** **

**U.S. SECURITIES ANDEXCHANGE COMMISSION**WASHINGTON, D.C.  20549

 

# **FORM 10-Q**

 
| **(Mark One)**                                                                                                                                                  |       |                                                                                          |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                            |       |                                                                                          |
| **ý**                                                                                                                                                      | ** ** | **Quarterly report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**  |
|                                                                                                                                                            |       |                                                                                          |
| **For the quarterly period ended  September 30, 2005 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)

 

                Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.

 

ý Yes  o No

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

ý Yes  o No

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act)

 

o Yes  ý No

 

As of November 2, 2005,the number of outstanding shares of the Registrant’s Common Stock was48,901,455

 

 

----

 

**September30, 2005**

 

**INDEX**

 
| ** ** | **Page(s)**           |
|------------|-----------------------|
| Part I     | Financial Information |   |
|       |                  |   |
|       | Item  1.              | Financial  Statements (unaudited) |   |
|       |                  |   |   |
|       |                  | Condensed Consolidated Statements of  Operations for the Three and Nine Months Ended September 30, 2005 and October  1, 2004 | 3 |
|       |                  |   |   |
|       |                  | Condensed Consolidated Balance Sheets at  September 30, 2005 and December 31, 2004 | 4 |
|       |                  |   |   |
|       |                  | Condensed Consolidated Statements of Cash  Flows for the Nine Months Ended September 30, 2005 and October 1, 2004 | 5 |
|       |                  |   |   |
|       |                  | Notes to Condensed Consolidated Financial  Statements | 6-12 |
|       |                  |   |   |
|       | Item 2.               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 13-19 |
|       |                  |   |   |
|       | Item 3.               | Quantitative and Qualitative  Disclosures about Market Risks | 19 |
|       |                  |   |   |
|       | Item  4.              | Controls and Procedures | 19 |
|       |                  |   |   |
| Part  II   | Other  Information    |   |
|       |                  |   |   |
|       | Item  1.              | Legal Proceedings | 20 |
|       |                  |   |   |
|       | Item 2.               | Unregistered  Sales of Equity Securities and Use of Proceeds | 20 |
|       |                  |   |   |
|       | Item  6.              | Exhibits | 20 |
|       |                  |   |   |
| Signatures | 21                    |

 

2

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**Item1.  FinancialStatements**

 

**AVOCENTCORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited,in thousands, except per share data)

#### ** **

| ** **                                                    | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                                                    | ** ** | **Sept. 30,**                  | ** ** | **Oct. 1,**                   | ** ** | **Sept. 30,** | ** ** | **Oct. 1,** | ** ** |
| ** **                                                    | ** ** | **2005**                       | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                    | ** ** | ** **                     | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                     |       | $                              | 96,708     |                          | $          | 91,325 |   | $ | 263,051 |   | $ | 265,206 |   |
| Cost of sales                                                 |       | 39,388                         |       | 38,200                        |       | 109,322 |   | 111,379 |   |
| Gross profit                                                  |       | 57,320                         |       | 53,125                        |       | 153,729 |   | 153,827 |   |
|                                                          |       |                           |       |                          |       |   |   |   |   |
| Research and development  expenses                            |       | 14,640                         |       | 11,774                        |       | 43,495 |   | 32,428 |   |
| Acquired in-process research and development expense          |       | —                         |       | 1,050                         |       | — |   | 29,260 |   |
| Selling, general and administrative expenses                  |       | 20,764                         |       | 21,206                        |       | 67,069 |   | 63,578 |   |
| Amortization of intangible  assets                            |       | 2,731                          |       | 6,482                         |       | 15,976 |   | 17,656 |   |
| Total operating expenses                                      |       | 38,135                         |       | 40,512                        |       | 126,540 |   | 142,922 |   |
|                                                          |       |                           |       |                          |       |   |   |   |   |
| Income from operations                                        |       | 19,185                         |       | 12,613                        |       | 27,189 |   | 10,905 |   |
|                                                          |       |                           |       |                          |       |   |   |   |   |
| Income from settlement of  lawsuit                            |       | —                         |       | —                        |       | 5,000 |   | — |   |
| Net investment income                                         |       | 2,242                          |       | 1,297                         |       | 6,558 |   | 3,594 |   |
| Net realized investment  losses                               |       | (100                           | )          | (101                          | )          | (483 | ) | (269 | ) |
| Other income (expense),  net                                  |       | (75                            | )          | 26                            |       | (129 | ) | (122 | ) |
|                                                          |       |                           |       |                          |       |   |   |   |   |
| Income before income taxes                                    |       | 21,252                         |       | 13,835                        |       | 38,135 |   | 14,108 |   |
| Provision for income taxes                                    |       | 4,887                          |       | 3,013                         |       | 8,838 |   | 8,135 |   |
|                                                          |       |                           |       |                          |       |   |   |   |   |
| Net income                                                    |       | $                              | 16,365     |                          | $          | 10,822 |   | $ | 29,297 |   | $ | 5,97315,512 |   |
|                                                          |       |                           |       |                          |       |   |   |   |   |
| Earnings per share:                                           |       |                           |       |                          |       |   |   |   |   |
| Basic                                                         |       | $                              | 0.33       |                          | $          | 0.22 |   | $ | 0.59 |   | $ | 0.12 |   |
| Diluted                                                       |       | $                              | 0.33       |                          | $          | 0.21 |   | $ | 0.58 |   | $ | 0.12 |   |
|                                                          |       |                           |       |                          |       |   |   |   |   |
| Weighted average shares used in computing earnings per share: |       |                           |       |                          |       |   |   |   |   |
| Basic                                                         |       | 48,966                         |       | 49,323                        |       | 49,550 |   | 48,663 |   |
| Diluted                                                       |       | 49,879                         |       | 50,502                        |       | 50,524 |   | 50,283 |   |

 

 

 

See notes accompanying these condensed consolidatedfinancial statements

 

3

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**AVOCENTCORPORATION**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

(Unaudited,in thousands, except per share data)

 
| ** **                                                                                                                                                                                               | ** **   | **September 30,** | ** **   | **December 31,** | ** **   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|-------------------|--------------|------------------|--------------|
| ** **                                                                                                                                                                                               | ** **   | **2005**          | ** **   | **2004**         | ** **   |
| *** ***                                                                                                                                                                                             | *** *** | *** ***      | *** *** | *** ***     | *** *** |
| **ASSETS**                                                                                                                                                                                               |         |              |         |             |         |
| Current assets:                                                                                                                                                                                          |         |              |         |             |         |
| Cash and cash equivalents                                                                                                                                                                                |         | $                 | 52,310       |             | $            | 44,724 |   |
| Investments maturing within one year                                                                                                                                                                     |         | 211,876           |         | 195,075          |         |
| Accounts receivable, net                                                                                                                                                                                 |         | 57,890            |         | 60,948           |         |
| Inventories, net                                                                                                                                                                                         |         | 21,495            |         | 21,232           |         |
| Other current assets                                                                                                                                                                                     |         | 8,361             |         | 5,923            |         |
| Deferred tax assets, net                                                                                                                                                                                 |         | 4,173             |         | 6,720            |         |
| Total current assets                                                                                                                                                                                     |         | 356,105           |         | 334,622          |         |
| Investments                                                                                                                                                                                              |         | 67,220            |         | 90,217           |         |
| Property held for lease,  net                                                                                                                                                                            |         | 1,183             |         | 1,330            |         |
| Property and equipment,  net                                                                                                                                                                             |         | 38,367            |         | 39,896           |         |
| Goodwill                                                                                                                                                                                                 |         | 269,992           |         | 269,892          |         |
| Other intangible assets,  net                                                                                                                                                                            |         | 18,290            |         | 33,981           |         |
| Other assets                                                                                                                                                                                             |         | 894               |         | 843              |         |
| Total assets                                                                                                                                                                                             |         | $                 | 752,051      |             | $            | 770,781 |   |
|                                                                                                                                                                                                     |         |              |         |             |         |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                           |         |              |         |             |         |
| Current liabilities:                                                                                                                                                                                     |         |              |         |             |         |
| Accounts payable                                                                                                                                                                                         |         | $                 | 8,694        |             | $            | 9,171 |   |
| Accrued wages and commissions                                                                                                                                                                            |         | 8,411             |         | 12,197           |         |
| Accrued liabilities                                                                                                                                                                                      |         | 19,407            |         | 15,661           |         |
| Income taxes payable                                                                                                                                                                                     |         | 11,697            |         | 8,494            |         |
| Other current liabilities                                                                                                                                                                                |         | 2,740             |         | 1,106            |         |
| Total current liabilities                                                                                                                                                                                |         | 50,949            |         | 46,629           |         |
|                                                                                                                                                                                                     |         |              |         |             |         |
| Deferred tax liabilities,  net                                                                                                                                                                           |         | 735               |         | 8,985            |         |
| Other non-current  liabilities                                                                                                                                                                           |         | 989               |         | 1,870            |         |
| Total liabilities                                                                                                                                                                                        |         | 52,673            |         | 57,484           |         |
|                                                                                                                                                                                                     |         |              |         |             |         |
| Commitments and  contingencies                                                                                                                                                                           |         |              |         |             |         |
|                                                                                                                                                                                                     |         |              |         |             |         |
| Stockholders’ equity:                                                                                                                                                                               |         |              |         |             |         |
| Preferred stock, $0.001 par value; 5,000 shares authorized, no shares  issued and outstanding as of September 30, 2005 and December 31, 2004,  respectively                                              |         | —            |         | —           |         |
| Common stock, $0.001 par value; 200,000 shares authorized, September  30, 2005 — 51,289 shares issued and 48,914 outstanding; December 31, 2004 —  50,332 shares issued and 50,232 outstanding |         | 51                |         | 50               |         |
| Additional paid-in capital                                                                                                                                                                               |         | 1,097,221         |         | 1,075,171        |         |
| Accumulated other comprehensive loss                                                                                                                                                                     |         | (763              | )            | (56              | )            |
| Deferred compensation                                                                                                                                                                                    |         | (509              | )            | (2,038           | )            |
| Accumulated deficit                                                                                                                                                                                      |         | (326,555          | )            | (355,852         | )            |
| Treasury stock, at cost; September 30, 2005 — 2,375 shares; December  31, 2004 — 100 shares                                                                                                    |         | (70,067           | )            | (3,978           | )            |
| Total stockholders’ equity                                                                                                                                                                          |         | 699,378           |         | 713,297          |         |
| Total liabilities and stockholders’ equity                                                                                                                                                          |         | $                 | 752,051      |             | $            | 770,781 |   |

 

 

 

Seenotes accompanying these condensed consolidated financial statements

 

4

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**AVOCENTCORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited,in thousands)

 
| ** **                                                                         | ** **   | **For the nine months ended** | ** **   |
|------------------------------------------------------------------------------------|--------------|-------------------------------|--------------|
| ** **                                                                         | ** **   | **September 30, 2005**        | ** **   | **October 1, 2004** | ** ** |
| ** **                                                                         | *** *** | *** ***                  | *** *** | *** *** | *** *** |
| Cash flows from operating  activities:                                             | * *     | * *                      | * *     | * * | * * |
| Net income:                                                                        |         | $                             | 29,297       |   | $ | 5,973 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |         |                          |         |   |   |
| Depreciation                                                                       |         | 5,082                         |         | 4,565 |   |
| Amortization of intangible assets                                                  |         | 15,976                        |         | 17,656 |   |
| Stock-based compensation                                                           |         | 1,529                         |         | 4,286 |   |
| Acquired in-process research and development expenses                              |         | —                        |         | 29,260 |   |
| Amortization of premiums on investments                                            |         | 695                           |         | 2,660 |   |
| Net loss on sales of investments                                                   |         | 483                           |         | 269 |   |
| Income tax benefit from exercise of stock options                                  |         | 3,871                         |         | 2,510 |   |
| Changes in operating assets and liabilities (net of effects of  acquisitions):     |         |                          |         |   |   |
| Accounts receivable, net                                                           |         | 3,063                         |         | (10,384 | ) |
| Inventories, net                                                                   |         | (263                          | )            | 395 |   |
| Other assets                                                                       |         | (2,853                        | )            | 142 |   |
| Accounts payable                                                                   |         | (469                          | )            | (2,769 | ) |
| Accrued wages and commissions                                                      |         | (3,786                        | )            | (578 | ) |
| Accrued liabilities                                                                |         | 2,115                         |         | 274 |   |
| Income taxes, current and deferred                                                 |         | (2,757                        | )            | (3,027 | ) |
| Net cash provided by operating activities                                          |         | 51,983                        |         | 51,232 |   |
| ** **                                                                         | ** **   | ** **                    | ** **   | ** ** | ** ** |
| Cash flows from investing  activities:                                             |         |                          |         |   |   |
| Purchase of Sonic Mobility, net of cash received                                   |         | —                        |         | (9,141 | ) |
| Purchase of OSA, net of cash received (1)                                          |         | —                        |         | (47,179 | ) |
| Purchase of Crystal Link, net of cash received (1)                                 |         | —                        |         | (3,311 | ) |
| Purchases of property and equipment                                                |         | (3,553                        | )            | (5,377 | ) |
| Purchases of investments                                                           |         | (202,245                      | )            | (212,883 | ) |
| Proceeds from sales and maturities of investments                                  |         | 209,431                       |         | 192,555 |   |
| Net cash provided by (used in) investing activities                                |         | 3,633                         |         | (85,336 | ) |
|                                                                               |         |                          |         |   |   |
| Cash flows from financing  activities:                                             | ** **   | ** **                    | ** **   | ** ** | ** ** |
| Repayment of debt assumed at the acquisition of Crystal Link                       |         | —                        |         | (1,798 | ) |
| Proceeds from employee stock option exercises                                      |         | 13,675                        |         | 8,598 |   |
| Proceeds from employee stock purchase plan                                         |         | 4,505                         |         | 3,211 |   |
| Purchases of treasury stock                                                        |         | (66,089                       | )            | — |   |
| Net cash (used in) provided by financing activities                                |         | (47,909                       | )            | 10,011 |   |
|                                                                               |         |                          |         |   |   |
| Effect of exchange rate  changes on cash and cash equivalents                      |         | (121                          | )            | 119 |   |
|                                                                               |         |                          |         |   |   |
| Net increase (decrease) in  cash and cash equivalents                              |         | 7,586                         |         | (23,974 | ) |
| Cash and cash equivalents  at beginning of period                                  |         | 44,724                        |         | 76,492 |   |
| Cash and cash equivalents  at end of period                                        |         | $                             | 52,310       |   | $ | 52,518 |   |

 

 

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(1)          Supplementaldisclosure — In addition to the cash paid at the respective closings, we issued106 shares of our common stock valued at $3,500 to Crystal Link shareholdersand 1,229 shares of our common stock valued at $45,831 to OSA shareholders. Theissuance of common stock was recorded as non-cash consideration for theacquisition.

 

 

Seenotes accompanying these condensed consolidated financial statements.

 

5

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**AVOCENTCORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited,in thousands, except per share data)

 

Note 1.          Basis of Presentation

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inconformity with generally accepted accounting principles and reflect alladjustments consisting of normal recurring adjustments which, in the opinion ofmanagement, are necessary for a fair presentation of the results for the threeand nine months ended September 30, 2005 and October 1, 2004.  The results of operations for these periodsare not necessarily indicative of the results expected for the full fiscal yearor for any future periods.  Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities, disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates and assumptions.

 

The accompanyingunaudited condensed consolidated financial statements should be read inconjunction with the audited consolidated financial statements and the relatednotes contained in our Annual Report on Form 10-K for the year ended December31, 2004, which is on file with the Securities and Exchange Commission and isavailable at our website, www.avocent.com. The balance sheet presented in theaccompanying financial statements for December 31, 2004, was derived from theaudited financial statements filed in our 10-K for the period ended December31, 2004.

 

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

 

Our financialstatements are consolidated and include the accounts of Avocent Corporation andour wholly owned subsidiaries. Significant inter-company transactions and balances have been eliminatedin consolidation.

 

Note 2.          Inventories

 

Inventoriesconsisted of the following at:

 
| ** **       | ** ** | **September 30,   2005** | ** ** | **December 31,   2004** | ** ** |
|------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **       | ** ** | ** **               | ** ** | ** **              | ** ** |
| Raw materials    |       | $                        | 4,170      |                    | $          | 4,411 |   |
| Work-in-process  |       | 262                      |       | 356                     |       |
| Finished goods   |       | 17,063                   |       | 16,465                  |       |
| Inventories, net |       | $                        | 21,495     |                    | $          | 21,232 |   |

 

Inventories above have been reduced by reserves forexcess and obsolete inventories of $4,838 and $3,785 as of September 30, 2005and December 31, 2004, respectively.

 

Note 3.   StockOptions, Deferred Compensation and Stock Repurchases

 

Deferred compensation — We recorded$41,165 of deferred compensation related to Cybex employee stock options at thetime of the merger of Apex and Cybex on September 30, 2000, $2,752 of deferredcompensation related to the Equinox employee stock options at the time of theacquisition on January 3, 2001 and $6,350 of deferred compensation related tothe OSA employee stock options at the time of the acquisition on April 6,2004.  The deferred compensation is beingamortized over the vesting period of the options for which it was recorded.Amortization of deferred compensation totaled $510 for the three months endedSeptember 30, 2005 and $1,421 for the three months ended and October 1,2004.  Amortization of deferredcompensation totaled $1,529 for the nine months ended September 30, 2005 and$4,286 for the nine months ended October 1, 2004.

 

Stock option exercises — Shares of our common stock issued as a resultof option exercises totaled 776 shares during the nine months ended September30, 2005 and 492 shares during the nine months ended October 1, 2004.  Total proceeds received from these optionexercises were $13,675 for the nine months ended September 30, 2005 and $8,598for the nine months ended October 1, 2004. Common stock issued under our EmployeeStock Purchase Plan (“ESPP”) totaled 181 shares during the nine months endedSeptember 30, 2005 and 204 shares during the nine months ended October 1,2004.  Total proceeds received from theshares issued under the ESPP were $4,505 for the nine months ended September30, 2005 and $3,211 for the nine months ended October 1, 2004.

 

Stockrepurchases — During the fourth quarter of 2004 our Board of Directors approveda stock repurchase plan

 

6

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and we have purchased shareson the open market through various brokers under the approved plan. Werepurchased 500 shares of our common stock during the quarter ended September30, 2005 at a cost totaling $15,818. We repurchased 2,275 shares of our commonstock during the nine months ended September 30, 2005 at a cost totaling$66,089.  We may repurchase a total of4,000 shares under the plan.  We haverepurchased 2,375 shares under the plan since the approval of the plan in 2004.

 

Note 4.          AccumulatedOther Comprehensive Loss

 

We record unrealized gains and losses on our foreigncurrency translation adjustments and unrealized holding gains or losses on ouravailable-for-sale securities, net of tax, as accumulated other comprehensiveincome (loss), which is included as a separate component of stockholders’equity.  Comprehensive income for thefirst nine months of 2005 of $28,590 consists of $29,297 of net income, $301 ofunrealized losses on investments (net of deferred income taxes) and $406 offoreign currency translation loss.  Comprehensive income for the first nine months of 2004of $5,899 consists of $5,973 of net income, $193 of unrealized losses oninvestments (net of deferred income taxes) and $119 of foreign currencytranslation gain.  As of September 30, 2005 and December 31,2004, total accumulated other comprehensive loss was ($763) and ($56),respectively.

 

Note 5.          Earnings perShare
| ** **                                                          | ** ** | **Income (Numerator)** | ** ** | **Shares   (Denominator)** | ** ** | **Per-Share   Amount** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                          | ** ** | ** **                  | ** ** | ** **                 | ** ** | ** **             | ** ** |
| **For the three months ended  September 30, 2005**                  |       |                        |       |                       |       |                   |       |
| **Basic EPS**                                                       |       |                        |       |                       |       |                   |       |
| Net income available to common stockholders                         |       | $                           | 16,365     |                       | 48,966     |                   | $          | 0.33 |   |
| **Effect of Dilutive Securities**                                   |       |                        |       |                       |       |                   |       |
| Stock options                                                       |       | —                      |       | 913                        |       | —                 |       |
| **Diluted EPS**                                                     |       |                        |       |                       |       |                   |       |
| Net income available to common stockholders and assumed conversions |       | $                           | 16,365     |                       | 49,879     |                   | $          | 0.33 |   |
|                                                                |       |                        |       |                       |       |                   |       |
| **For the three months ended  October 1, 2004**                     |       |                        |       |                       |       |                   |       |
| **Basic EPS**                                                       |       |                        |       |                       |       |                   |       |
| Net income available to common stockholders                         |       | $                           | 10,822     |                       | 49,323     |                   | $          | 0.22 |   |
| **Effect of Dilutive Securities**                                   |       |                        |       |                       |       |                   |       |
| Stock options                                                       |       | —                      |       | 1,179                      |       | —                 |       |
| **Diluted EPS**                                                     |       |                        |       |                       |       |                   |       |
| Net income available to common stockholders and assumed conversions |       | $                           | 10,822     |                       | 50,502     |                   | $          | 0.21 |   |
|                                                                |       |                        |       |                       |       |                   |       |
| **For the nine months ended  September 30, 2005**                   |       |                        |       |                       |       |                   |       |
| **Basic EPS**                                                       |       |                        |       |                       |       |                   |       |
| Net income available to common stockholders                         |       | $                           | 29,297     |                       | 49,550     |                   | $          | 0.59 |   |
| **Effect of Dilutive Securities**                                   |       |                        |       |                       |       |                   |       |
| Stock options                                                       |       | —                      |       | 974                        |       | —                 |       |
| **Diluted EPS**                                                     |       |                        |       |                       |       |                   |       |
| Net income available to common stockholders and assumed conversions |       | $                           | 29,297     |                       | 50,524     |                   | $          | 0.58 |   |
|                                                                |       |                        |       |                       |       |                   |       |
| **For the nine months ended  October 1, 2004**                      |       |                        |       |                       |       |                   |       |
| **Basic EPS**                                                       |       |                        |       |                       |       |                   |       |
| Net income available to common stockholders                         |       | $                           | 5,973      |                       | 48,663     |                   | $          | 0.12 |   |
| **Effect of Dilutive Securities**                                   |       |                        |       |                       |       |                   |       |
| Stock options                                                       |       | —                      |       | 1,620                      |       | —                 |       |
| **Diluted EPS**                                                     |       |                        |       |                       |       |                   |       |
| Net income available to common stockholders and assumed conversions |       | $                           | 5,973      |                       | 50,283     |                   | $          | 0.12 |   |

 

Anti-dilutiveoptions to purchase common stock outstanding were excluded from thecalculations above.  Anti-dilutiveoptions totaled 2,571 and 2,567 for the three and nine months ended September30, 2005, respectively.  Anti-dilutiveoptions totaled 2,656 and 2,428 for the three and nine months ended October 1,2004, respectively.

 

Note 6.          SegmentReporting

** **

Wehave evaluated, and will periodically re-evaluate, our business in light of thesegment reporting requirements

 

7

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prescribed by SFAS No. 131, *Disclosures about Segments of an Enterprise and Related Information.*  We have determined that we should report ouroperations as a single operating segment. However, we supplementally report net sales by geographic region, aswell as by customer type.  Following is apresentation of net sales by geographic region and by customer type for thethree and nine months ended September 30, 2005 and October 1, 2004:

** **

| ** **        | ** ** | **For the Three Months  Ended** | ** ** | **For the Nine Months  Ended** | ** ** |
|-------------------|------------|---------------------------------|------------|--------------------------------|------------|
| ** **        | ** ** | **Sept. 30,   2005**            | ** ** | **October 1,   2004**          | ** ** | **Sept. 30,   2005** | ** ** | **October 1,   2004** | ** ** |
| Net sales:        | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States     |       | $58,018                         |       | $56,026                        |       | $150,768 |   | $160,076 |   |
| Rest of the World |       | 38,690                          |       | 35,299                         |       | 112,283 |   | 105,130 |   |
|              |       | $96,708                         |       | $91,325                        |       | $263,051 |   | $265,206 |   |

** **

| ** ** | ** ** | **For the Three Months  Ended** | ** ** | **For the Nine Months  Ended** | ** ** |
|------------|------------|---------------------------------|------------|--------------------------------|------------|
| ** ** | ** ** | **Sept. 30,   2005**            | ** ** | **October 1,   2004**          | ** ** | **Sept. 30,   2005** | ** ** | **October 1,   2004** | ** ** |
| ** ** | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales: | ** ** | ** **                      | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Branded    |       | $52,238                         |       | $49,170                        |       | $134,761 |   | $149,869 |   |
| OEM        |       | 44,470                          |       | 42,155                         |       | 128,290 |   | 115,337 |   |
|       |       | $96,708                         |       | $91,325                        |       | $263,051 |   | $265,206 |   |

** **

Wesell our products internationally to customers in several countries. Sales tocustomers in the Netherlands, including the European distribution facility forone of our OEM customers, accounted for 10% of sales in the first nine monthsof 2004.  No other country accounted formore than 10% of sales in the first nine months of either 2005 or 2004.

** **

**As ofSeptember 30, 2005, long-lived assets totaled $327,832, which includes $309,885held in the U.S. and $17,947 held outside of the U.S.  As of December 31, 2004, long-lived assetstotaled $345,099, which includes $324,417 held in the U.S. and $20,682 heldoutside of the U.S.**

** **

Subsequent to the end of our third quarter 2005, we announced plans forthe formation of five divisions within Avocent**. **These divisions include:

 

•                  ManagementSystems division, which includes our branded and OEM KVM, serial console, powercontrol and management appliance businesses;

•                  EmbeddedSoftware & Solutions division, focused on developing and marketing embeddedsystems and software including IPMI and embedded KVM technologies primarily forour OEM customers;

•                  Serial andAudio-Visual Solutions division, focused on expanding the markets for Avocent’sserial and wireless products;

•                  DesktopSolutions division, which includes Avocent’s existing extension and DigitalDesktops products with emphasis on development of major new products andmarkets in this area; and

•                  Mobile Solutionsdivision, which includes mobile device management and secure wireless systems administration.

 

We are in the process of reconfiguring our systems and defining newcost centers and operating measures to track the performance of the divisionsand to use as a basis for allocating resources in the future.  However, we currently are not managing ourbusiness under these divisions, and we do not expect to be functioning underthe five new divisions until the beginning of 2006.  We will evaluate our divisions based on therequirements in SFAS No. 131 and will provide the applicable segment data onthe new divisions in 2006.

** **

**Note 7.**          ForwardContracts

** **

We use forward contracts to reduce our foreigncurrency exposure related to the net cash flows from our internationaloperations. The majority of these contracts are short-term contracts (threemonths or less) and are marked-to-market each quarter and included in tradepayables, with the offsetting gain or loss included in other income (expense)in the accompanying condensed consolidated statements of operations.  As of September 30, 2005, we had one 30 dayopen forward contract, maturing on October 28, 2005, with a fair value of ($7).

 

8

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**Note 8.**          Goodwill andOther Intangible Assets

** **

**Acquired other intangible assets subject to amortizationwere as follows:**

** **

| ** **                        | ** ** | **September 30, 2005**       | ** ** | **December 31, 2004**        | ** ** |
|-----------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                        | ** ** | **Gross  Carrying  Amounts** | ** ** | **Accumulated Amortization** | ** ** | **Gross  Carrying  Amounts** | ** ** | **Accumulated Amortization** | ** ** |
|                              |       |                         |       |                         |       |   |   |   |   |
| Developed technology              |       | $                            | 21,070     |                         | $          | 13,096 |   | $ | 80,560 |   | $ | 62,293 |   |
| Patents and trademarks            |       | 10,791                       |       | 6,108                        |       | 21,508 |   | 14,318 |   |
| Customer base and  certifications |       | 4,870                        |       | 1,463                        |       | 6,483 |   | 1,961 |   |
| Non-compete agreements            |       | 2,520                        |       | 1,093                        |       | 5,793 |   | 3,070 |   |
| Licenses and other                |       | 1,814                        |       | 1,015                        |       | 1,814 |   | 535 |   |
|                              |       | $                            | 41,065     |                         | $          | 22,775 |   | $ | 116,158 |   | $ | 82,177 |   |

** **

**During the third quarter of 2005, we retired approximately$75,000 of fully amortized intangible assets and the related accumulatedamortization.  The retirement had noimpact on reported earnings or total assets.**

** **

**For the three months ended September 30, 2005 and October1, 2004, amortization expense for other intangible assets was $2,731 and$6,482, respectively. For the nine months ended September 30, 2005 and October1, 2004, amortization expense for other intangible assets was $15,976 and$17,656, respectively. The approximate estimated annual amortization for otherintangibles is as follows:**

** **

| **Years ending December 31:** | ** ** | ** ** | ** ** |
|-------------------------------|------------|------------|------------|
| 2005                          |       | $          | 19,500     |   |
| 2006                          |       | $          | 9,400      |   |
| 2007                          |       | $          | 3,500      |   |
| 2008                          |       | $          | 1,100      |   |
| 2009                          |       | $          | 800        |   |

** **

**For the nine months ended September 30, 2005, we recorded$100 of additional goodwill related to the Crystal Link Technologiesacquisition.**

** **

** **

** **

** **

** **

** **

** **

**Note 9.**          Product Warranties

 

The activity within theliability for warranty returns for the nine months ended September 30, 2005 wasas follows:

 
| ** **                                               | ** ** | **2005** | ** ** |
|----------------------------------------------------------|------------|----------|------------|
|                                                     |       |     |       |
| Balance, January 1, 2005                                 |       | $        | 2,760      |   |
|                                                     |       |     |       |
| Accruals for product warranties issued during the period |       | 239      |       |
| Settlements made during  the period                      |       | (156     | )          |
|                                                     |       |     |       |
| Balance, September 30,  2005                             |       | $        | 2,843      |   |

 

9

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Deferredrevenue related to our extended warranty program was $1,912 as of September 30,2005.  We recorded earned revenue fromthe amortization of deferred revenue related to extended warranties of $656 forthe nine months ended September 30, 2005. In addition, we recorded new extended warranties of $901 during the ninemonths ended September 30, 2005.

 

Note 10.**   **Income Taxes

 

Theprovision for income taxes was approximately $8,838 in the first nine months of2005, compared to $8,135 for the nine months ended October 1, 2004. Thedecrease in the effective tax rate is primarily attributable to the impact of$21,720 of acquired in-process research and development expense recorded duringthe second quarter of 2004 as a result of the acquisition of OSA which is notdeductible for tax purposes.

 

 

Note 11.**   **Patent Dispute

 

InMay 2001, we filed a complaint for patent infringement in the United StatesDistrict Court for the Southern District of New York against Raritan ComputerInc, which we settled in May 2005. Under the terms of the agreement, welicensed certain patents to Raritan, and entered into a worldwide, five-yearlitigation stand-still agreement that resolves all claims between the parties.The terms of the settlement called for an initial payment of $5,000 and 20consecutive quarterly royalty payments to be the greater of $750 or a fixedpercentage of covered product revenues. During the quarter ended July 1, 2005, we recorded the payment of $5,000received at the settlement in other income and began recording the quarterlyroyalty payments in net revenues.

 

In October 2003, we filed a complaint for patentinfringement in the United States District Court for the Northern District ofAlabama against ClearCube Technology, Inc. The ClearCube complaint seeks injunctive relief, damages, attorneys’fees, and costs under two of our patents. ClearCube has filed counterclaimsalleging non-infringement, unenforceability, invalidity, and misuse of theAvocent patents. A Markman hearing on claims construction wasoriginally set for February 2005, but in response to an inquiry from the Court,we agreed that the hearing should be postponed until the United States Court ofAppeals for the Federal Circuit issues its ruling on certain similar issuesraised in an unrelated patent case.  Thisruling was issued in June 2005 and the Markman hearing on claims constructionis now scheduled for December 2005.

** **

**Note 12.**    Stock BasedCompensation

** **

**Weapply Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related Interpretations inaccounting for our stock plans. Had compensation cost for our stock-basedcompensation plans been determined based on the fair value at the grant datesfor awards under those plans consistent with the method prescribed in SFAS No.123, *Accounting for Stock-Based Compensation*,our net income and earnings per share would have been reduced to the pro formaamounts indicated below.**

 
| ** **                                                                                                                             | ** ** | **Three Months ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                             | ** ** | **Sept. 30,  2005**    | ** ** | **October 1,  2004**  | ** ** | **Sept. 30, 2005** | ** ** | **October 1,  2004** | ** ** |
| Net income — as reported                                                                                                          |       | $                      | 16,365     |                  | $          | 10,822 |   | $ | 29,297 |   | $ | 5,973 |   |
| Add: Stock-based employee compensation expense included in reported  net income, net of related tax effects                            |       | 510                    |       | 1,421                 |       | 1,529 |   | 4,196 |   |
| Deduct: Total stock based employee compensation expense determined  under fair value method for all awards, net of related tax effects |       | 8,343                  |       | 7,966                 |       | 21,466 |   | 26,043 |   |
| Net income (loss) — pro  forma                                                                                                    |       | $                      | 8,532      |                  | $          | 4,277 |   | $ | 9,360 |   | $ | (15,874 | ) |
|                                                                                                                                   |       |                   |       |                  |       |   |   |   |   |
| Basic earnings per share —  as reported                                                                                           |       | $                      | 0.33       |                  | $          | 0.22 |   | $ | 0.59 |   | $ | 0.12 |   |
| Basic earnings (loss) per  share — pro forma                                                                                      |       | $                      | 0.17       |                  | $          | 0.09 |   | $ | 0.19 |   | $ | (0.33 | ) |
| Diluted earnings per share  — as reported                                                                                         |       | $                      | 0.33       |                  | $          | 0.21 |   | $ | 0.58 |   | $ | 0.12 |   |
| Diluted earnings (loss)  per share — pro forma                                                                                    |       | $                      | 0.17       |                  | $          | 0.09 |   | $ | 0.19 |   | $ | (0.33 | ) |

 

10

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The pro forma amounts reflected above are not representativeof the effects on reported net income (loss) in future years because, ingeneral, the options granted typically do not vest for several years andadditional awards are made each year. The fair value of each option grant isestimated on the grant date using the Black-Scholes option-pricing model usingthe following weighted-average assumptions:

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **Sept. 30, 2005**     | ** ** | **Oct. 1, 2004**      | ** ** | **Sept. 30, 2005** | ** ** | **Oct. 1, 2004** | ** ** |
| Dividend yield          |       | 0.0                    | %          | 0.0                   | %          | 0.0 | % | 0.0 | % |
| Expected life (years)   |       | 3.0                    |       | 1.0  — 4.5       |       | 1.5  — 4.5 |   | 1.0  — 4.5 |   |
| Expected volatility     |       | 48.1                   | %          | 33.0                  | %          | 45.1  — 48.1 | % | 33.0  — 55.0 | % |
| Risk-free interest rate |       | 3.99                   | %          | 3.36                  | %          | 3.16  — 3. 99 | % | 1.17  — 2.79 | % |

** **

On April 29, 2005, ourBoard of Directors approved a plan to accelerate vesting of all currentlyoutstanding stock options with an exercise price of greater than $25.00 whichare unvested on December 25, 2005.  Underthe provisions of APB 25, we estimate that there will be no compensationexpense related to accelerating these options as the options affected by theacceleration had exercise prices higher that the closing price of our commonstock as of the modification date.  As aresult of the Board’s action, we estimate that stock options to purchaseapproximately 1,100 shares of our common stock will become exercisableeffective December 25, 2005.  Theexercise prices of the affected stock options range from $25.17 to $41.57 pershare.  The closing price of Avocent’scommon stock on April 29, 2005 was $25.14.

** **

**Note 13.**    RecentlyIssued Accounting Standards and Regulatory Standards

 

InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), *Share based Payment*, which replaces SFAS No. 123 *Accounting for Stock Based Compensation* and APB Opinion No25 *Accounting for Stock Issued to Employees*.  SFAS 123R requires all share-based paymentsto employees, including grants of employee stock options, to be recognized inthe financial statements based on their fair values beginning with the firstannual period after June 15, 2005.  Thepro-forma disclosures previously permitted under SFAS No. 123 no longer will bean alternative to inclusion of the expense in the financial statements.  We are required to adopt SFAS 123R beginningJanuary 1, 2006.  Under SFAS 123R, wemust determine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost and thetransition method to be used at date of adoption.  The transition methods include prospectiveand retroactive adoption options. We expect to use the Black-Scholes optionpricing model to value options after the adoption.  In addition, we expect to utilize thestraight line method to amortize the expense and utilize the prospectivetransition method which requires that compensation expense begin being recordedfor all unvested stock options and restricted stock at the beginning of thefirst quarter of adoption of SFAS 123R. We are evaluating the requirements of SFAS 123R and expect the adoptionof SFAS 123R may have a material impact on our consolidated results ofoperations and earnings per share.  Wehave not determined the effect of adopting SFAS 123R and we have not determinedwhether the adoption will result in amounts similar to the current pro-formadisclosures under SFAS 123.  Under thecurrent approach of SFAS 123 we would have unamortized fair value of unvestedstock options of approximately $15,000 for currently outstanding stock optionsto be recognized as expense in our income statements after 2005, prior to theacceleration of vesting discussed in note 12. Following this acceleration we believe the balance to be expensed infuture periods will be reduced to approximately $2,000 for currentlyoutstanding stock options under the SFAS 123 methodology.

 

On October 22, 2004, theAmerican Jobs Creation Act of 2004 became law. This legislation repeals exporttax benefits, which have historically reduced our effective tax rate. Thislegislation phases in the repealed export tax benefits by allowing 100 percentof the repealed export benefits in 2004, 80 percent in 2005 and 60 percent in2006.  We do not expect this change tohave a material impact on our effective tax rate or provision for taxes in2005.

 

The legislation alsotransitions in a new tax deduction for qualifying U.S. manufacturingactivities. Under the guidance in FASB Staff Position No. FAS 109-1 whicharticulates the application of SFAS 109, *Accounting for IncomeTaxes*, to the tax deduction on qualified production activitiesprovided by this Act, the deduction will be treated as a “special deduction” asdescribed in SFAS 109. As such, we expect the new manufacturing activitiesdeduction provision of the new legislation may reduce our effective rate infuture periods as the deduction is taken on our tax returns.  We do not expect the deduction to have amaterial impact on our effective tax rate or income tax provision in 2005.

 

The legislation alsoprovides for the optional repatriation of earnings from foreign subsidiariesallowing an 85 percent dividends received deduction. The deduction is subjectto a number of limitations.   We haveperformed a preliminary analysis under the new legislation and we areconsidering repatriating up to $90,000 from overseas earnings pursuant to thisprovision during the fourth quarter of 2005. If we decide to repatriate any of the earnings to the U.S., we

 

11

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would incur additionalincome tax expense equal to the incremental U.S. income tax in excess of thecredits available for taxes already paid overseas.  If we repatriate the entire $90,000 in thefourth quarter of 2005, we estimate the potential tax expense to be $3,500,which we estimate would reduce diluted earnings per share $0.08 cents.

 

**Note 14.**    SubsequentEvents

 

During the period fromOctober 1, 2005 through November 2, 2005, we repurchased 150 additional sharesof our common stock on the open market under our Board approved stockrepurchase program, for a total cost of $4,529.

 

During October 2005, wesold our former Huntsville facility, which is classified as property held forlease on the condensed consolidated balance sheet, for net proceeds of $1,900and an after tax gain on sale of approximately $500.  The gain will be reported in the fourth quarterof 2005 financial statements.

** **

**12**

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** **

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

 

*THE INFORMATION IN THISITEM 2**“MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”**CONTAINS FORWARD-LOOKING STATEMENTS, INCLUDING, WITHOUT LIMITATION, STATEMENTSRELATING TO OUR FUTURE BUSINESS PROSPECTS AND ECONOMIC CONDITIONS IN GENERAL;STATEMENTS REGARDING OUR ABILITY TO PREDICT FUTURE SALES AND MANAGE INVENTORYLEVELS; STATEMENTS REGARDING PRICING PRESSURE; STATEMENTS REGARDING THEFLUCTUATION OF OUR REVENUE GROWTH IN RELATION TO ECONOMIC CONDITIONS AND ITRELATED SPENDING TRENDS; STATEMENTS REGARDING OUR PRODUCT PLATFORMS ANDOUR  ABILITY TO GENERATE GROWTH IN OUROVERALL BUSINESS; STATEMENTS REGARDING INCREASED SALES OF OUR DIGITAL PRODUCTSAND EMBEDDED SOLUTIONS AND THEIR ABILITY TO OFFSET PRICE DECLINES ANDCOMPETITIVE FACTORS; STATEMENTS REGARDING OUR REVENUES, GROSS MARGINS, OURRESEARCH AND DEVELOPMENT EXPENSES AND OUR SELLING, GENERAL AND ADMINISTRATIVEEXPENSES IN THE THIRD QUARTER OF 2005; STATEMENTS REGARDING FORMATION OF NEWOPERATING DIVISIONS; STATEMENTS REGARDING OUR LEGAL COSTS FOR PATENT LITIGATIONCASES; AND STATEMENTS REGARDING THE IMPACT OF SFAS 123R ON OUR RESULTS OFOPERATIONS AND EARNINGS PER SHARE.*

 

*THESE FORWARD-LOOKINGSTATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE OURACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THEFORWARD-LOOKING STATEMENTS.  FACTORS THATMIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THE RISKSASSOCIATED WITH GENERAL ECONOMIC CONDITIONS, RISKS ASSOCIATED WITH THEINTRODUCTION OF NEW PRODUCTS, RISKS ATTRIBUTABLE TO FUTURE PRODUCT DEMAND,SALES, AND EXPENSES, RISKS ASSOCIATED WITH PRODUCT DESIGN EFFORTS, RISKSASSOCIATED WITH RELIANCE ON A LIMITED NUMBER OF COMPONENT SUPPLIERS AND SINGLESOURCE COMPONENTS, THE LOSS OF ONE OF OUR OEM CUSTOMERS, A REDUCTION ORFLUCTUATIONS IN SALES OF OUR OEM OR BRANDED PRODUCTS, INTENSE COMPETITION ANDNEW PRODUCTS AND TECHNOLOGIES FROM EXISTING AND NEW COMPETITORS, RISKS RELATEDTO OBTAINING AND PROTECTING OUR INTELLECTUAL PROPERTY RIGHTS, FLUCTUATIONS INFOREIGN CURRENCIES, RISKS RELATED TO ACQUISITIONS AND THEIR SUBSEQUENTINTEGRATION, AND OTHER RISKS DETAILED IN OUR ANNUAL REPORT ON FORM 10-K, WHICH WAS FILED WITH THE SECURITIES ANDEXCHANGE COMMISSION ON MARCH 14, 2005.*

** **

**Overview**

 

Avocentdesigns, manufactures, licenses, and sells solutions that provide connectivityand centralized management of IT infrastructure.  We provide connectivity and managementproducts and technologies that centralize control of servers, mobile devices,and network appliances, increasing the efficiency of IT personnel. Servermanufacturers rely on Avocent KVM switches and embedded technology in theirsystems, and companies large and small depend on our products and technologiesfor managing their growing IT infrastructure.

 

Our innovations includeIP-based switching, centralized management, and intuitive software interfaces.Our products and technologies manage servers, serial devices, wireless devices,mobile devices, and embedded infrastructure. With more than two decades ofexperience, we have grown through product innovations, global expansion, andstrategic acquisitions.  Formed as aresult of the merger in 2000 between Apex Inc. and Cybex Computer ProductsCorporation, we subsequently acquired Equinox Systems Inc. in 2001, 2CComputing, Inc. in 2002, Soronti, Inc. in 2003, and Crystal Link Technologies,OSA Technologies, Inc., and Sonic Mobility, Inc. in 2004.

 

Our KVM switching systemseliminate the need for extra keyboards, monitors, and mice and allow businessesto save critical space in their data centers. Our KVM over IP switching systems eliminate distance limitations andprovide 24/7 access and control of an almost unlimited number of servers, evenwhen the servers are dispersed in different physical locations.  Our *DSView* softwaremanagement and KVM over IP switching systems allow IT managers to use a singleconsole to gain secure, local and remote access and control of servers andother network data center devices from any location.

 

Our innovative advances forthe data center include multi-platform switching, analog matrix switching, KVMextension over CAT 5, PCI bus extension, a proprietary on-screen menu switchingsystem, remote KVM over IP connectivity, digital serial over IP, digital-analogintegrated access to multiple servers, intelligent platform managementinterface (IPMI) solutions, wireless KVM, PDA and hand-held managementsolutions, and centralized management software for access and control ofnetwork infrastructure.

 

Our DSSeries*®*switches combine analog and digital connections, serialconnectivity, and external modem support in one switch. These appliancesintegrate our KVM over IP switching technology and CAT 5 connectivity.  IT managers and network administrators gainworldwide access and control of their servers and serial devices and can trackthem all from a single computer screen. In addition, we provide plug and play switching systems for the manynetwork administration, management, and storage problems faced by corporatecustomers, data centers, and mid-size businesses. Our connectivity solutionsinclude products and technologies sold or licensed under the Avocent, Cybex,and Equinox brands, including our *AMX*TM,***AutoView*TM*, Cstation*TM,*DSView®, DS Series, LongView*TM*,**OutLook®, SuperSerial*,*SwitchView®, Emerge*TM, *SonicAdmin*TM, and *SonicSentinel*TMproducts.

 

We market and sell ourproducts around the world to a diversified group of original equipmentmanufacturers (OEMs) dealers, distributors, resellers, and end users, primarilythrough our sales and customer support staff, advertisements in tradepublications, and participation in major industry trade shows.

 

13

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A substantial portion of ourrevenue is derived from sales to a limited number of OEMs who purchase ourswitching systems on a private-label or branded basis for integration and salewith their own products, sales through our reseller and distributor network,and sales to a limited number of direct customers. Sales to our OEM customersaccounted for 49% of sales in the first nine months of 2005 and 43% of sales inthe first nine months of 2004.  Sales toour branded customers accounted for 51% of sales in the first nine months of2005 and 57% of sales in the first nine months of 2004. We do not havecontracts with many of our branded customers, and in general, our OEM andbranded business customers are obligated to purchase products from us onlypursuant to binding purchase orders.  Theloss of, or material decline in orders from, these customers would have amaterial adverse effect on our business, financial condition, results ofoperations, and cash flows.  Our top fivecustomers include both OEM and branded customers, and accounted for 62% ofsales in the first nine months of 2005 and 64% of sales in the first ninemonths of 2004.

 

We sell products to dealers,end-users, and OEMs in the United States, Canada, Europe, and Asia as well asin other foreign markets.  Sales withinthe United States accounted for approximately 57% of sales in the first ninemonths of 2005 and 60% of sales in the first nine months of 2004.  Sales outside of the United States accountedfor 43% of sales in the first nine months of 2005 and 40% of sales in the firstnine months of 2004.  Sales to customersin the Netherlands, including the European distribution facility for one of ourOEM customers, accounted for 10% of our sales in the first nine months of2004.  No other country accounted formore than 10% of sales in the first nine months of either 2005 or 2004.

 

With continued industry-wideinitiatives to reduce all channel inventories and to shorten lead times, trendswith our major customers are, generally, to reduce the number of weeks offorward-committed firm orders. This trend continues to affect our business withcertain distributors, OEMs and other server manufacturers, and we believethat it will continue to make our future sales more difficult to predict andinventory levels more difficult to manage.

 

We continue to experiencesignificant price competition in the market for all of our products, and weexpect that pricing pressures will continue in the future.  In addition, general economic conditions arenot predictable, and we expect our revenue growth rate to fluctuate in relationto economic conditions and IT related spending trends.  Depending on future general economicconditions and other factors, our revenue could decline in the future.

 

Manyof our executive officers and directors are vested in significant amounts ofoptions to purchase shares of our common stock and continue to vest inadditional shares on a regular basis. These officers and directors have informed us that they have sold, andmay sell additional, shares of our common stock to provide liquidity anddiversify their portfolios.

 

Subsequent to the end of our third quarter 2005, we announced plans forthe formation of five divisions within Avocent**. **These divisions include:

 

•                  ManagementSystems division, which includes our branded and OEM KVM, serial console, powercontrol and management appliance businesses;

•                  EmbeddedSoftware & Solutions division, focused on developing and marketing embeddedsystems and software including IPMI and embedded KVM technologies primarily forour OEM customers;

•                  Serial andAudio-Visual Solutions division, focused on expanding the markets for Avocent’sserial and wireless products;

•                  DesktopSolutions division, which includes Avocent’s existing extension and DigitalDesktops products with emphasis on development of major new products andmarkets in this area; and

•                  MobileSolutions division, which includes mobile device management and secure wirelesssystems administration.

 

**We arein the process of reconfiguring our systems and defining new cost centers andoperating measures to track the performance of the divisions and to use as abasis for allocating resources in the future. However, we currently are not managing our business under thesedivisions, and we do not expect to be functioning under the five new divisionsuntil early 2006.  We will evaluate ourdivisions based on the requirements in SFAS No. 131 and expect to provideapplicable segment data on the new divisions in 2006.**

** **

**Webelieve our new business divisions will allow us to focus on new technology andgrowth opportunities to add product and shareholder value in the future. Weexpect our new corporate structure will enhance customer service, speed deliveryof products to market and better focus Avocent’s research, development andmarketing expenditures.  Although weanticipate that the formation of these five new divisions and thestreamlining of our corporate structure will result in a number of benefitsto our operations, the potential risks associated with ourrestructuring include, but are not limited to, loss of keymanagement, technical, and other key personnel, the disruptionof customer relationships, delay in the development or delivery of new productsand technologies, inefficiencies due to duplication of certainfunctions, and increased expenses.**

 

**Results of Operations**

 

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

 

14

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| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **Sept. 30,  2005**    | ** ** | **October 1,  2004**  | ** ** | **Sept. 30,  2005** | ** ** | **October 1,  2004** | ** ** |
|                                                 |       |                   |       |                  |       |   |   |   |   |
| Net sales                                            |       | 100.0                  | %          | 100.0                 | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                        |       | 40.7                   |       | 41.8                  |       | 41.6 |   | 42.0 |   |
|                                                 |       |                   |       |                  |       |   |   |   |   |
| Gross profit                                         |       | 59.3                   |       | 58.2                  |       | 58.4 |   | 58.0 |   |
| Operating expenses:                                  |       |                   |       |                  |       |   |   |   |   |
| Research and development  expenses                   |       | 15.1                   |       | 12.9                  |       | 16.5 |   | 12.2 |   |
| Acquired in-process research and development expense |       | —                 |       | 1.1                   |       | — |   | 11.0 |   |
| Selling, general and  administrative expenses        |       | 21.5                   |       | 23.2                  |       | 25.5 |   | 24.0 |   |
| Amortization of intangible  assets                   |       | 2.9                    |       | 7.1                   |       | 6.1 |   | 6.7 |   |
|                                                 |       |                   |       |                  |       |   |   |   |   |
| Total operating expenses                             |       | 39.5                   |       | 44.3                  |       | 48.1 |   | 53.9 |   |
|                                                 |       |                   |       |                  |       |   |   |   |   |
| Income from operations                               |       | 19.8                   |       | 13.9                  |       | 10.3 |   | 4.1 |   |
| Income from settlement of  lawsuit                   |       | —                 |       | —                |       | 1.9 |   | — |   |
| Net investment income                                |       | 2.4                    |       | 1.4                   |       | 2.5 |   | 1.4 |   |
| Net realized investment  losses                      |       | (0.1                   | )          | (0.1                  | )          | (0.2 | ) | (0.1 | ) |
| Other expense, net                                   |       | (0.1                   | )          | 0.0                   |       | 0.0 |   | (0.1 | ) |
|                                                 |       |                   |       |                  |       |   |   |   |   |
| Income before income taxes                           |       | 22.0                   |       | 15.2                  |       | 14.5 |   | 5.3 |   |
| Provision for income taxes                           |       | 5.1                    |       | 3.4                   |       | 3.4 |   | 3.0 |   |
|                                                 |       |                   |       |                  |       |   |   |   |   |
| Net income                                           |       | 16.9                   | %          | 11.8                  | %          | 11.1 | % | 2.3 | % |

** **

*Net sales.*  Our net sales consist of sales ofkeyboard, video, and mouse console switching systems, digital connectivitysolutions, serial connectivity devices, wireless extension products, IPMI,extension and remote access and management solutions and royalties fromlicensing our intellectual property.  Net sales increased 6% to $96.7 millionfor the third quarter of 2005 from $91.3 million for the third quarter of 2004as a result of various factors.  Onefactor was the increase in branded sales in the third quarter of 2005 ascompared to the third quarter of 2004. Branded sales were up $3.1 million, or 6.2%, compared to the thirdquarter of 2004.  Additionally, OEM saleswere up $2.3 million in the third quarter of 2005 as compared to the thirdquarter of 2004. Revenues from our Embedded Software and Solutions group, whichincludes embedded KVM offerings and our IPMI management solutions, contributedapproximately $6.2 million in the third quarter of 2005, compared to $1.6million in the third quarter of 2004.  Sales of our digital products continued toincrease and represented over 53% of our revenue in the third quarter of 2005as compared to 49% of our revenue in the third quarter of 2004.  Also, sales of our newer products, thoseintroduced within the last twelve months, contributed $25.3 million in revenueduring the third quarter of 2005.

 

OEMsales grew approximately 6% from $42.2 million in the third quarter of 2004 to$44.5 million in the third quarter of 2005. OEM sales were 46% of sales for thethird quarter of both 2005 and 2004.  Brandedsales increased by 6% from $49.2 million in the third quarter of 2004 to $52.2million in the third quarter of 2005.  Asa percentage of sales, branded sales accounted for 54% of sales in the thirdquarter of both 2005 and 2004.

 

Sales within the United States increased to $58.0million in the third quarter of 2005 from $56.0 million in the third quarter of2004.  International sales increased 10%,to $38.7 million in the third quarter of 2005 from $35.3 million in the thirdquarter of 2004.  Sales within the UnitedStates were 60% of sales for the third quarter of 2005 and 61% of sales for thethird quarter of 2004.  Internationalsales were 40% of sales for the third quarter of 2005 and 39% of sales for thethird quarter of 2004.

 

Net sales decreased 1% to$263.1 million for the first nine months of 2005 from $265.2 million for thefirst nine months of 2004, primarily as a result of the issues related to therevenue shortfall in the first quarter of 2005, which included issuessurrounding new branded product launches and lower than expected sales to oneof our OEM customers.   However, the ninemonth results benefited from the rebound in revenue during the second and thirdquarters of 2005.  Sales within theUnited States decreased by approximately 6% to $150.8 million in the first ninemonths of 2005 from $160.1 million in the first nine months of 2004.  International sales increased approximately 7% to $112.3 million in the first ninemonths of 2005 from $105.1 million in the first nine months of 2004.  Additionally, sales to our branded customersdecreased 10% to $134.8 million in the first nine months of 2005 from $149.9 inthe first nine months of 2004, while sales to our OEM customers increased 11%to $128.3 million in the first nine months of 2005 from $115.3 in the firstnine months of 2004.

 

Our outlook for the fourth quarter of 2005 is cautiousbut positive.  We remain positive aboutthe positioning of our current and expanding product platforms, but we see someconcern in certain market sectors regarding general economic conditions thatmay cause some companies to delay planned IT expenditures.  In addition, the market remains competitivewith continued increases in levels of spending by our competitors onadvertising and promotions and new product introductions.  Considering these factors, we believe ourrevenues will be in the range of $104 million to $109 million in the fourthquarter of 2005.

 

*Gross profit.*Grossprofit may be affected by a variety of factors, including: the ratio of salesamong our distribution channels, as OEM sales typically have lower grossmargins than our branded sales; absorption of fixed costs as sales levelsfluctuate; product mix, raw materials, and labor costs; new productintroductions by us and by our competitors; the level of our outsourcing ofmanufacturing and assembly services; and the amount of royalty revenue, whichtypically has no associated cost of goods sold. Gross margin improved to 59.3%in the third quarter of 2005 as compared to 58.2% in the third quarter of2004.  Gross margin was positivelyaffected by the $1.1

 

15

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millionof Raritan royalty revenue recorded during the third quarter of 2005.  Our digital, embedded, and IPMI revenues allincreased as well.  These product linestypically have higher margins compared to our other product lines.  These positive influences on gross marginwere partially offset by additional product costs from implementing newenvironmental regulations and transitioning to a new contract manufacturer.  Gross margin increased slightly to 58.4% forthe first nine months of 2005 from 58.0% for the first nine months of 2004,primarily as a result of the higher digital, embedded, IPMI, and royaltyrevenues for the first nine months of 2005, which offset the lower gross marginwe experienced in the first quarter of 2005 as a result of our lower thanexpected revenue.

 

We expect gross margin to remain in the 59% range for thefourth quarter of 2005.  We expect thefourth quarter of 2005 to follow the historical trend of being comprised ofhigher OEM and international branded sales, which typically have lower than ouraverage margin. We expect the continuing growth of revenue from our digitalproducts, higher royalty revenue and higher revenue from our embedded solutionswill continue to be sufficient to offset the factors mentioned as well as pricedeclines, competitive pressures and ongoing costs from our environmentalregulation compliance efforts.

 

*Research and development expenses.*  Researchand development expenses include compensation for engineers, support personnel,outside contracted services and materials costs, and are expensed as they areincurred.  Research anddevelopment expenses were $14.6 million, or 15.1% of net sales, in the thirdquarter of 2005 compared to $11.8 million, or 12.9% of net sales, for the thirdquarter of 2004.  The increase in theamount spent on research and development can be attributed to higher costs fromseveral new, significant projects, increased testing costs, and additionalheadcount for new programs, particularly in our Embedded Software and Solutionsgroup.  Researchand development expenses for the first nine months of 2005 increased to $43.5million from $32.4 million for the first nine months of 2004 primarily as aresult of the additional headcount from the acquisitions completed in2004 and over $800,000 of severance accruals recorded in the second quarter of2005 related to the closing of three satellite research and developmentsites.  Asa percentage of net sales, year-to-date research and development expensesincreased to 16.5% in  2005 from 12.2% in2004.

 

Wehave implemented plans to refocus our research and development spending,including the closing of the three satellite offices mentioned above.  However, increased spending on significantprojects and headcount additions for our Embedded Software and Solutions grouphave offset the reductions achieved from closing those offices.  In light of the current levels of commitmentin place for the fourth quarter, we expect research and development spending tobe relatively flat in the fourth quarter of 2005 compared to the third quarterof 2005.

 

*Acquired in-process research anddevelopment expense.*  Acquisition related expenses in the firstnine months of 2004 were comprised of thewrite-off of $21.7 million of in-process research and development expenserelated to the acquisition of OSA, the write-off of $6.5 million ofin-process research and development expense related to the acquisition ofCrystal Link,  and the write-off of$1.1 million of in-process research and development expense related to theacquisition of Sonic Mobility. There were no such charges in the first ninemonths of 2005.

 

***Selling, general and administrative expenses.***  Selling,general and administrative expenses include personnel costs for administration,finance, information systems, human resources, sales and marketing and generalmanagement, as well as some merger and acquisition related expenses, rent,utilities, legal and accounting expenses, bad debts, advertising, promotional material,trade show expenses and related travel costs. Selling, general and administrative expenses were $20.8 million, or21.5% of net sales, for the third quarter of 2005 compared to $21.2 million, or23.2% of net sales, for the third quarter of 2004.  The decrease in selling, general andadministrative expenses is primarily related to lower legal fees associatedwith protecting our intellectual property rights as we settled the litigationwith Raritan during the second quarter of 2005. Additionally, we experiencedlower advertising and promotion costs due to recent efforts to re-evaluateprograms for our new digital products. Year-to-date selling, general, and administrative expenses increased to$67.1 million, or 25.5% of net sales for 2005, from $63.6 million, or 24.0% ofyear-to-date net sales in 2004, as a result of the factors from the first sixmonths of the year, including $500,000 in severance accruals recorded in thesecond quarter of 2005 related to certain headcount reductions, higher legal feesin the first six months of 2005 associated with the Raritan case that settledin the second quarter of 2005 and increased costs associated with thelocalization of technical manuals and publications for certain products shippedinternationally.

** **

**Weexpect our selling, general and administrative expenses to be approximately$1.5 million to $2.0 million higher in the fourth quarter of 2005 when comparedto the third quarter of 2005.  Legal feesassociated with protecting our intellectual property should increase during thefourth quarter of 2005.  Additionally, weexpect to invest more in promoting our newer products based on the evaluationof our marketing programs performed in the third quarter of 2005, and we expectto add sales personnel in certain target markets.**

** **

***Amortization of intangible assets***. Amortization of $2.7 million in the third quarter of 2005 was comprisedof the amortization of the identifiable intangible assets created as a resultof the acquisitions of Equinox, 2C, Soronti, Crystal Link, OSA, and SonicMobility. Amortization of $6.5 million in the third quarter of 2004 wascomprised of the amortization of the identifiable intangible assets created asa result of the merger transaction between Apex and Cybex and the acquisitionsof Equinox, 2C, Soronti, Crystal Link, OSA, and Sonic Mobility.  The decrease in amortization expense relatesprimarily to recording no amortization expense for developed technology orpatents and trademarks recorded on the merger of Apex and Cybex, as theseassets had an estimated life of five years and were fully

** **

**16**

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** **

**amortized at the end of the secondquarter of 2005. Amortization expense decreased from $17.7 million in the firstnine months of 2004 to $16.0 million in the first nine months of 2005 as aresult of the factors mentioned above. Amortization expense in the fourth quarter of 2005 is expected to remainflat when compared to the amount from the third quarter of 2005.**

** **

*Income from settlement oflawsuit**.** *The $5 million of incomefrom the settlement of lawsuit in the first nine months of 2005 is comprisedentirely of the payment received in the second quarter of 2005 as a result ofthe settled patent infringement lawsuit brought by Avocent against Raritan Computer Inc.In part, the terms of the settlement called for an initial payment of $5million, related to past product sales by Raritan.

 

*Net investment income**.** *Net******investmentincome increased to $2.2 million in the third quarter of 2005 compared to $1.3million in the third quarter of 2004.  The improved results were due to higher interestrates on investments and higher amounts invested of cash generated fromoperations.  Net investment incomeincreased from $3.6 million in the first nine months of 2004 to $6.6 million inthe first nine months of 2005 as a result of the factors mentioned above.

 

*Net realized investment losses. *Net realizedinvestment losses remained relatively constant at $101,000 in the third quarterof 2004 and $100,000 in third quarter of 2005.  Net realized investment lossesincreased from $269,000 in the first nine months of 2004 to $483,000 in firstnine months of 2005.  The increase for the nine months to dateresulted from certain sales of investments prior to maturity to fund our ongoingshare repurchase program.

 

*Other income (expense), net.*  Net other income (expense)decreased slightly from $26,000 of income in the third quarter of 2004, to$75,000 of expense in the third quarter of 2005. For the nine months to date,net other expense increased from $122,000 in the first nine months of 2004 to$129,000 in the first nine months of 2005.

 

*Provisionfor income taxes.*  The provision for incometaxes was approximately $8.8 million in the first nine months of 2005, comparedto $8.1 million for the nine months ended October 1, 2004.  The decreasein the effective tax rate is primarily attributable to the impact of $21.7million of acquired in-process research and development expense recorded duringthe second quarter of 2004 as a result of the acquisition of OSA, which is notdeductible for tax purposes.

 

*Net income.*  Net income for the thirdquarter of 2005 was $16.4 million compared to $10.8 million for the thirdquarter of 2004, as a result of the above factors.  As a percentage of sales, net income for thethird quarter of 2005 was 16.9%, compared to 11.8% for the third quarter of2004. For the first nine months of the year, net income was $29.3 million, or11.1% of net sales, in 2005, compared to $6.0 million, or 2.3%, in 2004, as aresult of the factors mentioned above.

 

 

 

**Liquidityand Capital Resources**

 

As of September 30, 2005, our principal sources ofliquidity consisted of approximately $333 million in cash, cashequivalents, and investments.  We have nooutstanding debt or available credit facilities as of this filing.

 

Our operating activities generated cash of almost $52.0million in the first nine months of 2005, compared to approximately $51.2million in the nine months of 2004.  Thecontinued positive cash flow is the result of a variety of factors, butprimarily due to an increase in net income and accrued liabilities and adecrease to accounts receivable, offset by increases in other assets anddecreases in accounts payables, and accrued compensation.  Inventoriesincreased slightly from $21.2 million at December 31, 2004 to $21.5 million atSeptember 30, 2005.  The slight increasein inventory was primarily the result of adding inventory related to a recentchange of contract manufacturers.  Ourinventory turns improved to just over 7.3 turns for the third quarter of 2005,slightly above the third quarter of 2004, and above the 6.4 level from thesecond quarter of 2005.  We will continueto monitor our inventory closely and expect our inventory turns to remain closeto our stated target of 7.0 turns as sales volume increases.  Our decrease in receivables positivelyimpacted cash flows for the quarter as accounts receivable decreased from $60.9million at December 31, 2004 to $57.9 million at September 30, 2005.   Our DSOs, or days sales outstanding,declined slightly to 54 days, compared to 55 days from the third quarter of2004, and remained steady at 54 days in the second quarter of 2005, both ofwhich were better than our goal of 60 days. Our accounts receivable agingremains strong, with 1% of the balance greater than 30 days past due.

 

Inthe ordinary course of our business, we may at any point in time have asignificant amount of contractual commitments not yet recognized in ourfinancial statements. These commitments relate primarily to our need toschedule the purchase of inventories in advance of the related forecasted salesto customers. We have longer lead times for the products we purchase fromsuppliers based in Asia than those for our U.S. based and European suppliers.Our actual contractual commitments are typically limited to products needed forone to three months of forecasted sales. The liabilities for these inventorypurchases along with the related inventory assets are typically recognized uponour receipt of the products. We also have at any point in time a variety ofshort term contractual commitments for services such as advertising, marketing,accounting, legal, and research and development activities. The liabilities forthese services and the related expenses are typically recognized upon ourreceipt of the related services.  As ofSeptember 30,

 

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2005, we had $36.9 millionof such commitments.  None of ourexpected purchase commitments required payment beyond the next year.

 

We intend to use a portion of our cash and investmentsfor strategic acquisitions of technologies and companies that will enhance andcomplement our existing technologies and help increase our sales.

 

Under our board-approvedstock repurchase plan, we repurchased 500,000 shares of our common stock duringthe quarter ended September 30, 2005 at a cost totaling $15.8 million. Werepurchased 2.3 million shares of our common stock during the nine months endedSeptember 30, 2005 at a cost totaling $66.1 million.  During the period October 1, 2005 throughNovember 2, 2005 we repurchased an additional 150,000 shares under this programat a total cost of approximately $4.5 million. We expect to continue to repurchase shares from time to time to offsetthe dilution from stock option exercises and to return a portion of our cashand investments to shareholders.

 

**Investments**

 

Ourinvestments consist primarily of bank deposits, money market funds, corporatebonds, municipal bonds, commercial paper, mortgage backed securities guaranteedby U.S. government agencies, and common stock. We classify our debt and equitysecurities as available-for-sale securities and report them at fair value, withunrealized gains and losses excluded from earnings and reported as a separatecomponent of stockholders’ equity. We periodically review our investmentportfolio for investments considered to have sustained an other-than-temporarydecline in value.   Upon review of ourinvestment portfolio for the three months ended September 30, 2005, noinvestment was considered to have sustained an other-than-temporary decline,and accordingly no impairment charges were recorded during the three monthsended September 30, 2005.

 

DuringOctober 2005, we sold our former Huntsville facility, which is classified asproperty held for lease on the condensed consolidated balance sheet, for netproceeds of $1.9 million and an after tax gain on sale of approximately$500,000.  The gain will be reported inthe fourth quarter of 2005 financial statements.

 

**Recently Issued AccountingStandards and Regulatory Standards**

 

In December 2004, the FASBissued SFAS No. 123 (revised 2004), *Share based Payme*nt,which replaces SFAS No. 123 *Accounting for Stock BasedCompensatio*n and APB Opinion No 25 *Accountingfor Stock Issued to Employees*. SFAS 123R requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the financial statementsbased on their fair values beginning with the first annual period after June15, 2005.  The pro-forma disclosurespreviously permitted under SFAS No. 123 no longer will be an alternative toinclusion of the expense in the financial statements.  We are required to adopt SFAS 123R beginningJanuary 1, 2006.  Under SFAS 123R, wemust determine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost and thetransition method to be used at date of adoption.  The transition methods include prospectiveand retroactive adoption options. We expect to use the Black-Scholes optionpricing model to value options.  Inaddition, we expect to utilize the straight line method to amortize the expenseand utilize the prospective transition method which requires that compensationexpense begin being recorded for all unvested stock options and restrictedstock at the beginning of the first quarter of adoption of SFAS 123R.  We are evaluating the requirements of SFAS123R and the adoption of SFAS 123R may have a material impact on ourconsolidated results of operations and earnings per share.  However, we have not determined the effect ofadopting SFAS 123R and we have not determined whether the adoption will resultin amounts similar to the current pro-forma disclosures under SFAS 123. Underthe current approach of SFAS 123 we would have unamortized fair value ofunvested stock options of approximately $15 million for currently outstandingstock options to be recognized as expense in our income statements after 2005,prior to the acceleration of vesting discussed previously.  Following this acceleration we believe thebalance to be expensed in future periods would be reduced to approximately $2million for currently outstanding stock options under the SFAS 123 methodology.

 

OnOctober 22, 2004, the American Jobs Creation Act of 2004 became law. Thislegislation repeals export tax benefits, which have historically reduced oureffective tax rate. This legislation phases in the repealed export tax benefitsby allowing 100 percent of the repealed export benefits in 2004, 80 percent in2005 and 60 percent in 2006.  We do notexpect this change will have a material impact on our effective tax rate orprovision for taxes in 2005.

 

Thelegislation also transitions in a new tax deduction for qualifying U.S.manufacturing activities. Under the guidance in FASB Staff Position No. FAS109-1 which articulates the application of SFAS 109, *Accountingfor Income Taxes*, to the tax deduction on qualified productionactivities provided by the Act, the deduction will be treated as a “specialdeduction” as described in SFAS 109. As such, we expect the new manufacturingactivities deduction provision of the new legislation may reduce our effectiverate in future periods as the deduction is taken on our tax returns. We do notexpect the deduction to have a material impact on our effective tax rate orincome tax provision in 2005.

 

Thelegislation also provides for the optional repatriation of earnings fromforeign subsidiaries allowing an 85 percent dividends received deduction. Thededuction is subject to a number of limitations.   We have performed a preliminary analysisunder

 

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the new legislation andwe are considering repatriating up to $90.0 million from overseas earningspursuant to this provision during the fourth quarter of 2005.  If our intention to permanently reinvestoverseas earnings in our overseas operations changes and we decide torepatriate any of the earnings to the U.S., we would incur additional incometax expense equal to the incremental U.S. income tax in excess of the creditsavailable for taxes already paid overseas. If we repatriate the entire $90.0million in the fourth quarter of 2005, we estimate the potential tax expense tobe $3.5 million, which would reduce diluted earnings per share $0.08 cents.

 

**Item 3.****Quantitative and QualitativeDisclosures About Market Risks.**

 

Our primary market risk is the potential loss arisingfrom increases in interest rates, which could have an adverse impact on thefair value of our investment securities. Our investment policy is to manage ourinvestment portfolio to preserve principal and liquidity while maximizing thereturn on our investment portfolio through the investment of available funds.We diversify our investment portfolio by investing in a variety of highly-ratedinvestment-grade securities and through the use of different investmentmanagers. Our investment securities portfolio is primarily invested insecurities with maturities (or interest rate resets) of two years or less withat least an investment grade rating to minimize interest rate and credit riskas well as to provide for an immediate source of funds. Market risk, calculatedas the potential change in fair value in our investment portfolio resultingfrom a hypothetical 10% change in interest rates, was not material at September30, 2005.

 

We also face foreign currency exchange rate risk to theextent that the value of certain foreign currencies relative to the U.S. dollaraffects our financial results.  Ourinternational operations transact a portion of our business in currencies otherthan the U.S. dollar, predominantly the euro, and changes in exchange rates maypositively or negatively affect our revenues, gross margins, operating expenses,and retained earnings since these transactions are reported by us in U.S.dollars.  We periodically purchaseforeign currency forwards aimed at limiting the impact of currencyfluctuations.  These instruments provideonly limited protection against currency exchange risks, and there can be noassurance that such an approach will be successful, especially if a significantand sudden decline occurs in the value of local currencies. As of September30, 2005, we had one 30 day open forward contract, maturing on October 28,2005, with a fair value of approximately ($7,000).

 

 

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

 

a) *Evaluation of disclosure controls and procedures.*    Based on their evaluation as of September30, 2005, our Chief Executive Officer and Chief Financial Officer haveconcluded that our disclosure controls and procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) areeffective to ensure that information required to be disclosed by us in reportsthat we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in Securities andExchange Commission rules and forms.

 

(b)*Changes in internal control over financialreporting*.    There were nochanges in our internal controls over financial reporting during the quarterended September 30, 2005 that materially affected or is reasonably likely tomaterially affect, our internal controls over financial reporting. However, weimplemented a new investment software package in the third quarter of 2005,which we believe will improve our internal controls over our accounting forinvestments.

 

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### **PART II — OTHER INFORMATION**

 

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

 

InOctober 2003, we filed a complaint for patent infringement in the United StatesDistrict Court for the Northern District of Alabama against ClearCubeTechnology, Inc.  The ClearCube complaintseeks injunctive relief, damages, attorneys’ fees, and costs under two of ourpatents. ClearCube has filed counterclaims alleging non-infringement,unenforceability, invalidity, and misuse of the Avocent patents. A Markmanhearing on claims construction was originally set for February 2005, but inresponse to an inquiry from the Court, we agreed that the hearing should bepostponed until the United States Court of Appeals for the Federal Circuitissues its ruling on certain similar issues raised in an unrelated patent case.This ruling was issued in June 2005 and the Markman hearing on claimsconstruction is now scheduled for December 2005.

 

**Item 2.****          ****Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

In the fourth quarter of2004, our Board of Directors approved a stock repurchase program whereby wemay, from time to time, purchase up to two million shares of our common stockin the open market, in privately negotiated transactions or otherwise, atprices that we deem appropriate.  OurBoard increased the amount we may repurchase to four million shares in April2005.  The plan has no expiration date.Details of purchases made during the nine months ended September 30, 2005 areas 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 (1)** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
|                                      |       |                                                      |       |                                                     |       |                                                                                    |       |                                                                      |       |
| January 1, 2005 — January 31, 2005   |       | 195,600                                                   |       | $                                                        | 36.04      |                                                                                    | 295,600    |                                                                      | 1,704,400  |   |
| February 1, 2005 — February 28, 2005 |       | 154,400                                                   |       | $                                                        | 35.41      |                                                                                    | 450,000    |                                                                      | 1,550,000  |   |
| March 1, 2005 — April 1, 2005        |       | 350,000                                                   |       | $                                                        | 26.70      |                                                                                    | 800,000    |                                                                      | 1,200,000  |   |
| Quarter ended April 1, 2005               |       | 700,000                                                   |       | $                                                        | 31.23      |                                                                                    |       |                                                                      |       |   |
|                                      |       |                                                      |       |                                                     |       |                                                                                    |       |                                                                      |       |
| April 2, 2005 — April 29, 2005       |       | 275,000                                                   |       | $                                                        | 24.92      |                                                                                    | 1,075,000  |                                                                      | 2,925,000  |   |
| April 30, 2005 — May 27, 2005        |       | 294,969                                                   |       | $                                                        | 26.07      |                                                                                    | 1,369,969  |                                                                      | 2,630,031  |   |
| May 28, 2005 — July 1, 2005          |       | 505,031                                                   |       | $                                                        | 27.46      |                                                                                    | 1,875,000  |                                                                      | 2,125,000  |   |
| Quarter ended July 1, 2005                |       | 1,075,000                                                 |       | $                                                        | 26.43      |                                                                                    |       |                                                                      |       |   |
|                                      |       |                                                      |       |                                                     |       |                                                                                    |       |                                                                      |       |
| July 2, 2005 — July 29, 2005         |       | 200,000                                                   |       | $                                                        | 29.62      |                                                                                    | 2,075,000  |                                                                      | 1,925,000  |   |
| July 30, 2005 — August 26, 2005      |       | 125,000                                                   |       | $                                                        | 33.28      |                                                                                    | 2,200,000  |                                                                      | 1,800,000  |   |
| August 27, 2005 — September 30, 2005 |       | 175,000                                                   |       | $                                                        | 32.77      |                                                                                    | 2,375,000  |                                                                      | 1,625,000  |   |
| Quarter ended September 30, 2005          |       | 500,000                                                   |       | $                                                        | 31.64      |                                                                                    |       |                                                                      |       |   |
|                                      |       |                                                      |       |                                                     |       |                                                                                    |       |                                                                      |       |
| Totals                                    |       | 2,275,000                                                 |       | $                                                        | 29.05      |                                                                                    |       |                                                                      |       |   |

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(1)                                  Includesadditional two million shares approved by our Board of Directors for our stockrepurchase program on April 29, 2005. A total of four million shares is nowauthorized to be repurchased under the board approved program.

 

**Item 6.    Exhibits**.

 

(a) Exhibits

** **

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

** **

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

** **

32.1                         Certification of the Chief Executive Officer and the Chief FinancialOfficer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002.

 

ITEMS 3, 4 & 5 ARE NOT APPLICABLE ANDHAVE BEEN OMITTED.

 

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### **SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   |             | AVOCENT CORPORATION                                             |   |
|--------|------------------|-----------------------------------------------------------------|--------|
|   |             | (Registrant)                                                    |
|   |             |                                                            |
|   |             |                                                            |
|   |             |                                                            |
| Date:  | November 8, 2005 | /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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