of products under development areprojected to sell through sales channels and to customers that aresubstantially the same as current and historical sales channels andcustomers.  Pricing and margins will notdiffer significantly from historical pricing and margins.  Revenue for the project under development wasprojected through 2017.  Net incomeattributable to IPR&D was calculated by applying Touchpapers’ projectedgross, operating, and net profit margins to IPR&D revenue, whileconsidering Avocent’s historical results and industry prospects.  This product has an estimated economic lifeof approximately 7 years.  The discountrate used to value IPR&D was 21%.

 

**Ergo 2000, Inc. —**  On July 10, 2008 we acquired certainassets and assumed certain liabilities of Ergo 2000, Inc. (Ergo), aprivately held provider of rack-mounted LCD consoles with approximately 35employees based in Fullerton, California, for approximately $29,000 plusacquisition costs paid by Avocent. Ergo’s products were integrated into theManagement Systems business unit as part of that unit’s overall productoffering and related operating results were included in the consolidatedfinancial statements since the date of acquisition.

 

The acquisition was recorded under the purchase method of accounting,and the purchase price was allocated based on the fair value of the assetsacquired and liabilities assumed.  Thegoodwill recorded as a result of the acquisition will be allocated to our ManagementSystems unit and will not be amortized but will be included in our annualreview of goodwill for impairment. Amortization of the other intangible assets acquired and the goodwillrecorded is tax deductible.  Ourpreliminary allocation of the purchase consideration, excluding cash received,is as follows:

 

| Cash  consideration paid to owners         |   | $     | 27,500 |   |
|--------------------------------------------|--------|-------|--------|--------|
| Cash paid to  settle owners line of credit |   | 1,505 |   |
| Acquisition  costs paid by Avocent         |   | 307   |   |
| Total estimated  purchase consideration    |   | $     | 29,312 |   |

 

We fundedthe acquisition through available cash and borrowings from our line ofcredit.  On the closing of the Ergotransaction, we acquired $869 in cash held by Ergo.

 

The purchase consideration was allocated, on apreliminary basis, to the estimated fair values of the assets acquired andliabilities assumed, as follows:

 

| ** **              | ** ** | **Purchase  Price  Allocation** | ** ** | **Amortization  Period** | ** ** |
|-------------------------|------------|---------------------------------|------------|--------------------------|------------|
| Tangible assets         |       | $                               | 7,023      |                     | —     |   |
| Customer base           |       | 18,400                          |       | 5 years                  |       |
| Non-compete  agreements |       | 1,000                           |       | 3 years                  |       |
| Goodwill                |       | 5,031                           |       | —                   |       |
| Assumed  liabilities    |       | (2,142                          | )          | —                   |       |
|                    |       | $                               | 29,312     |                     |       |   |

 

The capitalizedamounts will be amortized on a straight-line basis over the estimated life ofthe intangibles.  An escrow account with$3,500 in cash is held for indemnifiable claims until February 1, 2010.

 

**Pro Forma Financial Information -**The following unaudited pro forma summary combines theresults of operations of Avocent, Touchpaper and Ergo as if the acquisitionshad occurred prior to the beginning of each period presented.  Certain adjustments have been made to reflectthe impact of the purchase transactions. These pro forma results have been prepared 

 

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** **

**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

forcomparative purposes only and do not purport to be indicative of what wouldhave occurred had the acquisitions been made at the beginning of each periodpresented, or of results which may occur in the future.

 

| ** **                | ** ** | **For the Three Months Ended** | ** ** | **For the Nine Months Ended** | ** ** |
|---------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                | ** ** | **Sept. 26, 2008**                       | ** ** | **Sept. 28, 2007**                      | ** ** | **Sept. 26, 2008** | ** ** | **Sept. 28, 2007** | ** ** |
| Net sales                 |       | $                                                  | 183,431    |                                              | $          | 179,018 |   | $ | 515,957 |   | $ | 496,292 |   |
| Net income                |       | $                                                  | 11,589     |                                              | $          | 14,638 |   | $ | 12,624 |   | $ | 27,430 |   |
| Income per basic  share   |       | $                                                  | 0.26       |                                              | $          | 0.29 |   | $ | 0.28 |   | $ | 0.54 |   |
| Income per  diluted share |       | $                                                  | 0.26       |                                              | $          | 0.29 |   | $ | 0.28 |   | $ | 0.53 |   |

** **

**The aboveamounts exclude acquired in-process research and development expense of $700for the three and nine months ended September 26, 2008 and September 28,2007, related to the Touchpaper acquisition.**

** **

Note 9.   Goodwilland Other Intangible Assets

 

**Other intangibleassets subject to amortization were as follows:**

** **

| ** **                                | ** ** | **September 26, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **Gross  Carrying  Amounts**     | ** ** | **Accumulated  Amortization**   | ** ** | **Gross  Carrying  Amounts** | ** ** | **Accumulated  Amortization** | ** ** |
|                                      |       |                             |       |                            |       |   |   |   |   |
| Developed  technology                     |       | $                                | 85,840     |                            | $          | 27,483 |   | $ | 56,840 |   | $ | 17,292 |   |
| Internally  developed software for resale |       | 21,900                           |       | 7,604                           |       | 21,900 |   | 4,867 |   |
| Patents and  trademarks                   |       | 30,958                           |       | 9,808                           |       | 30,670 |   | 6,590 |   |
| Customer base  and certifications         |       | 119,978                          |       | 38,250                          |       | 99,878 |   | 25,496 |   |
| Maintenance  contracts                    |       | 17,600                           |       | 4,400                           |       | 9,600 |   | 2,560 |   |
| Non-compete  agreements                   |       | 11,325                           |       | 7,747                           |       | 10,624 |   | 5,432 |   |
| Other                                     |       | 2,310                            |       | 2,179                           |       | 2,310 |   | 1,603 |   |
|                                      |       | $                                | 289,911    |                            | $          | 97,471 |   | $ | 231,822 |   | $ | 63,840 |   |

** **

**For the threemonths ended September 26, 2008 and September 28, 2007, amortizationexpense for other intangible assets was $13,383 and $10,469, respectively.  For the nine months ended September 26,2008 and September 28, 2007, amortization expense for other intangibleassets was $34,416 and $32,677, respectively. The approximate estimated annual amortization for other intangibles isas follows:**

** **

| **Years ending December 31:** | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|
| 2008, remainder                              |       | $          | 13,973     |   |
| 2009                                         |       | $          | 50,195     |   |
| 2010                                         |       | $          | 46,194     |   |
| 2011                                         |       | $          | 37,860     |   |
| 2012                                         |       | $          | 28,742     |   |
| Thereafter                                   |       | $          | 15,476     |   |

** **

**We evaluategoodwill for impairment in the fourth quarter of each fiscal year, unless circumstancesdictate measurement at an interim date.**

 

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** **

**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

** **

**The changes inthe carrying amount of goodwill for the year ended December 31, 2007, areas follows:**

** **

| ** **                                            | ** ** | **Management** | ** ** | ** **  | ** ** | **Other  Business** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|----------------|------------|-------------|------------|---------------------|------------|------------|------------|
| ** **                                            | ** ** | **Systems**    | ** ** | **LANDesk** | ** ** | **Units**           | ** ** | **Total**  | ** ** |
|                                                  |       |           |       |        |       |                |       |       |       |
| Balance as of  January 1, 2008                   |       | $              | 328,011    |        | $          | 252,355             |       | $          | 4,583      |   | $ | 584,949 |   |
|                                                  |       |           |       |        |       |                |       |       |       |
| Transfer of Broadcast  goodwill to Management Systems |       | 1,150          |       | —      |       | (1,150              | )          | —     |       |
|                                                  |       |           |       |        |       |                |       |       |       |
| Acquisition of  Touchpaper                            |       | —         |       | 23,630      |       | —              |       | 23,630     |       |
|                                                  |       |           |       |        |       |                |       |       |       |
| Acquisition of  Ergo                                  |       | 5,031          |       | —      |       | —              |       | 5,031      |       |
|                                                  |       |           |       |        |       |                |       |       |       |
| Balance as of  September 26, 2008                |       | $              | 334,192    |        | $          | 275,985             |       | $          | 3,433      |   | $ | 613,610 |   |

** **

**The goodwilltransfer from our other business units to Management Systems resulted from thetransfer of our**Broadcast product line (*see Note 6*).  Weallocated goodwill related to Connectivity and Control to its three productslines based on their relative fair Values. Approximately $1,150 was allocated to the Broadcast product linetransferred to Management Systems.

** **

**We perform anannual impairment test of goodwill in the fourth quarter of each year unlesscircumstances call for an intirim test. We have not yet completed our impairment test in the fourth quarter of2008 as of this filing but do not anticipate an adjustment will be requiredbased on our recent financial results and expected future results.  However, our business and operating resultsdepend to a significant extent on economic conditions in general and on ITspending in particular.  Any adversechange in IT spending due to adverse economic conditions, declining capitalspending levels, or other factors could have a material adverse effect on ourbusiness, financial condition, and results of operations.**  Recent news regarding the U.S and global economy indicate aslowing economy and our market capitalization has recently been below bookvalue.  Accordingly, and as required bySFAS 142, we will continue to monitor our goodwill for potential impairment inlight of this general economic uncertainty.

** **

**Note 10.  ProductWarranties and Deferred Revenue**

** **

We include anaccrued liability for warranty returns in our balance sheet within accruedcurrent liabilities. The activity within the liability for warranty returns forthe nine months ended September 26, 2008 was as follows:

 

| Balance,  January 1, 2008                            |   | $      | 1,854  |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Accruals for  product warranties issued during the period |   | 7,161  |   |
| Assumed on  acquisition                                   |   | 35     |   |
| Settlements made  during the period                       |   | (6,747 | )      |
| Balance,  September 26, 2008                         |   | $      | 2,303  |   |

 

We include anaccrued liability for extended warranty program in our balance sheet withindeferred revenue. The activity within deferred revenue for our extendedwarranty program for the nine months ended September 26, 2008 was asfollows:

 

| Balance,  January 1, 2008                        |   | $      | 5,388  |   |
|-------------------------------------------------------|--------|--------|--------|--------|
| New extended  warranty contracts                      |   | 3,362  |   |
| Earned revenue  from amortization of deferred revenue |   | (2,978 | )      |
| Balance,  September 26, 2008                     |   | $      | 5,772  |   |

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

We defer revenuefor subscription, service and maintenance contracts until earned, which isgenerally over the term of the contract or when services are performed.Deferred revenue was $68,812 as of September 26, 2008 and $60,647 as of December 31,2007.

 

Note 11. Income Taxes

 

The effective taxrate in the third quarter of 2008 was a provision of 22.7% compared to aprovision of 18.9% in the third quarter of 2007.  The provision for income taxes was $3,214 forthe third quarter of 2008, compared to a provision of $3,749 in the thirdquarter of 2007.  The effective tax ratefor the first nine months of 2008 was a provision of 25.6% compared to aprovision of 4.1% for the first nine months of 2007.  The provision for income taxes was an expenseof $5,199 for the first nine months of 2008, compared to an expense of $1,364for the first nine months of 2007.  Theincrease in the effective tax rate was primarily the result of the change inthe amount and mix of our pre-tax book income within taxable jurisdictions anda tax benefit recognized during the second quarter of 2007 associated within-process R&D previously charged to book expense.

 

During the secondquarter of 2007, we made certain elections under the Internal Revenue Code Sec.338(g) related to the LANDesk acquisition in August 2006.  As aresult of making these elections, the acquisition was treated for U.S. taxpurposes as an asset acquisition where we stepped up the tax basis in assetsand liabilities previously recognized in the purchase accounting.  We hadpreviously accounted for this acquisition as a qualified stock purchase, withcarryover tax basis in the assets and liabilities recorded.  Ourpreliminary purchase price allocation was based upon the initial structure ofthe transaction and did not take into consideration the tax impacts shouldthose elections be made within the required time period, including the taximpacts associated with the amount assigned to in-process R&D that wascharged to expense at acquisition.  During the second quarter of 2007, wereconsidered the measurement of deferred taxes related to this businesscombination to take into consideration the tax impacts of the electionsmade.  As a result, we adjusted the deferred tax accounts with the offsetreducing the amount of goodwill previously recognized from thistransaction.  In addition, we recognized a tax benefit of $6,500 during thequarter ended September 28, 2007 to take into consideration the taximpacts associated with the in-process R&D previously charged to expense ona gross basis at acquisition.

 

As of September 26,2008, we had total reserves for uncertain tax positions related to grossunrecognized tax benefits of $5,248, of which $3,486, if recognized, wouldaffect our effective tax rate.  Werecognize potential accrued interest and penalties related to unrecognized taxbenefits from our global operations within income tax expense. We recorded $394of such expenses during the first nine months of 2008.  As of September 26, 2008, we had accruedinterest payable related to the unrecognized tax benefits of $842.

 

We conductbusiness globally, and as a result our subsidiaries file income tax returns inthe U.S. federal jurisdiction and various state and foreign jurisdictions.  In the normal course of business we aresubject to examinations by taxing authorities throughout the world includingthe U.S.  With few exceptions, we are nolonger subject to U.S. federal, state, and local, and non-U.S. income taxexaminations for tax years prior to 2005.

 

In 2006, theInternal Revenue Service (IRS) commenced an examination of our U.S. income taxreturns for 2004 and 2005.  During the firstquarter of 2008, the IRS proposed certain adjustments relating primarily totransfer pricing, increasing our tax liabilities for those periods.  We reached a negotiated settlement with theIRS related to those adjustments resulting in an additional tax payment of$6,600, which we had accrued prior to 2008 and was paid during the firstquarter of 2008.   A payment for interestof $1,430, which we had previously accrued, associated with the additional taxliability was paid during the second quarter of 2008. During the third quarterof 2008, the IRS commenced an examination of our US income tax returns for 2006and 2007.   As of September 26, 2008the IRS has not issued any proposed adjustments for those periods.

 

Note 12. Fair ValueMeasurements

 

In September 2006, the FASB issued SFAS No. 157,“*Fair Value Measurements,*” (SFAS 157),which is effective for fiscal years beginning after November 15, 2007 andfor interim periods within those years. This statement defines fair value,establishes a framework for measuring fair value, and expands the relateddisclosure requirements. This statement applies under other accountingpronouncements that require or permit fair value measurements. The statementindicates, among other 

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

things,that a fair value measurement assumes that the transaction to sell an asset ortransfer a liability occurs in the principal market for the asset or liabilityor, in the absence of a principal market, the most advantageous market for theasset or liability. SFAS 157 defines fair value based upon an exit price model.We adopted SFAS 157 as of January 1, 2008, with the exception of theapplication of the statement to nonfinancial assets and nonfinancialliabilities. Nonfinancial assets and nonfinancial liabilities for which we havenot applied the provisions of SFAS 157 include those measured at fair value ingoodwill impairment testing, indefinite lived intangible assets measured atfair value for impairment testing, and those initially measured at fair valuein a business combination.

 

Relative to SFAS 157, the FASB issued FASB StaffPositions (FSP) 157-1, 157-2 and 157-3. FSP 157-1 amends SFAS 157 to excludeSFAS No. 13, “*Accounting for Leases*,”(SFAS 13) and its related interpretive accounting pronouncements that addressleasing transactions, while FSP 157-2 delays the effective date of theapplication of SFAS 157 to fiscal years beginning after November 15, 2008for all nonfinancial assets and nonfinancial liabilities that are recognized ordisclosed at fair value in the financial statements on a nonrecurringbasis.   FSP 157-3 clarified theapplication of SFAS 157 in determining the fair value of financial assets whenthe markets for those assets are inactive. FSP 157-3 was effective on issuancein October 2008, including periods in which financial results have notbeen issued.  We are currently evaluatingthese FSPs, but do not believe they will have a material impact on ourfinancial statements.

 

SFAS 157 establishes a valuation hierarchy fordisclosure of the inputs to valuation used to measure fair value. Thishierarchy prioritizes the inputs into three broad levels as follows. Level 1inputs are quoted prices (unadjusted) in active markets for identical assets orliabilities. Level 2 inputs are quoted prices for similar assets andliabilities in active markets or inputs that are observable for the asset orliability, either directly or indirectly through market corroboration, forsubstantially the full term of the financial instrument. Level 3 inputs areunobservable inputs based on our own assumptions used to measure assets andliabilities at fair value. A financial asset or liability’s classificationwithin the hierarchy is determined based on the lowest level input that issignificant to the fair value measurement.

 

The following table provides the assets andliabilities carried at fair value measured on a recurring basis as of September 26,2008:

 

| ** **              | ** ** | ** **                                               | ** ** | **Fair value measurements at Sept. 26, 2008** | ** ** |
|-------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **              | ** ** | **Total  Carrying  Value at  Sept. 26,  2008** | ** ** | **Quoted  prices in  active  markets  (Level 1)**                 | ** ** | **Significant  other  observable  inputs  (Level 2)** | ** ** | **Significant  unobservable  inputs  (Level 3)** | ** ** |
|                    |       |                                                     |       |                                                                        |       |   |   |   |   |
| Money market  funds     |       | $                                                        | 35,814     |                                                                        | $          | 35,814 |   | — |   | — |   |
| Derivative  liabilities |       | $                                                        | 330        |                                                                        | $          | — |   | $ | 330 |   | $ | — |   |
|                         |            |                                                          |            |                                                                             |            |  |  |  |  |  |  |  |  |

 

The fair market value of our money market fundsis measured at fair value using quoted prices in active markets.  These fair value measurements are classifiedwithin Level 1 of the valuation hierarchy.

 

The fair market value of “over-the-counter”derivatives is measured at fair value using expected cash flows over the lifeof the trade.  The fair value measurementis prepared using the closing mid-market rate/price environment on September 26,2008, using proprietary models, available market data and reasonableassumptions.  These fair value measurementsare classified within Level 2 of the valuation hierarchy.

 

Note 13.  Legal Matters

 

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

 

In January 2008,Avocent Redmond Corp. filed a complaint for unauthorized use of patentedinventions against the United States government in the United States Court ofFederal Claims.  The complaint alleges that the United States

 

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**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

government acceptedproducts manufactured and sold by Rose Electronics that are covered by patentsheld by Avocent Redmond.  The United States has answered and RoseElectronics has intervened.

 

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

 

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

 

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

 

We acquiredLANDesk Group Limited, a privately-held company, in August 2006, and theacquisition agreements provided for total initial consideration ofapproximately $407 million and a potential earn-out payment to the formershareholders of LANDesk of up to $60 million if LANDesk achieved specifiedrevenue targets for the full year of 2006.  Based on LANDesk’s 2006revenue results, we concluded that LANDesk did not achieve the minimum revenuetarget required to cause any earn-out payment and that no earn-out was earnedor payable.  Accordingly, we did not pay, and have not accrued for, anyearn-out payment.  The Shareholder Representative for the formershareholders of LANDesk has instituted the arbitration procedure describedin the acquisition agreements and is challenging our conclusion that noearn-out was earned or payable. We are in the process of preparing for thatarbitration proceeding.

 

We intend tovigorously defend each of these matters, but the outcome of any claim,litigation, or proceeding is always inherently uncertain.  Based on the facts and circumstancescurrently known to us, we believe that resolution of the foregoing matterswill not materially affect our operations, financial condition, or cash flows.

 

**Note 14. Restructuring, Integration and Retirement**

** **

During the thirdquarter of 2008, we announced a series of restructuring actions and began theintegration of our Ergo and Touchpaper acquisitions.  The restructuring and integration actions aredesigned to enhance competitiveness, improve efficiency, and reduce our overallcost structure.  The restructuring andintegration costs along with costs associated with our former CEO retirementincurred in the first quarter of 2008, have been separately identified as “Restructuring,integration and retirement expenses” within our operating expenses.  Restructuring and integration expensesinclude severance charges incurred for certain workforce reductions, costsassociated with the reduction of certain research and development investments,cost associated with the integration of marketing functions, and the costsassociated with the relocation of certain functions from our Redmond,Washington facility to Huntsville, Alabama.

 

We recorded $5,926and $13,627 for the three and nine months ended September 26, 2008,respectively.  These costs include stockcompensation costs of $480 and $2,999 for the three and nine months ended September 26,2008, respectively (see note 3).  Thesecosts also include $936 of integration related costs in the three and ninemonths ended September 26, 2008 and approximately $1,400 of costs to be settledin cash related to the retirement of our CEO in the first quarter of 2008.  The balance of these costs relates toseverance charges and other costs to be settled in cash.  As of September 26, 2008 we had accruedapproximately $6,012 related to severance costs, which was included in accruedwages and commissions in our consolidated balance sheet.  All costs associated with our restructuringand integration program were carried at the corporate level, none of thesecosts were allocated to a specific business unit.

 

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** **

**AVOCENTCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

(Unaudited, inthousands, except share data)

 

A rollforward ofthe liability for severance charges and other costs settled in cash associatedwith our restructuring programs is as follows:

 
|                                |   |   |   |
|-------------------------------------|--------|--------|--------|
| Balance,  January 1, 2008      |   | $      | — |   |
| Accruals for  severance costs       |   | 8,280  |   |
| Settlements made  during the period |   | (2,268 | )      |
| Balance,  September 26, 2008   |   | $      | 6,012  |   |

 

Excluding stockcompensation costs, we expect to record an additional $3,000 to $4,000 in thefourth quarter of 2008, for restructuring and integration expenses.  Most of these costs will be paid during thefourth quarter of 2008 and the first quarter of 2009.

 

**Note 15. Recently Issued Accounting Pronouncements**

 

In February 2007, the FASB issued SFAS No. 159,“*The Fair Value Option for Financial Assetsand Financial Liabilities — Including an amendment of FASB Statement No. 115”*(SFAS 159).  SFAS No. 159permits an entity to elect fair value as the initial and subsequent measurementattribute for many financial assets and liabilities.  Entities electing the fair value option wouldbe required to recognize changes in fair value in earnings.  Entities electing the fair value option arerequired to distinguish, on the face of the statement of financial position,the fair value of assets and liabilities for which the fair value option hasbeen elected and similar assets and liabilities measured using anothermeasurement attribute.  SFAS 159 iseffective for fiscal years beginning after November 15, 2007.  The adjustment to reflect the differencebetween the fair value and the carrying amount would be accounted for as acumulative-effect adjustment to retained earnings as of the date of initialadoption.  We have adopted SFAS 159 andhave elected not to measure any additional financial instruments or other itemsat fair value.

 

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

 

In March 2008,the FASB issued SFAS No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities*” (SFAS No. 161).SFAS No. 161 requires companies with derivative instruments to discloseinformation that would enable financial statement users to understand how andwhy a company uses derivative instruments, how derivative instruments andrelated hedged items are accounted for under SFAS No. 133, “*Accounting for Derivative Instruments and Hedging Activities*,”(SFAS No. 133) and how derivative instruments and related hedged itemsaffect a company’s financial position, financial performance and cash flows.The new requirements apply to derivative instruments and non-derivativeinstruments that are designated and qualify as hedging instruments and relatedhedged items accounted for under SFAS 133. SFAS 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008; however, early application is encouraged. We are currently evaluating the impact of SFAS 161, but do not expectits adoption to have a material impact on our financial statements.

 

In April 2008,the FASB issued FASB Staff Position No. 142-3, “Determination of theUseful Lives of Intangible Assets”, which amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of an intangible asset.  Thisinterpretation is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008 and interim periods within thoseyears.  We are currently evaluating theimpact of this staff position, but do not expect its adoption to have amaterial impact on our financial statements.

 

Note 16. Credit Facility

 

 In July 2008, we increased our debtcapacity by $90,000 with an addition to our credit facility.  The addition is a 3 year term loan (balancedue June 2011) with a variable rate similar to our line of credit andbears an initial interest rate of 4.41%. The addition to our credit facility will provide extra capacity andprovide strategic flexibility. We reduced the balance outstanding on ourrevolving line of credit by $90,000 with the proceeds from the term loan.

 

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** **

**Item 2.  Management’s Discussion andAnalysis of Financial Condition and Results of Operations.**

** **

*THEINFORMATION IN THIS ITEM 2 “MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”AND IN OTHER PARTS OF THIS FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS,INCLUDING, WITHOUT LIMITATION, STATEMENTS RELATING TO OUR FUTURE BUSINESSPROSPECTS AND ECONOMIC CONDITIONS IN GENERAL; STATEMENTS REGARDING OUR ABILITY TOPREDICT FUTURE SALES AND MANAGE INVENTORY LEVELS; STATEMENTS REGARDING PRICINGPRESSURE; STATEMENTS REGARDING THE FLUCTUATION OF OUR REVENUE GROWTH INRELATION TO ECONOMIC CONDITIONS AND IT RELATED SPENDING TRENDS; STATEMENTSREGARDING OUR PRODUCT DEVELOPMENT ACTIVITIES, OUR PRODUCT PLATFORMS, AND OURABILITY GROW OUR BUSINESS; STATEMENTS REGARDING FUTURE ACQUISITIONS; STATEMENTSABOUT THE SALE OF OUR CONNECTIVITY AND CONTROL BUSINESS UNIT; STATEMENTSREGARDING OUR ANTICIPATED FUTURE GROSS MARGINS, RESEARCH AND DEVELOPMENTEXPENSES, AND SELLING, GENERAL AND ADMINISTRATIVE EXPENSES; STATEMENTS ABOUTOUR MANAGEMENT TRANSITION AND RESTRUCTURING EFFORTS; STATEMENTS ABOUT FUTUREBORROWINGS UNDER OUR CREDIT FACILITES AND THE INTEREST ON AND REPAYMENT OFTHESE BORROWINGS; AND STATEMENTS REGARDING THE OUTCOME OF, AND OUR LEGAL COSTSFOR, PATENT AND OTHER LEGAL CLAIMS, LITIGATION, AND PROCEEDINGS.  THESE FORWARD-LOOKING STATEMENTS ARE SUBJECTTO CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE OUR ACTUAL RESULTS TODIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKINGSTATEMENTS.  FACTORS THAT MIGHT CAUSESUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN PART II,ITEM 1A “RISK FACTORS.”*

 

**Overview**

 

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

 

In July 2008, weacquired Touchpaper Group Limited (Touchpaper), a privately-held company basedin Woking, U.K. Touchpaper employed approximately 200 people, located primarilyin the UK.   Also in July 2008, we acquired certain assets and assumedcertain liabilities of Ergo 2000, Inc. (Ergo), a privately-held providerof rack-mounted LCD consoles with approximately 35 employees based inFullerton, California *(see Note 8 to thecondensed consolidated financial statements).*

 

For a more completedescription of our products, technologies and markets, please refer to our Form 10-K,which was filed on February 21, 2008.

 

Most of our revenue isderived from sales through our reseller and distributor network, sales to alimited number of OEMs (who purchase our switching systems on a private-labelor branded basis for integration and sale with their own products), and salesto a limited number of direct customers. Sales to our branded customersaccounted for 67% of sales in the first nine months of 2008 and 66% of sales inthe first nine months of 2007.  Sales toour OEM customers accounted for 33% of sales in the first nine months of 2008and 34% of sales in the first nine months of 2007.  We do not have contracts with many of ourbranded customers, and in general, our OEM and branded business customers areobligated to purchase products from us only pursuant to binding purchaseorders.  The loss of, or material declinein orders from, these customers would have a material adverse effect on ourbusiness, financial condition, results of operations, and cash flows.  Our top five customers include both OEM andbranded customers, and accounted for 48% and 53% of sales in the first nine monthsof 2008 and 2007, respectively.

 

We sell products toresellers, distributors, end-users, and OEMs in the United States, Canada,Europe, and Asia as well as in other foreign markets.  Sales within the United States accounted forapproximately 53% and 58% of first nine months sales in 2008 and 2007,respectively.  No foreign countryaccounted for more than 10% of sales in the first nine months of 2008 or 2007.

 

With continuedindustry-wide initiatives to reduce all channel inventories and to shorten leadtimes, trends with our major customers are, generally, to reduce the number ofweeks of forward-committed firm orders. This trend continues to affect our business with certain distributors,OEMs, and other server manufacturers, and we believe that it will continueto make our future sales more difficult to predict and inventory levels moredifficult to manage.

 

We experience significantprice competition in the market for all of our products, and we expect thatpricing pressures will continue in the future. In addition, our business and operating results depend to a significantextent on economic conditions in general and on IT spending in particular, andwe expect our revenue growth rate to fluctuate in relation to economicconditions and IT related spending trends. Any adverse change in IT spending due to adverse economic conditions,declining capital spending levels, or other factors could have a materialadverse effect on our business, financial condition, and results ofoperations.  World-wide efforts to cut capital spending, general economicuncertainty, and a weakening global economy could have a material adverseeffect on us.  For example, sincemid-2007, global credit and other financial markets have suffered substantialstress, volatility, illiquidity and disruption. This financial crisis could impact our business in a variety of ways,including insolvency of keysuppliers resulting in product delays, inability of customers to obtain creditto finance purchases of our products and/or customer insolvencies.

.

 

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**Many of our executive officers anddirectors are vested in significant amounts of options to purchase shares ofour common stock and restricted stock units (RSUs).  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.  During the first nine months of 2008, ourBoard of Directors granted time-based, market condition-based andperformance-based RSUs with two and three year vesting.  Awards with similar terms were also grantedin the second quarter of 2007.**

** **

In the first quarter of2008, we dissolved our Desktop Solutions Business Unit and transferred some ofits personnel and a portion of its technology into Management Systems.  We believe our remaining business units allowus to focus on new technology and growth opportunities and to add product andshareholder value in the future.  Webelieve this structure enhances customer service, speeds delivery of productsto market and better focuses our research, development, and marketingresources.   We recently announced ourintention to sell the majority of our emerging Connectivity and ControlBusiness Unit.  We have divided thisentrepreneurial business unit into its three product lines; the Equinox brandedserial business, the Broadcast business and the Pro Audio Visual business.  We have folded our Broadcast product lineinto Management Systems and intend to sell (or license the technology of) theremaining two parts of this business. All revenues and costs associated with our broadcast business areincluded within Management Systems and historical results for both ManagementSystems and our other business units have been adjusted to reflect this change.

 

**Our largest business unit, ManagementSystems, comprised 77% of our consolidated net revenue in the first nine monthsof 2008 and 79% in the first nine months of 2007.  LANDesk contributed 21% of net revenue to thefirst nine months of 2008 and 18% in the first nine months of 2007.  Our other business units and unallocatedrevenue comprised the remaining percentage of our consolidated net revenue in2008 and 2007.  See Note 6 in the notesto the condensed c**onsolidated financial statements contained in Part I, Item 1of this document.

** **

**Resultsof Operations**

 

The followingtable sets forth, for the periods indicated, selected income statement dataexpressed as a percentage of net sales:

** **

| ** **                                             | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **Sept. 26,  2008**         | ** ** | **Sept. 28,  2007**        | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
| Net sales                                              |       | 100.0                            | %          | 100.0                           | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                          |       | 37.7                             |       | 36.1                            |       | 36.9 |   | 37.2 |   |
| Gross profit                                           |       | 62.3                             |       | 63.9                            |       | 63.1 |   | 62.8 |   |
| Operating expenses:                                    |       |                             |       |                            |       |   |   |   |   |
| Research and  development expenses                     |       | 13.3                             |       | 14.0                            |       | 14.9 |   | 14.5 |   |
| Acquired  in-process research and development expenses |       | 0.4                              |       | —                          |       | 0.1 |   | — |   |
| Selling, general  and administrative expenses          |       | 32.9                             |       | 32.6                            |       | 35.7 |   | 34.6 |   |
| Restructuring,  integration and retirement expenses    |       | 3.2                              |       | —                          |       | 2.8 |   | — |   |
| Amortization of  intangible assets                     |       | 4.9                              |       | 4.7                             |       | 5.0 |   | 5.4 |   |
| Total operating  expenses                              |       | 54.7                             |       | 51.3                            |       | 58.5 |   | 54.5 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Income from  operations                                |       | 7.6                              |       | 12.6                            |       | 4.6 |   | 8.3 |   |
|                                                   |       |                             |       |                            |       |   |   |   |   |
| Net investment  income                                 |       | 0.2                              |       | 0.7                             |       | 0.4 |   | 0.6 |   |
| Interest expense                                       |       | (1.2                             | )          | (1.1                            | )          | (1.2 | ) | (1.4 | ) |
| Other income  (expense), net                           |       | 1.2                              |       | 0.1                             |       | 0.6 |   | — |   |
| Income before  provision (benefit) for income taxes    |       | 7.8                              |       | 12.3                            |       | 4.4 |   | 7.5 |   |
| Provision  (benefit) for income taxes                  |       | 1.8                              |       | 2.4                             |       | 1.1 |   | 0.3 |   |
| Net income                                             |       | 6.0                              | %          | 9.9                             | %          | 3.3 | % | 7.2 | % |

 

*Net sales.*  Our net sales consist of sales of  KVM console switching systems, digitalconnectivity products and technologies, software licenses and subscriptions,support and maintenance agreements, serial connectivity devices, wirelessextension products, IPMI, extension, remote access and management products andtechnologies, and royalties from licensing our intellectual property.

 

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| ** **                                           | ** ** | **For the three months ended** | ** ** | ** **           | ** ** | **For the nine months ended** | ** ** | ** **           | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------|------------|---------------------------------------------------|------------|----------------------|------------|
| **(dollars presented in 000’s)** | ** ** | **Sept. 26,  2008**                           | ** ** | **% of  Sales** | ** ** | **Sept. 28,  2007**                          | ** ** | **% of  Sales** | ** ** | **Sept. 26,  2008** | ** ** | **% of  Sales** | ** ** | **Sept. 28,  2007** | ** ** | **% of  Sales** | ** ** |
| Net revenue,  customer distribution                  |       |                                               |       |                 |       |                                              |       |                 |       |   |   |   |   |   |   |   |   |
| Branded                                              |       | $                                                  | 124,613    |                 | 68         | %                                                 | $          | 109,657              |       | 68 | % | $ | 325,147 |   | 67 | % | $ | 293,455 |   | 66 | % |
| OEM                                                  |       | 58,435                                             |       | 32                   | %          | 52,415                                            |       | 32                   | %          | 158,482 |   | 33 | % | 151,993 |   | 34 | % |
| Total net revenue                                    |       | $                                                  | 183,048    |                 | 100        | %                                                 | $          | 162,072              |       | 100 | % | $ | 483,629 |   | 100 | % | $ | 445,448 |   | 100 | % |

 

The 13% growth in sales from the third quarter of 2007compared to the third quarter of 2008 was the result of increased branded salesacross our geographic regions and increased international OEM sales.  In addition, the acquisition of Touchpaper,which closed early in the third quarter, contributed $7.5 million to our thirdquarter 2008 revenue.  The acquisition ofthe Ergo product line, which also closed early in the third quarter,contributed $6.6 million to our third quarter 2008 revenue.  Branded sales grew approximately 14% in thethird quarter of 2008 from the third quarter of 2007, primarily due to thecontribution of Touchpaper revenue and an increase in revenues from our secureswitch products.  Our OEM sales increasedapproximately 12% from the third quarter of 2007, primarily due to thecontribution of Ergo product revenue.  Our branded and OEM businesses grew in EMEA and Asia during the thirdquarter of 2008. We attribute the strength in our foreign markets partly to therevenue from our recent acquisitions and to our recent additions to ourinternational sales force.  Net salesincreased 9% from the first nine months of 2007 compared to the first ninemonths of 2008 for similar reasons experienced in the third quarter of 2008.

 
| ** **                                                         | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(dollars presented in 000’s)**               | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
| Net revenue:                                                       |       |                                               |       |                                              |       |   |   |   |   |
| Management  Systems                                                |       | $                                                  | 138,011    |                                              | $          | 129,222 |   | $ | 370,434 |   | $ | 351,580 |   |
| LANDesk                                                            |       | 41,559                                             |       | 28,648                                            |       | 102,594 |   | 80,065 |   |
| Other business  units                                              |       | 2,972                                              |       | 3,819                                             |       | 8,561 |   | 11,788 |   |
| Corporate and  unallocated                                         |       | 506                                                |       | 981                                               |       | 2,040 |   | 3,889 |   |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | —                                             |       | (598                                              | )          | — |   | (1,874 | ) |
| Total net  revenue                                                 |       | $                                                  | 183,048    |                                              | $          | 162,072 |   | $ | 483,629 |   | $ | 445,448 |   |

 

Our Management Systems Business Unit includes ourtraditional KVM products, our serial products and our embedded software andsolutions products (see Note 6 in the notesto our condensed consolidated financial statements in Part I Item I of thisdocument).  Management Systemssales increased approximately 7% in the third quarter 2008 compared to thethird quarter of 2007, primarily as a result of contribution from our Ergoacquisition and increases in the sales of our embedded software andsolutions.  Sales by product line forManagement Systems for the three and nine months ended September 26, 2008and September 28, 2007 were as follows:

 
| ** **                                           | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(dollars presented in 000’s)** | ** ** | **Sept. 26,  2008**                           | ** ** | **September  28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **September  28,  2007** | ** ** |
| Management  Systems net revenue:                     |       |                                               |       |                                              |       |   |   |   |   |
| KVM                                                  |       | $                                                  | 97,101     |                                              | $          | 99,181 |   | $ | 268,350 |   | $ | 268,917 |   |
| Serial  management                                   |       | 13,517                                             |       | 13,387                                            |       | 39,572 |   | 37,425 |   |
| Embedded  software and solutions                     |       | 10,229                                             |       | 8,662                                             |       | 26,981 |   | 24,136 |   |
| Other                                                |       | 17,164                                             |       | 7,992                                             |       | 35,531 |   | 21,102 |   |
| Total Management  Systems net revenue                |       | $                                                  | 138,011    |                                              | $          | 129,222 |   | $ | 370,434 |   | $ | 351,580 |   |

 

LANDesk revenue iscomprised of license-based revenue, primarily from the LANDesk Management Suite (LDMS)product, and subscription-based revenue, primarily from the LANDesk Security Suite productsand from maintenance and support agreements related to LANDesk ManagementSuite.  LANDesk revenue also includesrevenue from our Touchpaper acquisition. Compared to the third quarter of 2007, LANDesk revenues increased 45%during the third quarter of 2008.  Thegrowth in subscription and maintenance revenue and the addition of Touchpaperalso resulted in an increase to deferred revenue recorded on the balancesheet.  Deferred revenue increased to$74.6 million at September 26, 2008 from $66.1 million at December 31,2007.  Sales for LANDesk for the three andnine months ended September 26, 2008 and September 28, 2007 are asfollows:

 

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| ** **                                           | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(dollars presented in 000’s)** | ** ** | **Sept. 26,  2008**                           | ** ** | **Sept. 28,  2007**                          | ** ** | **Sept. 26,  2008** | ** ** | **Sept. 28,  2007** | ** ** |
| LANDesk net  revenue:                                | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Licenses and  royalties                              |       | $                                                  | 22,092     |                                              | $          | 16,741 |   | $ | 57,919 |   | $ | 46,912 |   |
| Maintenance and  services                            |       | 19,467                                             |       | 11,907                                            |       | 44,675 |   | 33,153 |   |
| Total LANDesk  net revenue                           |       | $                                                  | 41,559     |                                              | $          | 26,648 |   | $ | 102,594 |   | $ | 80,065 |   |

 

For the third quarter,consolidated international sales grew 32% in 2008 compared to 2007, while saleswithin the United States were relatively flat in 2008 compared to 2007.  As mentioned previously, our OEM and brandedbusinesses grew in EMEA and Asia, but only our branded business grew in NorthAmerica.  The growth experienced in ourNorth America branded business was not sufficient to offset the declines in ourNorth America OEM business.

 
| ** **                                           | ** ** | **For the three months ended** | ** ** | ** **           | ** ** | **For the nine months ended** | ** ** | ** **           | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------|------------|---------------------------------------------------|------------|----------------------|------------|
| **(dollars presented in 000’s)** | ** ** | **Sept. 26,  2008**                           | ** ** | **% of  Sales** | ** ** | **Sept. 28,  2007**                          | ** ** | **% of  Sales** | ** ** | **Sept. 26,  2008** | ** ** | **% of  Sales** | ** ** | **Sept. 28,  2007** | ** ** | **% of  Sales** | ** ** |
| Net revenue,  geographic region                      |       |                                               |       |                 |       |                                              |       |                 |       |   |   |   |   |   |   |   |   |
| United States                                        |       | $                                                  | 94,850     |                 | 52         | %                                                 | $          | 95,538               |       | 59 | % | $ | 256,217 |   | 53 | % | $ | 257,591 |   | 58 | % |
| International                                        |       | 88,198                                             |       | 48                   | %          | 66,534                                            |       | 41                   | %          | 227,412 |   | 47 | % | 187,857 |   | 42 | % |
| Total net  revenue                                   |       | $                                                  | 183,048    |                 | 100        | %                                                 | $          | 162,072              |       | 100 | % | $ | 483,629 |   | 100 | % | $ | 445,448 |   | 100 | % |

 

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

 
| ** **                                                         | ** ** | **For the three months ended** | ** ** | ** **        | ** ** | **For the nine months ended** | ** ** | ** **        | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------|------------|---------------------------------------------------|------------|-------------------|------------|
| **(dollars presented in 000’s)**                              | ** ** | **Sept. 26,  2008**                           | ** ** | **Gross  Margin** | ** ** | **Sept. 28,  2007**                          | ** ** | **Gross  Margin** | ** ** | **Sept. 26,  2008** | ** ** | **Gross  Margin** | ** ** | **Sept. 28,  2007** | ** ** | **Gross  Margin** | ** ** |
| Management  Systems                                                |       | $                                                  | 81,950     |              | 59.4       | %                                                 | $          | 79,452            |       | 61.5 | % | $ | 222,213 |   | 60.0 | % | $ | 212,731 |   | 60.5 | % |
| LANDesk                                                            |       | 35,088                                             |       | 84.4              | %          | 25,225                                            |       | 88.1              | %          | 88,281 |   | 86.0 | % | 70,342 |   | 87.9 | % |
| Other business  units                                              |       | 926                                                |       | 31.2              | %          | 1,707                                             |       | 44.7              | %          | 3,029 |   | 35.4 | % | 3,736 |   | 32.3 | % |
| Corporate and  unallocated                                         |       | 599                                                |       |              |       | 944                                               |       |              |       | 2,097 |   |   |   | 3,822 |   |   |   |
| Stock-based  compensation                                          |       | (298                                               | )          |              |       | (373                                              | )          |              |       | (797 | ) |   |   | (853 | ) |   |   |
| Intangible  amortization – developed technology               |       | (4,218                                             | )          |              |       | (2,767                                            | )          |              |       | (9,753 | ) |   |   | (8,217 | ) |   |   |
| Amortization of  fair value adjustment to LANDesk deferred revenue |       | —                                             |       |              |       | (598                                              | )          |              |       | — |   |   |   | (1,874 | ) |   |   |
| Gross profit and  margin                                           |       | $                                                  | 114,047    |              | 62.3       | %                                                 | $          | 103,590           |       | 63.9 | % | $ | 305,070 |   | 63.1 | % | $ | 279,687 |   | 62.8 | % |

 

The decline ingross margin during the third quarter of 2008 resulted from a change in productmix as a result of the acquisitions within Management Systems and LANDesk andthe price reductions on certain older analog products (see Note 6 in the notes to our condensed consolidated financialstatements in Part I Item I of this document).  Management Systems experienced increasedsales for certain secure switch products during the third quarter of 2008.  These products carry lower margins than ourother Management Systems products; therefore the sales increase had a directimpact on our margins in the third quarter of 2008.  In addition, margins on the Ergo products aremuch lower than margins on our legacy products. Similarly, margins on the Touchpaper product line are lower than thelegacy LANDesk product line due to Touchpaper’s higher component ofprofessional services.  In the thirdquarter 2008, Ergo products contributed $1.5 million to gross profit, whileTouchpaper contributed $4.2 million to gross profit.  As Touchpaper and Ergo become fullyintegrated into Avocent, we expect margins on these acquired product lines toimprove.  For the nine months ended September 26,2008, compared to the nine months ended September 28, 2007, our grossprofit and margin improved as a result of significantly higher revenues,especially within our LANDesk business unit which carries significantly highergross margins, offset somewhat by the impact of the lower margins from ouracquisitions.

 

*Operatingexpenses.*

 
| ** **                                             | ** ** | **For the three months ended** | ** ** | ** **           | ** ** | **For the nine months ended** | ** ** | ** **           | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------|------------|---------------------------------------------------|------------|----------------------|------------|
| **(dollars presented in 000’s)**                  | ** ** | **Sept. 26,  2008**                           | ** ** | **% of  Sales** | ** ** | **Sept. 28,  2007**                          | ** ** | **% of  Sales** | ** ** | **Sept. 26,  2008** | ** ** | **% of**

**Sales** | ** ** | **Sept. 28,  2007** | ** ** | **% of**

**Sales** | ** ** |
| Research and  development expenses                     |       | $                                                  | 24,398     |                 | 13.3       | %                                                 | $          | 22,751               |       | 14.0 | % | $ | 72,126 |   | 14.9 | % | $ | 64,821 |   | 14.5 | % |
| Acquired  in-process research and development expenses |       | 700                                                |       | 0.4                  | %          | —                                            |       |                 |       | 700 |   | 0.1 | % | — |   |   |   |
| Selling, general  and administrative expenses          |       | 60,266                                             |       | 32.9                 | %          | 52,820                                            |       | 32.6                 | %          | 172,830 |   | 35.7 | % | 153,922 |   | 34.6 | % |
| Restructuring,  integration and retirement expenses    |       | 5,926                                              |       | 3.2                  | %          | —                                            |       |                 |       | 13,627 |   | 2.8 | % | — |   |   |   |
| Amortization of  intangible assets                     |       | 8,971                                              |       | 4.9                  | %          | 7,581                                             |       | 4.7                  | %          | 24,123 |   | 5.0 | % | 24,124 |   | 5.4 | % |
|                                                   |       | $                                                  | 100,261    |                 | 54.7       | %                                                 | $          | 83,152               |       | 51.3 | % | $ | 283,406 |   | 58.5 | % | $ | 242,867 |   | 54.5 | % |

 

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*Research and development expenses.*  Research and development expenses includecompensation for engineers, support personnel, outside contracted services, andmaterials costs, all of which are expensed as incurred.  R&D increased 7% in the third quarter of2008 from the third quarter of 2007. Costs related to salaries, including costs for added headcount from theacquisitions, increased approximately $1.5 million in the third quarter of 2008compared to the third quarter of 2007. Our recent acquisitions added over$700,000 to R&D costs during the third quarter of 2008 and were the primaryreason behind the increased costs. R&D increased 11% from the first nine months of 2007 compared to thefirst nine months of 2008 for similar reasons as that experienced in the thirdquarter of 2008.  We believe that thetimely development of innovative products and enhancements to existing productsis essential to maintaining our competitive position, and we will continue tomake significant investments in research and development.

 

*Acquiredin-process research and development expense.*  Acquisition related expenses for the threeand nine months ended September 26, 2008 were comprised solely of thenon-recurring write-off of $700,000 of in-process research and developmentexpense related to the acquisition of Touchpaper.  There were no such charges for the three andnine months ended September 28, 2007.

 

*Selling, general and administrative expenses.*  Selling, general and administrative expensesinclude personnel, materials, services and other related costs foradministration, finance, information systems, human resources, sales andmarketing and general management, rent, utilities, legal and accountingexpenses, bad debts, advertising, promotional material, trade show expenses,and related travel costs.  Selling,general and administrative expenses increased 14% in the third quarter of 2008from the third quarter of 2007. Our recent acquisitions added over $4.1 millionin SG&A costs during the third quarter of 2008 and were the primary reasonbehind the increased costs.  Ourintegration strategy for Ergo include headcount reductions and reduced facilitycosts as we complete the transition of Ergo into Avocent’s operations.  For Touchpaper, our integration strategy willinclude some headcount reductions as well. The increase in selling, general and administrative expenses alsoresulted from increased sales commissions resulting from increased sales forthe period.  Compared to the thirdquarter of 2007, salaries, commissions and bonuses, including costs for addedheadcount from the acquisitions, increased approximately $4.5 million in thethird quarter of 2008.  Selling, generaland administrative expenses increased 12% in the first nine months of 2008 fromthe first nine months of 2007 for similar reasons as that experienced in thethird quarter of 2008 listed above.

 

*Restructuring,integration and retirement expenses**. ***Restructuring,integration and retirement expenses for the third quarter of 2008 relate toseverance charges incurred for certain workforce reductions related to thereduction in certain research and development investments, the integration ofmarketing functions, shifting our Asian support operations from Shannon,Ireland to Singapore, the relocation of certain functions from our Redmond,Washington facility to Huntsville, Alabama, and the integration of ouracquisitions into our operations,. In addition to the third quarter charges,restructuring, integration and retirement charges for the first nine months of2008 includes the retirement costs for our former CEO of $2.2 million.

 

***Amortizationof intangible assets***.  Amortization was$9.0 million in the third quarter of 2008 and $24.1 million in the first ninemonths of 2008 compared to amortization of $7.6 million in the third quarter of2007 and $24.2 million in the first nine months of 2007.  The increase in amortization for the quarterwas due to the acquisitions of Touchpaper and Ergo.    Amortization for the first nine months of2008 was flat compared to 2007 as the completion of amortization for certainother intangibles in late 2007 offset the increase for the intangibles acquiredin 2008.

** **

*Stock-based compensation. *We allocatestock-based compensation expense based on the department in which an employeeworks.  Stock compensation expenses byincome statement classification for the three and nine months ended September 26,2008 and September 28, 2007 were as follows:

 
| ** **                                           | ** ** | **For the three months ended** | ** ** | ** **           | ** ** | **For the nine months ended** | ** ** | ** **           | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------|------------|---------------------------------------------------|------------|----------------------|------------|
| **(dollars presented in 000’s)** | ** ** | **Sept. 26,  2008**                           | ** ** | **% of  Sales** | ** ** | **Sept. 28,  2007**                          | ** ** | **% of  Sales** | ** ** | **Sept. 26,**

**2008** | ** ** | **% of  Sales** | ** ** | **Sept. 28,**

**2007** | ** ** | **% of  Sales** | ** ** |
|                                                 |       |                                               |       |                 |       |                                              |       |                 |       |   |   |   |   |   |   |   |   |
| Cost of sales                                        |       | $                                                  | 298        |                 |       |                                              | $          | 373                  |       |   |   | $ | 797 |   |   |   | $ | 853 |   |   |   |
| Research and  development expense                    |       | 1,523                                              |       |                 |       | 1,916                                             |       |                 |       | 3,878 |   |   |   | 4,422 |   |   |   |
| Selling, general  and administrative expense         |       | 3,986                                              |       |                 |       | 4,021                                             |       |                 |       | 9,288 |   |   |   | 9,799 |   |   |   |
| Restructuring  and retirement expense                |       | 480                                                |       |                 |       | —                                            |       |                 |       | 2,999 |   |   |   | — |   |   |   |
|                                                 |       | $                                                  | 6,287      |                 | 3.4        | %                                                 | $          | 6,310                |       | 3.9 | % | $ | 16,962 |   | 3.5 | % | $ | 15,074 |   | 3.4 | % |

 

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Stock-based compensation remained steadyin the third quarter 2008 from the third quarter 2007.  However, stock-based compensation increased13% for the nine months of 2008 compared to the first nine months of 2007. Theincrease is primarily a result of charges associated with the acceleratedvesting for certain RSU’s and other equity related charges associated withrestructuring actions taken in the first half of 2008, disclosed separatelyabove.  We accelerated 194,000 RSUsduring the first nine months of 2008. Additionally, we recorded charges associated with the acceleratedvesting for certain RSUs and other equity related charges for the retirement ofour former CEO taken in the first quarter of 2008.

 

*Netinvestment income**.** *Net******investmentincome decreased to $295,000 in the third quarter of 2008 as compared to $1.1million in the third quarter of 2007. Net******investment income decreasedto $1.9 million in the first nine months of 2008 as compared to $2.9 million inthe first nine months of 2007.  Thisdecline was primarily the result of using excess cash to fund our recentacquisitions.

 

*Interestexpense.*Interest expense results from borrowings under our$250 million unsecured line of credit obtained in the second quarter of 2006and our $90 million term loan obtained in the third quarter of 2008.  Interest expense increased to $2.3 million inthe third quarter 2008, compared to $1.9 million in the third quarter of 2007due to higher borrowings as we borrowed an additional $50 million to help fundthe acquisitions of Touchpaper and Ergo in July 2008.  Interest expense declined to $5.9 million inthe first nine months of 2008, compared to $6.4 million in the first ninemonths of 2007 as a result of lower average borrowings during the first half of2008, somewhat offset by increased borrowings in the third quarter of 2008.

 

*Other income (expense), net.*  Other income (expense), net increased from$207,000 in the third quarter of 2007 to $2.4 million in the third quarter of2008.  We recorded a gain ofapproximately $3.2 million in the third quarter of 2008 from a foreign currencyexchange gain related to the tax free repatriation of capital from a Europeansubsidiary to help fund the acquisition of Touchpaper.  Net other income (expense) improved from anexpense of $95,000 in the first nine months of 2007 to income of $2.7 millionin the first nine months of 2008 for reasons similar to the third quarter of2008.

 

*Provision(benefit) for income taxes.* The effective tax rate in the third quarter of 2008 was a provision of22.7% compared to a provision of 18.9% in the third quarter of 2007.  The provision for income taxes was $3.2million for the third quarter of 2008, compared to a provision of $3.7 millionin the third quarter of 2007.  Theeffective tax rate for the first nine months of 2008 was a provision of 25.6%compared to a provision of 4.1% in the first half of 2007.  The provision for income taxes was $5.2million for the first nine months of 2008, compared to a provision of $1.4million for the first nine months of 2007. As discussed in Note 11 to the condensed consolidated financialstatements, the increase in the effective tax rate was primarily the result ofthe change in the amount and geographical mix of our pre-tax book income and atax benefit recognized during the second quarter of 2007 associated within-process R&D previously charged to book expense.  We adopted FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”on January 1, 2007.  As of September 26,2008, we had total reserves for uncertain tax positions related to grossunrecognized tax benefits of $5.2 million of which $3.5 million, if recognized,would affect our effective tax rate.

 

*Netincome.*  Net income forthe second quarter of 2008 was $11.0 million compared to $16.1 million for thethird quarter of 2007, as a result of the factors detailed in the abovediscussion.  Net income, as a percentageof sales for the third quarter of 2008 was 6.0%, compared to 9.90% for thethird quarter of 2007.  Net income forthe first nine months of 2008 was $15.1 million compared to $31.9 million forthe first nine months of 2007, as a result of the factors detailed in the abovediscussion.  Net income, as a percentageof sales for the first nine months of 2008 was 3.3%, compared to 7.2% for thefirst nine months of 2007.

 

**Liquidityand Capital Resources**

 

As of September 26,2008, our principal sources of liquidity consisted of $115 million in cash andcash equivalents and a $160 million available balance from our $340 millioncredit facility that is available for general corporate purposes.  In the third quarter of 2008 we amended our$250 million line of credit by adding a $90 million term loan to the existingfacility. The balance of the entire facility is due in June 2011.  The term loan and line of credit have similarvariable interest rates. The addition to our credit facility will give us extracapacity and provide strategic flexibility.

 

The line of credit and term loan contain affirmativeand negative covenants, including limitations on our ability to (i) makedistributions, investments, and other payments unless we satisfy certainfinancial tests or other criteria, (ii) incur additional indebtedness, (iii) restructureour subsidiaries, and (iv) make acquisitions and capital expenditures.  The financial tests include aninterest coverage ratio and a total leverage ratio.  We are currently in compliance with thesecovenants and related tests as of September 26, 2008.  All of theserestrictions could affect our ability to operate our business and may limit ourability to take advantage of potential business opportunities as theyarise.  The failure to comply with thesecovenants could result in an event of default which, if not cured or waived,could have a material 

 

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adverse effect on us.

 

We used borrowings underthe line of credit in July 2008 to fund the acquisitions of Touchpaper andErgo 2000.  In the future we may acquireother technologies or companies that we believe will enhance and/or complementour existing products and technologies and increase our sales.  The line of credit and term loan currentlybear an interest rate of LIBOR plus 175 basis points.  There was $180 million outstanding under thecredit facility as of September 26, 2008. We classify these obligations as long-term as they mature in June 2011.  We expect to repay the borrowings from futurecash flows from operations.  A summary ofour cash flows is as follows:

 
| ** **                                           | ** ** | **Nine months ended** | ** ** |
|------------------------------------------------------|------------|---------------------------------|------------|
| **(dollars presented in 000’s)** | ** ** | **Sept. 26,  2008**        | ** ** | **Sept. 28,  2007** | ** ** |
| Total cash  provided by (used in):                   |       |                            |       |   |   |
| Operating  activities                                |       | $                               | 66,161     |   | $ | 98,884 |   |
| Investing  activities                                |       | (77,061                         | )          | (8,978 | ) |
| Financing  activities                                |       | 22,120                          |       | (76,268 | ) |
| Effect of  exchange rate changes on cash             |       | (1,502                          | )          | 1,141 |   |
| Increase in cash  and cash equivalents               |       | $                               | 9,718      |   | $ | 14,779 |   |

 

The decline in cash flows from operations in the first nine months of 2008 was primarily the result of working capital increases to fund the growth in our business (changes in accounts receivable, inventories, accrued wages and commissions and income taxes payable), which were partially offset by higher accounts receivable collections during the first nine months 2007.  During the first nine months of 2008, we paid approximately $8.0 million to the Internal Revenue Service related to settling previously accrued federal income tax matters.  Our accounts receivable increased $8.2 million from December 31, 2007 to September 26, 2008 as a result of increased sales through September 2008.  This increase in accounts receivable was somewhat minimized by continued improved cash collections.  Additionally, we made significant progress in collecting older balances outstanding at our LANDesk location in the first nine months of 2007, resulting in a large decrease in receivables outstanding as of September 28, 2007.  Our accrued wages and commissions have increased in 2008 compared to 2007 as a result of increased sales for the comparable periods and accrued severance related to our restructuring programs.

 

Our days sales outstanding (DSO) improved to 63 days at the end of the first nine months of 2008 compared to 65 days at the end of the first nine months of 2007.  DSO improved as a result of higher sales in the first nine months of 2008 compared to the first nine months of 2007 and continued improvement in cash collections.  Inventories decreased $4.5 million from December 31, 2007 to September 26, 2008.  Our inventory turns improved significantly to 8.6 at September 26, 2008 compared to 6.8 at September 28, 2007.  The improvement in 2008 was due to higher sales volume experienced in the first nine months of 2008 combined with our lower inventory balance as of September 26, 2008.

 

Our investing activitiesused over $77 million of cash flow in the first nine months of 2008, primarilyas the result of the Ergo and Touchpaper acquisitions that closed early in thethird quarter of 2008.  We convertedmatured investments to cash to help fund the repurchase of 4 million shares under our stock repurchase program in thefirst quarter of 2008.  Our investingactivities used $9.0 million of cash flow in the first nine months of 2007which included $71 million of cash payments for investment purchases.

 

Our financing activitiesused the cash provided by operations, as well as additional borrowings, torepurchase approximately 4 million shares of our common stock during the firstquarter of 2008 at a cost totaling $64 million. These treasury shares were purchased through various brokers under thestock repurchase program approved by our Board of Directors.  As of September 26, 2008 we haveapproximately 2.3 million shares available for purchase under the program.

 

During the second quarterof 2008, we approved a series of restructuring activities.  As of September 26, 2008, we had accruedapproximately $6.0 million related to restructuring costs and expect to recordan additional $3 million to $4 million of restructuring and integrationexpenses in the fourth quarter of 2008. Most of these costs will be paid during the fourth quarter of 2008 andthe first quarter of 2009.

 

**Off-Balance Sheet Arrangements andContractual Obligations**

 

In the ordinarycourse of our business, we may at any point in time have a significant amountof contractual commitments not yet recognized in our financial statements.  These commitments relate primarily to ourneed to schedule the purchase of inventories in advance of the relatedforecasted sales to customers.  We havelonger lead times for the products we purchase from suppliers based in Asiathan those for our U.S. based and European based suppliers.  Our actual contractual commitments aretypically limited to products needed for one to three months of forecastedsales.  The liabilities for theseinventory purchases, along with the related 

 

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inventory assetsare typically recognized upon our receipt of the products.  We also have, at any point in time, a varietyof short term contractual commitments for services such as advertising,marketing, accounting, legal, and research and development activities.  The liabilities for these services and therelated expenses are typically recognized upon our receipt of the relatedservices.  In our 2007 Form 10-K, wedisclosed our contractual obligations in the section entitled “Liquidity andCapital Resources” in Part II Item 7. At September 26, 2008, therehave been no material changes to contractual obligations outside the ordinarycourse of business.  Our debt balanceincreased to $180 million at September 26, 2008 from $95 million at December 31,2007.  The increase in our level ofborrowings, if sustained at the higher level, will result in higher interestpayments in future periods.

 

Other than operatingleases for offices and warehouse space, we do not engage in off-balance sheetfinancing arrangements or have any variable-interest entities. As of September 26,2008 we did not have any off-balance sheet arrangements as defined in Item303(a)(4)(ii) of SEC Regulation S-K.

 

**Non-GAAP Operational Measures**

 

To supplement ourconsolidated financial statements presented in accordance with GAAP, we presentinvestors with certain non-GAAP operational measures which we use internally tomanage our businesses, including net sales, gross profit, operating expenses,and the resulting operating income, income before taxes, operational netincome, and operational earnings per share, all of which primarily exclude theeffects of amortization and depreciation related to purchase accountingadjustments, stock-based compensation, certain restructuring and retirementcosts, and acquired in-process research and development expenses.  These operational measures also include theamortization of the fair value adjustment to LANDesk deferred revenue relatedto the purchase accounting adjustment to reduce deferred revenue at theacquisition of LANDesk.  Specifically, weuse the following non-GAAP measures:

 
| ** **                                  | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **Non-GAAP Operational Measures** | ** ** | **Sept. 26, 2008**     | ** ** | **Sept. 28, 2007**    | ** ** | **Sept. 26, 2008** | ** ** | **Sept. 28, 2007** | ** ** |
| **(dollars presented in 000’s)**       | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operational net  sales                      |       | $                                | 183,048    |                            | $          | 162,670 |   | $ | 483,629 |   | $ | 447,322 |   |
| Operational  gross profit                   |       | $                                | 118,564    |                            | $          | 107,329 |   | $ | 315,620 |   | $ | 290,631 |   |
| Operational  operating income               |       | $                                | 39,410     |                            | $          | 37,696 |   | $ | 83,997 |   | $ | 86,134 |   |
| Operational net  income                     |       | $                                | 30,441     |                            | $          | 28,519 |   | $ | 63,289 |   | $ | 62,364 |   |
| Operational  diluted earnings per share     |       | $                                | 0.67       |                            | $          | 0.56 |   | $ | 1.38 |   | $ | 1.21 |   |

 

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

 

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

 

·                            Thenon-GAAP operating expense operational measure consists of GAAP operatingexpenses, excluding the impact of stock-based compensation, restructuring andintegration costs and amortization related to purchase accounting adjustmentsas they relate to the particular operating expense.

 

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

 

·                            Thenon-GAAP net income operational measure consists of GAAP net income, adjustedby the non-GAAP operational measures described above and the tax effects ofthese non-GAAP operational measures.

 

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

 

Weprovide the following reconciliations between GAAP and our operationalmeasures:

 

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| ** **                                              | ** ** | **GAAP**      | ** ** | ** **       | ** ** | **Purchase**    | ** ** | **Restructuring,  Integration** | ** ** | **Non-GAAP**    | ** ** |
|---------------------------------------------------------|------------|---------------|------------|------------------|------------|-----------------|------------|---------------------------------|------------|-----------------|------------|
| ** **                                              | ** ** | **Financial** | ** ** | **Stock-based**  | ** ** | **Accounting**  | ** ** | **and Retirement**         | ** ** | **Operational** | ** ** |
| ** **                                              | ** ** | **Measures**  | ** ** | **Compensation** | ** ** | **Adjustments** | ** ** | **Expenses**                    | ** ** | **Measures**    | ** ** |
| **For the  three months ended September 26, 2008** |       |          |       |             |       |            |       |                            |       |            |       |
| Operational net  sales                                  |       | $             | 183,048    |             | —     |            | —     |                            | —     |            | $          | 183,048 |   |
| Operational  gross profit                               |       | $             | 114,047    |             | 298        |            | 4,219      |                            | —     |            | $          | 118,564 |   |
| Operational  operating income                           |       | $             | 13,786     |             | 6,287      |            | 13,891     |                            | 5,446      |            | $          | 39,410 |   |
| Operational net  income                                 |       | $             | 10,961     |             | 4,802      |            | 10,518     |                            | 4,160      |            | $          | 30,441 |   |
| Operational  diluted earnings per share                 |       | $             | 0.24       |             | 0.11       |            | 0.23       |                            | 0.09       |            | $          | 0.67 |   |
|                                                    |       |          |       |             |       |            |       |                            |       |            |       |
| **For the  three months ended September 28, 2007** |       |          |       |             |       |            |       |                            |       |            |       |
| Operational net  sales                                  |       | $             | 162,072    |             | —     |            | 598        |                            | —     |            | $          | 162,670 |   |
| Operational  gross profit                               |       | $             | 103,590    |             | 373        |            | 3,366      |                            | —     |            | $          | 107,329 |   |
| Operational  operating income                           |       | $             | 20,438     |             | 6,310      |            | 10,948     |                            | —     |            | $          | 37,696 |   |
| Operational net  income                                 |       | $             | 16,117     |             | 4,859      |            | 7,543      |                            | —     |            | $          | 28,519 |   |
| Operational  diluted earnings per share                 |       | $             | 0.32       |             | 0.09       |            | 0.15       |                            | —     |            | $          | 0.56 |   |
|                                                    |       |          |       |             |       |            |       |                            |       |            |       |
| **For the  nine months ended September 26, 2008**  |       |          |       |             |       |            |       |                            |       |            |       |
| Operational net  sales                                  |       | $             | 483,629    |             | —     |            | —     |                            | —     |            | $          | 483,629 |   |
| Operational  gross profit                               |       | $             | 305,070    |             | 797        |            | 9,753      |                            | —     |            | $          | 315,620 |   |
| Operational  operating income                           |       | $             | 21,664     |             | 16,962     |            | 34,743     |                            | 10,628     |            | $          | 83,997 |   |
| Operational net  income                                 |       | $             | 15,135     |             | 12,978     |            | 27,044     |                            | 8,132      |            | $          | 63,289 |   |
| Operational  diluted earnings per share                 |       | $             | 0.33       |             | 0.28       |            | 0.59       |                            | 0.18       |            | $          | 1.38 |   |
|                                                    |       |          |       |             |       |            |       |                            |       |            |       |
| **For the  nine months ended September 28, 2007**  |       |          |       |             |       |            |       |                            |       |            |       |
| Operational net  sales                                  |       | $             | 445,448    |             | —     |            | 1,874      |                            | —     |            | $          | 447,322 |   |
| Operational  gross profit                               |       | $             | 279,687    |             | 853        |            | 10,091     |                            | —     |            | $          | 290,631 |   |
| Operational  operating income                           |       | $             | 36,820     |             | 15,074     |            | 34,240     |                            | —     |            | $          | 86,134 |   |
| Operational net  income                                 |       | $             | 31,863     |             | 11,390     |            | 19,111     |                            | —     |            | $          | 62,364 |   |
| Operational  diluted earnings per share                 |       | $             | 0.62       |             | 0.22       |            | 0.37       |                            | —     |            | $          | 1.21 |   |

 

We believe that excluding depreciationand amortization associated with purchase accounting adjustments as well as thetax impact of certain purchase accounting elections for prior acquisitionsprovides meaningful supplemental information and an alternative presentationuseful to investors’ understanding our core operating results and trendsbetween periods.  Not only are thesedepreciation and amortization and tax impact adjustments based on amountsassigned in purchase accounting, that may have little bearing on present orfuture replacement costs, but they also are based on management’s estimates ofremaining useful lives.

 

Similarly, we believe that excludingstock-based compensation and restructuring, integration and retirement expensesprovides meaningful supplemental information and an alternative presentationuseful to investors’ understanding of our core operating results and trends,especially when comparing those results on a consistent basis to results for previousperiods and anticipated results for future periods.

 

We also believe that, in excludingstock-based compensation and restructuring, integration and retirement expensesand depreciation and amortization associated with purchase accounting adjustments(together with the related tax effects), our non-GAAP financial measuresprovide investors with transparency into the information and basis used bymanagement and our Board of Directors 

 

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tomeasure and forecast our results of operations, to compare on a consistentbasis our results of operations for the current period to that of priorperiods, to compare our results of operations on a more consistent basisagainst that of other companies in making financial and operating decisions,and to establish targets for management incentive compensation.

 

These non-GAAP operational measures havehistorically been used as key performance metrics by our senior management asthey evaluate both the performance of the consolidated financial results aswell as those of individual business segments. These non-GAAP operational measures are reviewed individually as well asin total in measuring our performance against internal and externalexpectations for the period and the expectations for such key non-GAAPoperational measures are the basis for any financial guidance provided bymanagement for future periods.  Webelieve that the use of each of these non-GAAP financial measures providesenhanced consistency and comparability with our past financial reports, andalso facilitates comparisons with other companies in our industry, many ofwhich use similar non-GAAP financial measures to supplement their GAAP results. We provide this information to investors to enable them to performadditional analyses of past, present and future operating performance, compareus to other companies, and evaluate our ongoing financial operations.

 

We believe that each of these operationalmeasures is useful to investors in their assessment of our operatingperformance and the valuation of our company.   Operational net sales,gross profit, operating income, operational net income, and operational earningsper share are significant measures used by management for:

 

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

 

·                  Evaluatingthe operating performance of our company;

 

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

 

·                  Establishinginternal operating targets.

 

These non-GAAP operational measures,including operational net sales, operational gross profit, operationaloperating income, operational net income, and operational earnings per shareare used by us as broad measures of financial performance that encompass ouroperating performance, cash, capital structure, investment management, andincome tax planning effectiveness.  These operational measures are notcalculated in accordance with GAAP, and should be considered supplemental to,and not as a substitute for, or superior to, financial measures calculated inaccordance with GAAP.  These operational measures have limitations in thatthey do not reflect all of the costs or reductions to revenues associated withthe operations of our business as determined in accordance with GAAP.  In addition, these operational measures maynot be comparable to non-GAAP financial measures reported by other companies.  As a result, one should not consider thesemeasures in isolation or as a substitute for analysis of our results asreported under GAAP.  We compensate for these limitations by analyzingcurrent and future results on a GAAP basis as well as a non-GAAP basis,prominently disclosing GAAP results and providing reconciliations from GAAPresults to non-GAAP operational measures.  We expect to continue to incur expensessimilar to the non-GAAP adjustments described above, and the exclusion orinclusion of these items from our non-GAAP financial measures should not beconstrued as an inference that these costs are unusual or infrequent.  Some of the limitations in relying on ournon-GAAP financial measures are:

 

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

 

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

 

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

 

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**Recently Issued Accounting Standards andRegulatory Standards**

 

In September 2006, the FASB issuedSFAS No. 157, “*Fair Value Measurements”*(SFAS 157), which clarifies that fair value estimates should be based on theassumptions market participants would use when pricing an asset or liabilityand establishes a fair value hierarchy that prioritizes the information used todevelop those assumptions.  Under SFAS157, fair value measurements would 

 

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beseparately disclosed by level within the fair value hierarchy.  SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007. On February 12, 2008, the FASB delayed the effective date of SFAS157 for nonfinancial assets and liabilities, except for items that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually), to fiscal years beginning after November 15,2008.  We adopted SFAS 157 as of January 1,2008, with the exception of the application of the statement to nonfinancialassets and nonfinancial liabilities. Refer to Note 12 to the CondensedConsolidated Financial Statements for additional discussion on fair valuemeasurements.

 

In February 2007, the FASB issuedSFAS No. 159, “*The Fair Value Optionfor Financial Assets and Financial Liabilities — Including an amendment ofFASB Statement No. 115”* (SFAS 159).  SFAS 159 permits an entity to elect fairvalue as the initial and subsequent measurement attribute for many financialassets and liabilities.  Entities electingthe fair value option would be required to recognize changes in fair value inearnings.  Entities electing the fairvalue option are required to distinguish, on the face of the statement offinancial position, the fair value of assets and liabilities for which the fairvalue option has been elected and similar assets and liabilities measured usinganother measurement attribute. SFAS 159 is effective for fiscal years beginning after November 15,2007.  The adjustment to reflect thedifference between the fair value and the carrying amount would be accountedfor as a cumulative-effect adjustment to retained earnings as of the date ofinitial adoption.  We have adopted SFAS159 and have elected not to measure any additional financial instruments orother items at fair value.

 

In December 2007, the FASB issuedSFAS No. 141(R), “*Business Combinations”*(SFAS 141(R)), which replaces SFAS 141.  SFAS 141(R) establishes principlesand requirements for how an acquirer in a business combination recognizes andmeasures in its financial statements the identifiable assets acquired, theliabilities assumed, and any controlling interest; recognizes and measures thegoodwill acquired in the business combination or a gain from a bargainpurchase; and determines what information to disclose to enable users of thefinancial statements to evaluate the nature and financial effects of thebusiness combination.  SFAS 141(R) isto be applied prospectively to business combinations for which the acquisitiondate is on or after an entity’s fiscal year that begins after December 15,2008.  We will assess the impact ofSFAS 141(R) on future acquisitions, however the application of SFAS141(R) will result in a significant change in accounting for any suchfuture acquisitions after the effective date.

 

In March 2008,the FASB issued SFAS No. 161, “*Disclosures aboutDerivative Instruments and Hedging Activities*” (SFAS 161). SFAS 161requires companies with derivative instruments to disclose information thatwould enable financial statement users to understand how and why a company usesderivative instruments, how derivative instruments and related hedged items areaccounted for under SFAS No. 133, “*Accounting for DerivativeInstruments and Hedging Activities*,” (SFAS 133) and how derivativeinstruments and related hedged items affect a company’s financial position,financial performance and cash flows. The new requirements apply to derivativeinstruments and non-derivative instruments that are designated and qualify ashedging instruments and related hedged items accounted for under SFAS 133. SFAS161 is effective for financial statements issued for fiscal years and interimperiods beginning after November 15, 2008. We are currently evaluating theimpact of SFAS 161, but do not expect its adoption to have a material impact onour financial statements.

 

In April 2008,the FASB issued FASB Staff Position No. 142-3, “Determination of theUseful Lives of Intangible Assets”, which amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of an intangible asset.  Thisinterpretation is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008 and interim periods within thoseyears.  We are currently evaluating theimpact of this staff position, but do not expect its adoption to have amaterial impact on our financial statements.

 

**Updates to Critical AccountingEstimates**

 

As discussed belowand in Note 12 to the Condensed Consolidated Financial Statements, we haveadopted SFAS 157 as of January 1, 2008, with the exception of theapplication of the statement to nonfinancial assets and nonfinancialliabilities, the deferral of which was permitted under FSP 157-2. Other thanthis change, there have been no significant changes in our critical accountingestimates during the first nine months of 2008.

 

Substantially allof our financial assets and liabilities are measured at fair value based uponLevel 2 inputs, as defined under SFAS 157. The fair value measurement is preparedusing the closing mid-market rate/price environment on September 26, 2008,using proprietary models, available market data, and reasonable assumptions.

 

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

 

Our primary market riskis the interest rate risk on our bank line of credit and term loan, whichcurrently bear interest at a variable rate of LIBOR plus 175 basis points.  We have partially hedged this exposure tointerest rate risk with interest rate swaps, which have a collective remainingnotional amount of $100 million as of September 26, 2008, through RegionsBank.

 

We also face foreign currency exchange rate risk tothe extent that the value of certain foreign currencies relative to the U.S.dollar affects our financial results. Our international operations transact a significant portion of ourbusiness in currencies other than the U.S. dollar, predominantly the euro, andchanges in exchange rates may positively or negatively affect our revenue,gross margins, operating expenses, and retained earnings since thesetransactions are reported by us in U.S. dollars.  We occasionally purchase foreign currencyforwards aimed at limiting the impact of currency fluctuations.  These instruments provide only limitedprotection against currency exchange risks, and there can be no assurance thatsuch an approach will be successful, especially if a significant and suddendecline occurs in the value of local currencies.  As of September 26, 2008, we had fouropen forward contracts with an approximate fair value of $(14,000).

 

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

 

(a) *Evaluation of disclosurecontrols and procedures.*   Based on their evaluation as of September 26, 2008, our ChiefExecutive Officer and Chief Financial Officer have concluded that ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934) are effective.

 

(b) *Changes in internal control over financial reporting*.    Except as they relate to the acquisitionsof Touchpaper and Ergo, there were no changes in our internal controls overfinancial reporting during the quarter ended September 26, 2008 thatmaterially affected or are reasonably likely to materially affect, our internalcontrols over financial reporting.  Weexpect both Ergo and Touchpaper to be completely integrated into our systemsand to have adopted our procedures by early 2009.

 

### **PART II –OTHER INFORMATION**

### ** **

**Item 1.****           Legal Proceedings.**

 

In January 2007,we filed a complaint for patent infringement in the United States DistrictCourt for the Western District of Washington against Aten Technology, Inc.,Aten International Co., Ltd, Belkin Corporation, Rose Electronics and itsgeneral partners, and Trippe Manufacturing Company.  The defendants filed counterclaims allegingnon-infringement, unenforceability, and invalidity.  In May 2007, we entered into aSettlement and License Agreement with Trippe Manufacturing, and dismissedTrippe from the lawsuit.  In October 2007,the District Court stayed the action pending a re-examination of our patents bythe Patent and Trademark Office.  Thatre-examination is currently underway.

 

In January 2008,Avocent Redmond Corp. filed a complaint for unauthorized use of patentedinventions against the United States government in the United States Court ofFederal Claims.  The complaint alleges that the United States governmentaccepted products manufactured and sold by Rose Electronics that are covered bypatents held by Avocent Redmond.  The United States has answered and RoseElectronics has intervened.

 

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

 

In April 2007, wefiled a complaint for declaratory judgment against Aten International Co., Ltd.in the United States District Court for the Northern District of Alabama.  We are seeking a declaratory judgment thattwo patents owned by Aten and asserted against us are invalid and that certainof products alleged by Aten to infringe do not infringe these patents.  In August 2007, Aten’s motion to dismissfor lack of personal jurisdiction was granted, and we have appealed that rulingto the Federal Circuit Court of Appeals. Oral arguments were held in February 2008.

 

In November 2007,Gemini IP, LLC filed a complaint for patent infringement in the United StatesDistrict Court for the Eastern District of Texas, Sherman Division, againstAvocent Corporation and our subsidiary LANDesk Software, Inc.  The complaint alleges infringement of aGemini patent through the sales of a LANDesk product.  The complaint seeks injunctive relief,damages, attorneys’ fees, and costs.  AvocentCorporation was dismissed from the lawsuit in January 2008, and we havemade a claim for indemnification against the LANDesk escrow account.  In April 2008, the District Court stayedthe action pending a review of the Gemini Patent by the Patent and TrademarkOffice.

 

We acquired LANDesk GroupLimited, a privately-held company, in August 2006, and the acquisitionagreements provided for total initial consideration of approximately $407million and a potential earn-out payment to the former shareholders of LANDeskof up to $60 million if LANDesk achieved specified revenue targets for the fullyear of 2006.  Based on LANDesk’s 2006 revenue results, we concluded thatLANDesk did not achieve the minimum revenue target required to cause anyearn-out payment and that no earn-out was earned or payable.  Accordingly,we did not pay, and have not accrued for, any earn-out payment.  TheShareholder Representative for the former shareholders of LANDesk hasinstituted the arbitration procedure described in the acquisitionagreements and is challenging our conclusion that no earn-out was earned orpayable.  We are in the process ofpreparing for that arbitration proceeding.

 

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**Item 1A. Risk Factors.**

 

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

 

**Difficultiesencountered during challenging and changing economic conditions could adverselyaffect our results of operations.**

 

Our business andoperating results depend to a significant extent on economic conditions ingeneral and on IT spending and the server market in particular, and we expectour revenue growth rate to fluctuate in relation to economic conditions and ITrelated spending trends.  Any adversechange in IT spending or in the server market due to adverse economicconditions, declining capital spending levels, or other factors could have amaterial adverse effect on our business, financial condition, and results ofoperations.  World-wide efforts to cut capital spending, general economicuncertainty, and a weakening global economy could have a material adverseeffect on us.  For example, sincemid-2007, global credit and other financial markets have suffered substantialstress, volatility, illiquidity and disruption.  This financial crisis could impact ourbusiness in a variety of ways, including insolvency of key suppliers resulting in product delays,inability of customers to obtain credit to finance purchases of our productsand/or customer insolvencies. In addition, we continue to see industry-wide initiatives by OEMs and bydistributors and resellers of our hardware products to reduce their inventoriesand to shorten their lead times, thereby reducing early commitments to firmorders by our major OEM and our distributor and reseller customers.

 

Our ability toeffectively manage during changing economic conditions will require us tocontinue to implement and improve our operational, financial, and informationsystems and internal controls and will likely require additional managementpersonnel.  In addition, we believe that we must continue to developimproved engineering, financial, marketing, sales, and customer servicecapabilities in order to develop new products and technologies, secure newcustomers, and effectively serve the evolving needs of present and futurecustomers.  We may not be successful in strengthening thesecapabilities.  Without adequate management, engineering, financial,product development, marketing, sales, and customer service capabilities, ourability to effectively manage during changing economic conditions, expand andenhance our product lines, further penetrate existing markets, and develop newmarkets will be significantly limited.  If we are unable to effectivelymanage during challenging and changing economic conditions, our business,financial condition, and results of operations could be materially adverselyaffected.

 

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

 

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

 

·                                          Difficultyintegrating the acquired company’s personnel, distribution channels, products,product roadmaps, technologies, systems, processes, and operations, includingproduct development, product delivery, order management, and informationsystems;

 

·                                          Difficultyin conforming the acquired company’s financial policies and practices to ourpolicies and practices and in implementing and maintaining adequate internalsystems and controls over the financial reporting and information systems ofthe acquired company;

 

·                                          Diversionof management’s attention and disruption of our current business and thechallenges associated with managing the resulting larger company following anyacquisition;

 

·                                          Difficultyin combining product and technology offerings and entering into new markets(such as software) or geographical areas in which we have no or limited directexperience and where our competitors may have stronger market positions;

 

·                                          Lossof management, sales, technical, or other key personnel (at either Avocent orin the acquired company) or the loss of customers, distributors, resellers,vendors, or other business relationships as a result of the acquisition;

 

·                                          Revenuefrom the acquired company not meeting our expectation, and the potential lossof the acquired company’s customers, distributors, resellers, suppliers, orother partners;

 

·                                          Delaysor difficulties and the attendant expense in evaluating, coordinating, andcombining administrative, manufacturing, research and development and otheroperations, facilities, and relationships with third parties in accordance withlocal laws and other obligations while maintaining adequate standards, controlsand procedures, including financial controls and controls over informationsystems;

 

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

 

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

 

·                                          Dilutionof existing stockholders as a result of issuing equity securities, includingthe assumption of any stock options or other stock awards to employees issuedby the acquired company;

 

·                                          Overpaymentfor any acquisition or investment or unanticipated costs or liabilities;

 

·                                          Assumptionof liabilities of the acquired company, including any potential intellectualproperty infringement claims or other litigation and any unrecorded taxobligations; and

 

·                                          Incurringsubstantial write-offs, restructuring charges, interest expense, amortization,and transactional expenses.

 

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

 

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

 

The markets for ourproducts and technologies are highly fragmented, rapidly evolving, andintensely competitive, and we expect these characteristics to continue andincrease.  Aggressive competition from both hardware and software productsand technologies could lengthen the customer evaluation process and result in pricereductions and loss of sales, which would materially harm our business. Our business is highly sensitive to the introduction of new products andtechnologies (such as virtualization), price changes, and marketing efforts bynumerous and varied competitors.  Accordingly, our future success will behighly dependent upon our timely completion and introduction of new productsand technologies and features at competitive prices and performance levels thataddress changing industry trends and the evolving needs of our customers. We continue to experience aggressive price competition and increased customersensitivity to product prices, and pricing and margin pressures are likely toincrease in the future.  Because of this competition, we may have to continueto lower the prices of many of our products and technologies or offer greaterfunctionality within our products to deliver greater value to customers to staycompetitive, while at the same time trying to maintain or improve our revenueand gross margin.  Because our business model is based on providinginnovative and high quality products, we may spend a proportionately greateramount on research and development than some of our competitors.  If wecannot proportionately decrease our cost structure on a timely basis inresponse to competitive price pressures, our gross margin and profitabilitycould be adversely affected.  In addition, if our pricing, functionality,and other factors are not sufficiently competitive, or if there is an adversereaction to our product decisions, we may lose market share in certain areas,which could adversely affect our revenue and prospects.

 

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

 

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

 

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

 

Certain of our customers,such as Dell, Hewlett-Packard, IBM, Symantec, and Microsoft, presently offercompetitive hardware and/or software products and technologies that address manyof the problems our products and technologies address.  These customerscould decide to manufacture or enhance their own switching, IPMI, or otherembedded technologies, or systems management or security products, or offerproducts or technologies supplied by competitors.  Companies with hardwaremanufacturing experience or network management products, many of which aresubstantially larger than we are and have significantly more financialresources than we do, also offer products or technologies that compete withus.  Established companies with hardware manufacturing or networkmanagement experience (such as Intel, Cisco, or EMC) could also offer newproducts, new technologies (such as virtualization), or new solutions thatcompete with, or reduce the demand for, our products and technologies.

 

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

 

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

 

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

 

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

 

Our hardware productscombine components, such as printed circuit boards, connectors, semiconductors,memory, cable assemblies, power supplies and enclosures that are manufacturedby other companies and are generally available to competitors and potentialcompetitors.  Our software products combine software or content from thirdparties, such as open source software or technology, drivers, security, oranti-virus information, which may also be generally available to our competitorsand potential competitors.  Our future success will depend in large partupon continued innovative application of commercially available components andsoftware or technology, and continued enhancements to our proprietary hardware,software, firmware, and other technologies, the expansion and enhancement ofexisting products and technologies, and our development and introduction of newproducts and technologies that address changing industry trends and customerneeds on a cost-effective and timely basis.  If we fail to respond on atimely basis to technological developments, changes in industry standards,customer requirements, competitive products, product localization, or softwareinnovations, we will lose customers, and our business will be greatly harmed. Similar results could occur if we experience significant delays in thedevelopment or introduction of new products or technologies.

 

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Due to our significantreliance on OEM relationships, our hardware development efforts may often befocused on developing new products, technologies, or enhancements for OEMcustomers.  As a result, our OEM relationships may negatively affect ourability to develop new and enhanced products and technologies for our non-OEMcustomers.  Moreover, these new products, technologies, or enhancementsfor OEM customers may not be available to, or readily marketable to, othercustomers without significant modification and delay.  The expansion,termination, or significant disruption of our relationship with certainOEMs or other customers for whom we devote significant product developmentresources is likely to result in lost opportunities with respect to thedevelopment of products, technologies, or enhancements for our other customers.

 

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

 

Our future successdepends in part upon our ability to protect proprietary rights in our productsand technologies.  We seek to protect our intellectual property rights byinvoking the benefits of the patent, trademark, copyright, trade secret, andunfair competition laws of the United States and other countries andprotections provided by confidentiality and nondisclosure agreements and otherlegal agreements.  These laws and practices, however, afford only limitedprotection.  There can be no assurance that the steps we have taken toprotect our intellectual property rights, or that the steps we take in thefuture, will be adequate to prevent or detect misappropriation of ourintellectual property or technologies or that our competitors will notindependently develop proprietary or other technologies that are substantiallyequivalent or superior to our products or technologies.  In addition, our proprietary information maybe misused or improperly disclosed by third parties entrusted with thisinformation.  There also can be noassurance that our proprietary rights will not be challenged, invalidated, oravoided.

 

The U.S. Patent andTrademark Office has issued several patents to us for various aspects of ourproducts.  We have various corresponding patent applications pending underthe provisions of the Patent Cooperation Treaty, which permits the filing ofcorresponding foreign patent applications in numerous foreign countries withina limited time period.  We also have other United States and foreignpatent applications pending.  There can be no assurance that any additionalpatents will be issued from any of those pending applications or that anypatents will be issued in any additional countries where our products can besold.  Claims allowed in our patents or in any pending patent applicationsmay not be of sufficient scope or strength for, or provide meaningfulprotection or any commercial advantage to us or such claims may not be upheldif challenged.  Also, competitors may develop their own intellectualproperty or technologies, obtain their own patents, or challenge the validityof, or be able to design around, our patents.  The laws of certain foreigncountries in which our products are or may be developed, manufactured, or sold(particularly certain countries in Asia) may not protect our products or intellectualproperty rights to the same extent as do the laws of the United States and thusincrease the likelihood of piracy of our technologies and products.

 

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

 

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

 

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**Our recently-announced restructuring may disrupt ouroperations and adversely affect our operating and financial results.**

 

In fiscal July 2008, we announced a series ofactions designed to enhance competitiveness, improve our efficiency, and reduceour cost structure.  We initiatedworkforce reduction and consolidation actions designed to intensify our focuson our growth areas and improve our operating efficiency.  The restructuring includes actions to reducecertain research and development investments in lower growth product areas,integrate our marketing functions, and shift support for our Asian operationsfrom Shannon, Ireland, to our recently-established regional hub in Singapore.  We are also relocating certain functions fromRedmond, Washington to Huntsville, Alabama. The impact of these organizational improvements will result in a netdecrease of approximately 110 positions or approximately 5% of our globalworkforce.  In fiscal July 2008, wealso announced that, as part of our continued focus on core markets, we intendto sell the portion of our entrepreneurial Connectivity and Controls businessunit dedicated to our Professional Audio Video and our Equinox serial products.  The restructuring activities couldcreate uncertainty and confusion among our employees, customers, andsuppliers.  In addition, therestructuring activities might not result in the cost savings or efficiencieswe anticipate and may result in temporary operational inefficiencies.   As a result, these restructuring activitiescould have a material adverse effect on our business, financial condition, andresults of operations.  The factors described above also could disrupt ourproduct development, manufacturing, and sales, which would affect our financialresults.

 

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

 

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

 

·                                          Thevolume, timing, pricing, and contractual terms of orders, particularly fromOEMs, resellers, and other large customers, a significant portion of which tendto occur late in each quarter;

 

·                                          Thetiming of shipments;

 

·                                          Theunpredictable nature of the sales cycle for software products and the timingand completion of delivery of software products;

 

·                                          Thetiming of new product introductions, new technologies, and enhancements by usand by our competitors, and the possibility that customers may defer purchasesof our products in anticipation of these new products, new technologies, andenhancements;

 

·                                          Changesin or our failure to accurately predict product or distribution and resellerchannel mixes, including changes in the mix of software licenses in whichrevenue is recognized upfront as opposed to subscription licenses that aredeferred over time and changes in the mix of revenue attributable tohigher-margin products as opposed to lower-margin sales or services;

 

·                                          Changesin demand for our products and services;

 

·                                          Changesin pricing policies or price reductions;

 

·                                          Changesin laws, regulations, or other government requirements;

 

·                                          Changesin renewal rates for software upgrade protection or maintenance;

 

·                                          Competitionfrom new products, technologies, business models, and price reductions bycompetitors;

 

·                                          Theavailability and cost of supplies, components, or third-party code or contenton commercially reasonable terms;

 

·                                          Compatibilityor interoperability of our products with third-party systems and applications;

 

·                                          Salesand marketing expenses related to entering into new markets, introducing newproducts, new technologies, and retaining current OEMs, resellers, and otherlarge customers;

 

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·                                          Fluctuationsin sales of servers and personal computers due to changes in technology (suchas virtualization), economic conditions, or capital spending levels;

 

·                                          Theamount and timing of operating expenses and capital expenditures relating tothe expansion of our business and operations; and

 

·                                          Costsassociated with legal proceedings, including legal fees and any adversejudgments or settlements.

 

Our operating resultswill continue to be affected by seasonal trends, by general conditions in theIT market, and by general economic conditions.  Depending on the severityand longevity of the current economic crisis, we may see fluctuations in ouroperating results.  In addition, we haveexperienced, and we expect to continue to experience, some degree ofseasonality due to customer buying cycles and delays in customer orders duringunfavorable economic periods.  We believe that the third and fourthquarters will generally have higher net sales levels due to customer budgetingand procurement cycles, which may depress net sales in other quarters.  Inaddition, European sales are often weaker during the summer months.  Inthe past, we have typically seen a sequential decline in revenue from thefourth quarter of a year to the first quarter of the following year, and whileit is difficult to predict revenue in any quarter, we expect that this patternwill continue in the future.  Many of the factors that create and affectseasonal trends are beyond our control.

 

Our quarterly sales havealso reflected a pattern in which a disproportionate percentage of each quarter’stotal sales occur toward the end of the quarter, and this trend has become morepronounced in recent periods.  Our increasedfocus on the software market continues this trend with a greater proportion ofour software revenue coming from software license and subscriptions booked inthe last weeks or days of each quarter.  This uneven sales pattern makesprediction of revenue, earnings, and working capital for each financial perioddifficult, increases the risk of unanticipated variations in quarterly resultsand financial condition, and places pressure on our hardware inventorymanagement and logistics systems.  If predicted demand for hardware issubstantially greater than orders, there will be excess inventory. Alternatively, if hardware orders substantially exceed predicted demand, we maynot be able to fulfill all of the orders received in the last few weeks of eachquarter.  Other developments late in a quarter, such as a systems failure,component pricing movements, actions or announcements from our competitors,global logistics disruptions, or large sales opportunities not being completedwhen predicted, could adversely impact inventory levels and results ofoperations in a manner that is disproportionate to the number of days in thequarter affected.  In addition,accounting requirements associated with satisfying the various elementsnecessary to recognize software revenue may result in significant fluctuationsin our quarterly results.

 

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

 

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

 

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

 

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

 

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

 

·                                          Theratio of sales through indirect channels to direct sales, since indirect salestypically have lower gross margins than direct sales;

 

·                                          Theratio of sales in established markets to sales in new markets with differentpricing and cost structures;

 

·                                          Changesin product mix, because sales of some of our products and technologies willhave lower gross margins than sales of other products or technologies (e.g. oursoftware products tend to have higher gross margins);

 

·                                          Increasedprice competition;

 

·                                          Changesin product costs and sales discounts;

 

·                                          Changesin raw materials, freight, regulatory, certification, import or exportexpenses, tariffs, and labor costs;

 

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·                                          Introductionof new products, services, business models, and technologies by us and by ourcompetitors;

 

·                                          Thelevel of and costs for third-party technology and code used in our softwareproducts; and

 

·                                          Thelevel of and costs for outsourcing of our manufacturing and assembly servicesfor our hardware products and the impact this can have on our inventoryvaluation of older products.

 

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

 

**Asubstantial portion of our business consists of sales to a limited number ofresellers and distributors that are not obligated to continue doing businesswith us, and these sales vary considerably from quarter to quarter.**

 

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

 

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

 

·                                          Concentrationof business in a limited number of resellers and distributors could result insignificant damage to our business upon the termination of a resellerrelationship;

 

·                                          Terminationof reseller and distributor agreements or reduced or delayed orders;

 

·                                          Difficultyin predicting sales to resellers and distributors who do not have long-termcommitments to purchase from us, which requires us to maintain sufficientinventory levels to satisfy anticipated demand;

 

·                                          Lackof visibility of end user customers and revenue recognition and channelinventory issues related to sales by resellers and distributors;

 

·                                          Resellersand distributors electing to resell or increase their marketing of competingproducts or technologies or reduced marketing of our products; and

 

·                                          Changesin corporate ownership, financial condition, credit worthiness, paymentpatterns, business direction, sales compensation related to our products, orproduct mix by the resellers and distributors.

 

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

 

The loss of one or morelarge resellers or distributors could materially harm our business.  Whilewe have reseller and distributor agreements, none of our resellers or distributorsare obligated to purchase products from us.  Consequently, any reseller ordistributor could cease doing business with us at any time.  Ourdependence upon a few resellers and distributors could result in a significantconcentration of credit risk, thus a substantial portion of our tradereceivables outstanding from time to time may be concentrated among a limitednumber of customers.  In addition, the inability to accurately forecastthe timing and volume of orders for sales of branded products to resellers anddistributors during any given quarter could adversely affect operating resultsfor such quarter and, potentially, for future periods.  If weunderestimate sales, we will not be able to fill orders on a timelybasis.  This could cause customer dissatisfaction and loss of futurebusiness.  If we overestimate sales, we will experience increased costsfrom inventory storage, waste, and obsolescence.

 

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

 

We expect to relyincreasingly on distributors and resellers, VARs (including LANDesk VARs whoare also referred to as “Expert Service Providers” or “ESPs”), and systemsintegrators for the distribution and sale of our branded hardware and softwareproducts.  Our strategy contemplates the expansion of our distributor andreseller networks both domestically and internationally, particularly in Asia,and an increase in the number of customers licensing our products through theseexpanded channels.  Our future success will depend in part on our abilityto attract, train, and motivate new distributors and resellers and expand ourrelationships with current distributors and resellers.  We may not besuccessful in expanding our distributor and reseller relationships.  Wewill be required to invest significant additional resources in order to expandthese relationships, and the cost of this investment may exceed the marginsgenerated from this investment. Conducting business through indirect sales channels presents a number ofrisks, including:

 

·                                          Difficultiesin replacing any lost or terminated distributors or resellers;

 

·                                          Existingor new distributors and resellers may not be able to effectively sell ourcurrent or future products or services;

 

·                                          Potentialdistributors and resellers deciding not to enter into relationships with usbecause of our existing relationships with other distributors and resellerswith which they compete;

 

·                                          Ourability to provide proper training and technical support to our distributorsand resellers;

 

·                                          Thepossibility of damage or impairment to our market position, brands or trademarksas a result of the actions of our distributors and resellers;

 

·                                          Distributorsand resellers electing to place greater emphasis on products or servicesoffered by our competitors; and

 

·                                          Thelack of direct control over the business practices, marketing, sales andservices offered by distributors and resellers.

 

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

 

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

 

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

 

A substantial portion ofour sales is concentrated among a limited number of OEM customers.  Salesto these OEMs represented approximately 35% of net sales in 2007, 40% of netsales in 2006, and 48% of net sales in 2005.  Sales to Hewlett-Packardrepresented approximately 12% of net sales in 2007, 14% of our net sales in2006, and 20% of our net sales in 2005.  Sales to Dell represented approximately12% of net sales in 2007, 14% of net sales in 2006, and 15% of our net sales in2005.

 

We have experienced, andwe expect to continue to experience, period-to-period variability in sales tothese OEM customers.  Any cancellation, rescheduling, or reduction oforders by OEM customers in the future could materially adversely affect ouroperating results.  Although our OEM customers typically place orders forproducts up to several months prior to scheduled shipment dates, these ordersare subject to cancellation.

 

Our OEM business issubject to many risks, including:

 

·                                          Contracttermination or reduced or delayed orders;

 

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

 

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

 

·                                          Adoptionof competing products or technologies developed by third parties for the OEMs,acquisition or internal development of competing products or technologies bythe OEMs, or changes in the OEMs’ marketing of competing products or reducedmarketing of our products; and

 

·                                          Changesin corporate ownership, financial condition, credit worthiness, paymentpatterns, business direction, sales compensation related to our products, orproduct mix by the OEMs.

 

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

 

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

 

We use multiplewarehouses for many of our OEM customers to fulfill their hardware orders undera just-in-time inventory management system, which requires us to maintainsufficient inventory levels of our hardware products at each of thesewarehouses to satisfy anticipated demand from our OEM customers, and wegenerally recognize revenue only when these OEM customers take possession ofour hardware products.  We are required to plan production, ordercomponents, and undertake our manufacturing activities prior to the time thatthese orders become firm or the products are accepted.  In addition, ourOEM customers have requested, and are likely to continue to request from timeto time, that we delay shipment dates or cancel orders for hardware productsthat are subject to firm orders.  As a result, at any time we may beholding a significant amount of OEM-branded hardware products in inventory, andour sales to OEMs for future quarters are difficult to predict.  Theinability to accurately predict the timing and volume of hardware orders forour OEM customers during any given quarter could adversely affect operatingresults for that quarter and, potentially, for future quarters.  If weunderestimate sales, we may not be able to fill orders on a timely basis. This could cause customer dissatisfaction and loss of future business.  Ifwe overestimate sales, we may experience increased costs from inventorystorage, waste, and obsolescence.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Continued growth of oursales is likely to be accompanied by increasing demands on customer serviceoperations.  As a result of our commitment to a high level of customerservice, we will need to invest significant resources in the maintenance andimprovement of our customer service resources.  Any failure to maintainadequate customer service could cause customer dissatisfaction, result inreduced sales of products, reductions in the renewals of software maintenanceand support agreements, and, accordingly, materially adversely affect ourbusiness, financial condition, and results of operations.

 

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

 

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

 

·                                          Difficultiesin managing foreign distributors and resellers;

 

·                                          Longerpayment cycles and problems in collecting accounts receivable;

 

·                                          Theeffects of seasonal customer demand;

 

·                                          Differinglicense terms and conditions to meet local requirements;

 

·                                          Changesin regulatory requirements;

 

·                                          Difficultiesin meeting the requirements of different international product regulations,including import and export requirements, tariffs, and other trade barriers;

 

·                                          Risksrelating to the protection of our intellectual property rights;

 

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

 

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·                                          Fluctuationsin currency exchange rates; and

 

·                                          Potentiallyadverse tax consequences and political instability.

 

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

 

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

 

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

 

·                                          Ongoinginstability or changes in a country’s or region’s economic or politicalconditions, including inflation, recession, interest rate fluctuations, andactual or anticipated military or political conflicts, particularly in areaswhere we have offices or other facilities;

 

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

 

·                                          Longeraccounts receivable cycles and financial instability among customers;

 

·                                          Taxor trade regulations, tariffs, duties, and procedures and actions affectingproduction, pricing, and marketing of or payments for products;

 

·                                          Locallabor conditions and other regulations;

 

·                                          Differingtechnology standards or customer requirements;

 

·                                          Limitedor unfavorable intellectual property protection in certain foreign countriesincluding the loss of proprietary information due to piracy ormisappropriation;

 

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

 

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

 

·                                          Medicalepidemics, such as avian flu or Severe Acute Respiratory Syndrome (SARS);

 

·                                          Seasonalreductions in business activity in certain foreign countries, such as thesummer months in Europe;

 

·                                          Compliancewith a wide variety of complex laws, treaties, and regulations that increasethe risks of doing business in certain foreign countries;

 

·                                          Restrictionsagainst repatriation of earnings from our international operations;

 

·                                          Difficultiesin staffing and managing international operations, including the difficulty inmanaging a geographically dispersed workforce;

 

·                                          Possiblenon-compliance with our Code of Conduct or other corporate policies due toinconsistent laws, interpretations, and/or application of corporate standardsin foreign countries;

 

·                                          Increasedfinancial accounting and reporting burdens and complexities; and

 

·                                          Theneed to localize our products.

 

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The factors describedabove also could disrupt our product development and manufacturing, keysuppliers, and OEMs and resellers located outside of the United States. For example, we rely on manufacturers in Asia and Europe for the assemblyand manufacture of many of our hardware products, and we conduct substantialsoftware development and testing operations in China and Taiwan.  Accordingly, we are directly affected byeconomic, political, and military conditions in the regions where we haveoperations, including China and Taiwan. In particular, any interruption or curtailment of trade between Chinaand its present trading partners could materially adversely affect our productdevelopment, product releases, support, business, operating results, andfinancial condition.

 

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

 

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

 

Currently, a majority ofour international business is conducted in U.S. dollars.  However, as weexpand our international operations, it is likely that international businesswill increasingly be conducted in foreign currencies. Fluctuations in the valueof foreign currencies relative to the U.S. dollar have caused, and are expectedto increasingly cause, currency transaction gains and losses.  Inaddition, currency fluctuations could also affect our reported resultsexpressed in U.S. dollars.  While weattempt to hedge our foreign currency exposure, we cannot predict the effect ofexchange rate fluctuations upon future quarterly and annual operating results,and we may experience currency losses in the future.

 

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

 

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

 

·                                          Customers’budgetary constraints, fluctuations, or uncertainty, internal acceptancerequirements, and procurement procedures;

 

·                                          Concernsabout the actions or announcements of our competitors and their products;

 

·                                          Concernsabout the future or performance of our company; and

 

·                                          Changesin economic conditions generally and in the technology market specifically.

 

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

 

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

 

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

 

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Maintenance revenuerelated to the licensing of our software products is a significant part of ourcurrent and future operating revenue.  Ingeneral, maintenance fees increase with the increase in the use of our software.  Accordingly, we receive higher maintenancefees with new license agreements and as existing customers install more of oursoftware products on additional systems. Due to increased discounting for larger sales opportunities, maintenancefees on a per unit basis for such large deals can be lower than average.  In addition, customers are generally providedannual maintenance discounts for entering into long-term maintenanceagreements.  Declines in our licensebookings, increases in long-term maintenance agreements, customers electing tomigrate to competitive products or find alternatives to our products, and/orincreased discounting could lead to reduced software maintenance revenue andreduced gross margins.

 

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

 

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

 

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

 

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

 

·                                          Ownersor licensees of third-party systems could adopt more restrictive policies orimpose unfavorable or unacceptable terms and conditions for access to theirproducts making it more difficult for us to make our products compatible withtheir products and resulting in higher research and development costs for usfor the enhancement or modification of our existing products and thedevelopment of new products;

 

·                                          Functionalityprovided by third-party code, content, or other intellectual property in ourproducts may become obsolete, defective, or incompatible with future versionsof our products, may not be adequately maintained or updated, and we may beunable to find viable alternatives or develop our own proprietary solution;

 

·                                          Quality,warranty, and support terms vary dramatically when licensing third-party code,content, or other intellectual property and we have limited ability to controlquality issues with third-party code, content, or other intellectual propertyand we must depend on our own research and development personnel to evaluateand select third-party code, content, or other intellectual property that webelieve is of the most value to our customers; and

 

·                                          Technicaldifficulties in integrating our products and third-party code, content, orother intellectual property to create a combined solution, and the risk thatcustomers will not perceive the need for such integrated solutions.

 

Any significant terminationof a third-party license, change in third-party license provisions, increase inthe cost of such third-party code, content or other intellectual property,failure of a code, content or other intellectual property provider to remaincompetitive in functionality, or defect in or a quality issue could delay orinterrupt our ability to develop and deliver software products to customers ona timely basis.  This could delay ourrevenue recognition and adversely affect our business, financial condition, andresults of operations and possibly expose us to claims under license agreementswith our customers and possibly increased litigation fees and expenses.  Our failure to anticipate, manage, and adaptto these risks could result in significant delays in our products releases,changes in our product roadmaps, and damage to our operating results.

 

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

 

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

 

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

 

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

 

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

 

·                                          Freeor open source software or technology becoming competitive with our proprietarytechnology, which could cause sales of our products to decline or force us toreduce the fees we charge for our products, which could have a material adverseimpact on our revenue and operating margins;

 

·                                          Requiringthat we make available the source code for any modifications or derivativeworks we make to or from the free or open source software, and that we licenseor contribute such modifications or derivative works under the terms of aparticular free or open source license or other license granting third partiescertain rights of further use;

 

·                                          Ourproprietary software could be combined with open source software in such a waythat we would be required to release the source code of our proprietarysoftware; and

 

·                                          Thelack of any warranty, maintenance, or support for most open source software ortechnology.

 

We have established processesto help minimize these risks to the extent within our control, including areview process for screening requests from our development organizations forthe use of free or open source, but we cannot be sure that all free or opensource software, technology, or tools are submitted for approval prior to usein our products or in the development of our products or that all use is incompliance with our corporate policies. These risks, if not eliminated, couldnegatively affect our ability to sell and license our products and couldmaterially impact our business.

 

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

 

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

 

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We have historically usedstock options and are currently using restricted stock units, including bothtime-based,  performance-based and marketconditioned-based shares, as a key component in our executive and employeecompensation programs in order to align employees’ interests with the interestsof our stockholders, encourage employee retention, and provide competitivecompensation packages.  Many of our employee stock options are fullyvested, but most of these outstanding and vested options are currentlyunderwater.  This could affect our ability to retain presentemployees.  In addition, we are now required to record a charge toearnings for employee stock option grants and other equity incentives. Moreover, applicable stock exchange listing standards relating to obtainingstockholder approval of equity compensation plans could make it more difficultor expensive for us to make equity awards to employees in the future.  Asa result, we may incur increased compensation costs, change our equitycompensation strategy, or find it difficult to attract, retain, and motivateemployees, any of which could materially adversely affect our business.

 

As we expand ourinternational operations, we will be required to recruit and retain experiencedmanagement, sales and technical personnel in our international offices, and weexpect that the identification, recruitment, training and retention of suchpersonnel will require significant management time and effort and resources.  Competition for employees with the skillsrequired, particularly management, engineering and other technical personnel,is intense, and there can be no assurance that we will be able to attract andretain highly skilled employees in sufficient numbers to sustain our current businessor to support future growth.  We may need to pay recruiting or agency feesand offer additional compensation or incentives to attract and retain these andother employees, resulting in an increase to our operating expenses.

 

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

 

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

 

In January 2008,John R. Cooper, our Chief Executive Officer and the Chairman of the Board ofDirectors at that time, announced his resignation, effective March 31,2008.  Edwin L. Harper, one of ourDirectors, was elected as Chairman of our Board of Directors in January 2008and as Interim Chief Executive Officers effective April 1, 2008.  Our Board of Directors electedMichael J. Borman as our new Chief Executive Officer and a member ofour Board of Directors, effective July 15, 2008.  The transition to a new chief executiveofficer could create uncertainty and confusion among our employees, customers,and stockholders.  In addition, this transition may adversely affect ordelay customer purchase decisions or decisions about the strategic direction ofour business and raised concerns among our employees, customers, andstockholders, all of which could affect our sales, profitability, or results ofoperations.

 

**Our line of credit or term loancould adversely affect us and our operations.**

 

In the second quarter of2006, we obtained a $250 million unsecured, five-year, revolving, bank line ofcredit, and we used borrowings under this line of credit to fund a portion ofthe LANDesk acquisition and the purchase of our shares under ourrecently-expanded stock repurchase program. In July 2008, we amended the line of credit and borrowed anadditional $90 million under a three-year term note.  We may increase this bank debt or seek otherbank debt in the future.  The balanceoutstanding on our debt agreements was $180 million as of September 26, 2008.  Interest expense on borrowings under the termloan and additional future borrowings under the line of credit could adverselyaffect our future net income, margins, expenses, and financial conditions by:

 

·                                          Requiringus to dedicate a substantial portion of our cash flow from operations topayments on our indebtedness, which would reduce the availability of our cashflow to fund internal growth through working capital and capital expendituresand for other general corporate purposes;

 

·                                          Increasingour vulnerability to economic downturns in our industry;

 

·                                          Increasingour vulnerability to interest rate increases to the extent any of our variablerate debt is not hedged;

 

·                                          Placingus at a competitive disadvantage compared to our competitors that have lessdebt in relation to cash flow;

 

·                                          Limitingour flexibility in planning for or reacting to changes in our business and ourindustry;

 

·                                          Limiting,among other things, our ability to borrow additional funds, refinance the lineof credit, or obtain other financing capacity; and

 

·                                          Subjectingus to a risk of noncompliance with financial and other restrictive covenants inour indebtedness.

 

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The line of credit and term loan contain affirmativeand negative covenants, including limitations on our ability to (i) makedistributions, investments, and other payments unless we satisfy certainfinancial tests or other criteria, (ii) incur additional indebtedness, (iii) restructureour subsidiaries, and (iv) make acquisitions and capitalexpenditures.  All of these restrictionscould affect our ability to operate our business and may limit our ability totake advantage of potential business opportunities as they arise.  The failure to comply with these covenantscould result in an event of default which, if not cured or waived, could have amaterial adverse effect on us.

 

Our ability to complywith these provisions of our line of credit and term loan may be affected bychanges in the economic or business conditions or other events beyond ourcontrol.  If we do not comply with thesecovenants and restrictions, we could be in default under our line of creditand/or the term loan, and our debt, together with accrued interest, could thenbe declared immediately due and payable. There can be no assurance that we will be able to obtain sufficientfunds to enable us to repay or refinance our debt obligations on commerciallyreasonable terms or at all.  We also faceinterest rate risk on our bank line of credit and term loan which currentlybears interest at a variable rate of LIBOR plus 175 basis points.  We have partially hedged this exposure tointerest rate risk with interest rate swaps, which have a remaining notionalamount of $100 million, through a well established financial institution.

 

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

 

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

 

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

 

Section 404 of theSarbanes-Oxley Act of 2002 requires that we implement and maintain adequateinternal systems and effective internal controls over financial reporting andinformation systems.  The absence of suchcontrols could have a material adverse effect on our business, financialcondition, and results of operations.  Inaddition, correction of any “significant deficiencies” or “material weaknesses”(as defined under PCAOB guidelines) could require additional remedial measuresincluding hiring additional personnel, which could be costly and time-consuming.  If a significant deficiency or materialweakness exists at any year-end (including a material weakness identified priorto year-end for which there is an insufficient period of time to evaluate andconfirm the effectiveness of the corrections or related new procedures), ourmanagement and our auditors will be unable to report favorably as to theeffectiveness of our control over financial reporting or informationsystems.  This could result in a loss ofinvestor confidence in the accuracy and completeness of our financial reportsand our management, which could result in a decline of our stock price, damageto our business reputation, and potential litigation.

 

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

 

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

 

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

 

Some of our operationsuse substances regulated under various federal, state, and international lawsgoverning the environment, including those governing the discharge ofpollutants into the air and water, the management and disposal of hazardoussubstances and wastes, and the cleanup of contaminated sites.  Many of ourproducts are subject to various federal, state, and international lawsgoverning chemical substances in products, including those regulating themanufacture and distribution of chemical substances and those restricting thepresence of certain substances in electronics products.  We could incursubstantial costs, including cleanup costs, fines, civil or criminal sanctions,third-party property damage, or personal injury claims if we were to violate orbecome 

 

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liable underenvironmental laws or if our products become non-compliant with environmentallaws.  We also face increasing complexity in our product design andprocurement operations as we adjust to new and future requirements relating tothe materials composition of our products, including the restrictions on leadand certain other substances that will apply to specified electronics productsput on the market in the European Union as of July 1, 2006 (Restriction ofHazardous Substances Directive) and similar legislation in China and othercountries.  The ultimate costs under environmental laws and the timing ofthese costs are difficult to predict, and liability under some environmentallaws relating to contaminated sites can be imposed retroactively and on a jointand several basis.

 

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

 

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

 

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

 

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

 

**Ourstock price may be volatile.**

 

Our stock has experiencedsignificant volatility in price, in particular whenever there has been adifference between our actual financial results and the published expectationsof analysts.  We have also experienced changesin our stock price as a result of speculation in the press or investmentcommunity about our strategic position, financial position, results ofoperations, business, or significant transactions or acquisitions.  The stock market in general has experiencedprice and volume fluctuations that have negatively affected the market price ofmany publicly-held companies in ways seemingly unrelated to the actualoperating performance of these companies. For instance, in the past severalweeks stock prices in the U.S. have reacted dramatically in connection withrecent events in the U.S. and global economy. Our stock price has been similarly volatile. These factors, as well asgeneral economic and political conditions and the announcement of proposed andcompleted acquisitions or other significant transactions, or any difficultiesassociated with such transactions, by us or our current or potentialcompetitors, may materially adversely affect the market price of our commonstock in the future. Additionally, volatility, lack of positive performance inour stock price or changes to our overall compensation program including ourstock incentive program may adversely affect our ability to retain keyemployees, virtually all of whom are compensated, in part, based on theperformance of our stock price.

 

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**Item2.****           UnregisteredSales of Equity Securities and Use of Proceeds.**

 

In 2004 our Boardof Directors approved a stock repurchase program whereby we may purchase sharesof our common stock.  Our Board hasapproved a total of 19 million shares to be repurchased under this program,including 4 million additional shares approved by our Board in January 2008.  The plan has no expiration date.  Details of purchases made during the threeand nine months ended September 26, 2008 are as follows:

 
| **Period:**                                          | ** ** | **Total Number of  Shares Purchased  During the Period** | ** ** | **Average Price Paid  Per Share for Period  Presented** | ** ** | **Total Cumulative**

**Number of  Shares Purchased as  Part of Publicly  Announced Plan** | ** ** | **Maximum  Number of  Shares  Remaining to  Purchase Under  the  Plan** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
|                                                 |       |                                                                              |       |                                                                             |       |                                                                                                                          |       |                                                                                   |       |
| January 1,  2008 — January 25, 2008   |       | 1,587,575                                                                         |       | $                                                                                | 15.59      |                                                                                                                          | 14,287,575 |                                                                                   | 4,712,425  |   |
| January 26,  2008 — February 22, 2008 |       | 1,462,425                                                                         |       | $                                                                                | 16.56      |                                                                                                                          | 15,750,000 |                                                                                   | 3,250,000  |   |
| February 23,  2008 — March 28, 2008   |       | 862,300                                                                           |       | $                                                                                | 16.22      |                                                                                                                          | 16,612,300 |                                                                                   | 2,387,700  |   |
| Quarter ended  March 28, 2008                   |       | 3,912,300                                                                         |       | $                                                                                | 16.09      |                                                                                                                          |       |                                                                                   |       |   |
| March 29,  2008 — April 25, 2008      |       | 87,700                                                                            |       | $                                                                                | 17.02      |                                                                                                                          | 16,700,000 |                                                                                   | 2,300,000  |   |
| April 26,  2008 — May 23, 2008        |       | —                                                                            |       | —                                                                           |       | 16,700,000                                                                                                                    |       | 2,300,000                                                                              |       |
| May 24,  2008 — June 27, 2008         |       | —                                                                            |       | —                                                                           |       | 16,700,000                                                                                                                    |       | 2,300,000                                                                              |       |
| Quarter ended  June 27, 2008                    |       | 87,700                                                                            |       | $                                                                                | 17.02      |                                                                                                                          |       |                                                                                   |       |   |
| Six Months ended  June 27, 2008                 |       | 4,000,000                                                                         |       | $                                                                                | 16.11      |                                                                                                                          |       |                                                                                   |       |   |

 

Therewere no shares repurchased during the three months ended September 26,2008.  Approximately 172,000 shares werewithheld as payment for employee payroll withholding taxes at the release ofvested restricted stock units in the first nine months of 2008 (*see Note 3 to our condensed consolidated financialstatements contained in Part I, Item 1 of this quarterly report*).  The 172,000 shares were considered to betreasury shares; however, these treasury shares were immediately retired andare not considered in the table above.

 

**Item5.****           OtherInformation.**

 

*Amendmentto Avocent Corporation Amended and Restated Bylaws*

 

EffectiveOctober 31, 2008, our Board of Directors amended Sections 2.3 and 2.5 of theAmended and Restated Bylaws of Avocent Corporation to address when a specialmeeting of stockholders can be held and the advance notice procedures fordirector elections and stockholder proposals. The amendment to Section 2.3 specifies that action by our Board ofDirectors means a resolution adopted by a majority of the total number ofauthorized directors whether or not any vacancies exist in previouslyauthorized director positions, and the amendment to Section 2.5 sets forththree separate and distinct processes for advance notice of stockholderbusiness, advance notice of director nominations at annual meetings, andadvance notice of director nominations for special meetings.  Section 2.5 also details the dates by whichthe Company must receive notice of any such proposal or nomination and theinformation that must be provided to the Company.  A copy of the amendment is filed as Exhibit3.2 hereto and is incorporated herein by reference. 

 

*Form ofRevised Equity Agreements for 2005 Equity Incentive Plan and 2008 InducementEquity Incentive Plan*

 

OnOctober 31, 2008, our Board of Directors approved amended forms of a restrictedstock unit agreement and a performance share agreement under the AvocentCorporation 2005 Equity Incentive Plan and the Avocent Corporation 2008Inducement Equity Incentive Plan to bring such forms into compliance withSection 409A of the Internal Revenue Code. These forms of agreement are filed as Exhibit 90.20 hereto andincorporated herein by reference.

 

*AmendedEmployee Stock Purchase Plan*

 

OnOctober 31, 2008, our Board of Directors approved the resumption of our 2000Employee Stock Purchase Plan (the “Plan”), which we had suspended at the end of2005, and approved an amended Plan. Under the amended Plan, eligible employees are offered the opportunityto purchase shares of our common stock at a 10% discount off the market value ofthe stock at the end of two six-month purchase periods each year.  The amended Plan is filed as Exhibit 90.21hereto and incorporated herein by reference.

 

**Item6.****           Exhibits.**

 

(a) Exhibits

 
| **3.2**    | ** ** | **Amended  and Restated Bylaws of Avocent Corporation**                                                                                                                                            |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                         |
| **31.1**   | ** ** | **Sarbanes-Oxley  Act of 2002 Section 302(a) Certification of the Chief Executive  Officer**                                                                                             |
| ** ** | ** ** | ** **                                                                                                                                                                                         |
| **31.2**   | ** ** | **Sarbanes-Oxley  Act of 2002 Section 302(a) Certification of the**Chief Financial  Officer                                                                                              |
| ** ** | ** ** | ** **                                                                                                                                                                                         |
| 32.1       |       | Certification of the Chief Executive Officer and the Chief Financial  Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
|       |       |                                                                                                                                                                                               |
| 99.20      |       | Form of Amended  and Restated Agreements under 2005 and 2008 Equity Plans                                                                                                                     |
|       |       |                                                                                                                                                                                               |
| 99.21      |       | Amended and Restated Employee Stock Purchase Plan                                                                                                                                                  |

 

ITEMS 3 AND 4 ARE NOTAPPLICABLE AND HAVE BEEN OMITTED.

 

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### **SIGNATURE**

### ** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   |                  | AVOCENT CORPORATION                                             |
|--------|-----------------------|-----------------------------------------------------------------|
|   |                  | (Registrant)                                                    |
|   |                  |                                                            |
|   |                  |                                                            |
| Date:  | November 5, 2008 | /s/  Edward H. Blankenship                                      |
|   |                  | Edward H. Blankenship                                           |
|   |                  | Senior Vice President  of Finance, Chief Financial              |
|   |                  | Officer, and Assistant  Secretary (Principal Financial Officer) |

 

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