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Table of Contents

 

 

 

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

x

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended September 30, 2009 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

 

AVOCENT CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

91-2032368

(State or Other Jurisdiction of Incorporation or Organization)

 

(I.R.S. Employer Identification Number)

 

 

 

4991 Corporate Drive
Huntsville, Alabama

 


35805

(Address of Principal Executive Offices)

 

(Zip Code)

 

256-430-4000
(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. x Yes o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

 

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

 

Large accelerated filer x

 

Accelerated filer o

Non-accelerated filer o

 

Smaller reporting company o

 

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

 

As of October 30, 2009, the number of outstanding shares of the Registrant’s Common Stock was 44,591,979.

 

 

 



Table of Contents

 

AVOCENT CORPORATION

FORM 10-Q

September 30, 2009

 

INDEX

 

 

 

Page(s)

 

 

 

Part I

Financial Information

 

 

 

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

 

 

 

 

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and September 26, 2008

 

3

 

 

Consolidated Balance Sheets at September 30, 2009 and December 31, 2008

 

4

 

 

Condensed Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2009 and September 26, 2008

 

5

 

 

Notes to Condensed Consolidated Financial Statements

 

6-18

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

19-30

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risks

 

30

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

31

 

 

 

 

 

Part II

Other Information

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

31

 

 

 

 

 

 

Item 1A.

Risk Factors

 

32

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

48

 

 

 

 

 

 

Item 6.

Exhibits

 

49

 

 

 

 

 

Signature

 

50

 

2



Table of Contents

 

PART I —FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

AVOCENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share data)

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

September 30,

 

September 26,

 

September 30,

 

September 26,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net sales:

 

 

 

 

 

 

 

 

 

Products

 

$

93,564

 

$

131,693

 

$

263,828

 

$

354,861

 

Licenses and royalties

 

24,948

 

30,873

 

71,185

 

80,688

 

Services

 

19,043

 

20,482

 

57,235

 

48,080

 

Total net sales

 

137,555

 

183,048

 

392,248

 

483,629

 

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

Products

 

43,648

 

58,355

 

120,499

 

154,685

 

Licenses and royalties

 

308

 

566

 

1,243

 

1,935

 

Services

 

4,822

 

5,862

 

14,406

 

12,186

 

Amortization of intangibles related to licenses and royalties

 

4,133

 

4,218

 

12,823

 

9,753

 

Total cost of sales (including stock compensation of $552 and $1,014 for the three and nine months ended Sept. 30, 2009; $298 and $797 for the three and nine months ended Sept. 26, 2008)

 

52,911

 

69,001

 

148,971

 

178,559

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

84,644

 

114,047

 

243,277

 

305,070

 

 

 

 

 

 

 

 

 

 

 

Research and development expenses (including stock compensation of $869 and $2,727 for the three and nine months ended Sept. 30, 2009; $1,523 and $3,878 for the three and nine months ended Sept. 26, 2008)

 

19,548

 

24,398

 

61,077

 

72,126

 

Acquired in-process research and development expenses

 

 

700

 

 

700

 

Selling, general and administrative expenses (including stock compensation of $5,194 and $10,992 for the three and nine months ended Sept. 30, 2009; $3,986 and $9,288 for the three and nine months ended Sept. 26, 2008)

 

52,182

 

60,266

 

149,521

 

172,830

 

Restructuring, integration and retirement expenses (including stock compensation of ($142) and ($138) for the three and nine months ended Sept. 30, 2009; $480 and $2,999 for the three and nine months ended Sept. 26, 2008)

 

2,884

 

5,926

 

9,709

 

13,627

 

Amortization of intangible assets

 

7,780

 

8,971

 

25,843

 

24,123

 

Impairment of goodwill

 

 

 

80,000

 

 

Total operating expenses

 

82,394

 

100,261

 

326,150

 

283,406

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

2,250

 

13,786

 

(82,873

)

21,664

 

 

 

 

 

 

 

 

 

 

 

Net investment income

 

105

 

295

 

390

 

1,863

 

Interest expense

 

(1,845

)

(2,268

)

(6,079

)

(5,915

)

Other income, net

 

1,888

 

2,362

 

724

 

2,722

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before provision (benefit) for income taxes

 

2,398

 

14,175

 

(87,838

)

20,334

 

Provision (benefit) for income taxes

 

(4,652

)

3,214

 

(31,617

)

5,199

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

7,050

 

$

10,961

 

$

(56,221

)

$

15,135

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share:

 

$

0.16

 

$

0.24

 

$

(1.27

)

$

0.33

 

Basic

 

$

0.16

 

$

0.24

 

$

(1.27

)

$

0.33

 

Diluted

 

 

 

 

 

 

 

 

 

Weighted average shares used in computing earnings (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

44,341

 

44,792

 

44,383

 

45,241

 

Diluted

 

44,801

 

45,467

 

44,383

 

45,868

 

 

See notes accompanying these condensed consolidated financial statements.

 

3



Table of Contents

 

Avocent Corporation

Consolidated Balance Sheets

(Unaudited, in thousands, except per share data)

 

 

 

September 30,
2009

 

December 31,
2008

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

110,103

 

$

126,858

 

Accounts receivable, less allowance for doubtful accounts of $3,562 and $4,548 at September 30, 2009 and December 31, 2008, respectively

 

99,536

 

122,133

 

Other receivables

 

7,752

 

12,281

 

Inventories

 

24,236

 

31,516

 

Other current assets

 

7,871

 

5,209

 

Deferred tax assets, net

 

7,544

 

6,885

 

Total current assets

 

257,042

 

304,882

 

 

 

 

 

 

 

Property and equipment, net

 

35,266

 

38,197

 

Goodwill

 

535,529

 

616,326

 

Other intangible assets, net

 

142,088

 

180,276

 

Deferred tax asset, non-current

 

46,198

 

10,873

 

Other assets

 

5,705

 

3,616

 

Total assets

 

$

1,021,828

 

$

1,154,170

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

13,504

 

$

17,494

 

Accrued wages and commissions

 

23,206

 

30,966

 

Accrued liabilities

 

29,484

 

42,027

 

Income taxes payable

 

15,035

 

11,678

 

Deferred revenue, current

 

65,678

 

66,248

 

Total current liabilities

 

146,907

 

168,413

 

 

 

 

 

 

 

Unsecured bank credit facility

 

125,000

 

170,000

 

Deferred revenue, non-current

 

7,134

 

9,572

 

Other non-current liabilities

 

3,480

 

4,028

 

Total liabilities

 

282,521

 

352,013

 

 

 

 

 

 

 

Commitments and contingencies (see Note 13)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, par value $0.001 per share; 5,000 shares authorized; no shares issued and outstanding

 

 

 

Common stock, par value $0.001 per share; 200,000 shares authorized; September 30, 2009 — 55,307 shares issued and 44,280 outstanding; December 31, 2008 — 54,533 shares issued and 44,706 outstanding;

 

55

 

55

 

Additional paid-in capital

 

1,237,480

 

1,230,840

 

Accumulated other comprehensive income (loss)

 

599

 

(1,606

)

Accumulated deficit

 

(249,468

)

(193,247

)

Treasury stock, at cost; September 30, 2009, 11,027 shares; December 31, 2008, 9,827 shares;

 

(249,359

)

(233,885

)

Total stockholders’ equity

 

739,307

 

802,157

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

1,021,828

 

$

1,154,170

 

 

See notes accompanying these condensed consolidated financial statements.

 

4



Table of Contents

 

AVOCENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 

 

 

For the nine months ended

 

 

 

September 30,

 

September 26,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

(56,221

)

$

15,135

 

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

6,113

 

7,027

 

Amortization of intangible assets

 

39,002

 

34,416

 

Stock-based compensation

 

14,586

 

16,957

 

Acquired in-process research and development expense

 

 

700

 

Net loss on disposition of fixed assets

 

238

 

548

 

Impairment of goodwill

 

80,000

 

 

Tax adjustments from stock-based compensation

 

3,216

 

(85

)

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

Accounts receivable, net

 

24,670

 

(8,214

)

Inventories

 

7,356

 

4,521

 

Other assets

 

239

 

(3,127

)

Accounts payable

 

(6,632

)

(4,252

)

Accrued wages and commissions

 

(7,760

)

4,170

 

Accrued other liabilities and deferred revenue

 

(17,306

)

3,532

 

Income taxes, current and deferred

 

(36,061

)

(5,167

)

Net cash provided by operating activities

 

51,440

 

66,161

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of Ergo, net of cash received

 

 

(28,443

)

Purchase of Touchpaper, net of cash received

 

 

(47,113

)

Purchase of other intangible assets

 

(727

)

(674

)

Additional consideration paid for LANDesk and Touchpaper

 

(4,077

)

 

Purchases of property and equipment

 

(3,823

)

(6,773

)

Proceeds from sale of property and equipment

 

622

 

 

Maturities and proceeds from sales of investments

 

 

5,942

 

Net cash used in investing activities

 

(8,005

)

(77,061

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Borrowings under term loan

 

 

90,000

 

Payments under unsecured line of credit, net

 

(45,000

)

(5,000

)

Proceeds from employee stock plans

 

1,509

 

1,484

 

Tax adjustments from stock-based compensation

 

(3,216

)

85

 

Purchases of treasury stock

 

(15,474

)

(64,449

)

Net cash (used in) provided by financing activities

 

(62,181

)

22,120

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

1,991

 

(1,502

)

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

(16,755

)

9,718

 

Cash and cash equivalents at beginning of period

 

126,858

 

105,183

 

Cash and cash equivalents at end of period

 

$

110,103

 

$

114,901

 

 

See notes accompanying these condensed consolidated financial statements.

 

5



Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

Note 1.   Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles and reflect all adjustments consisting of normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of the results for the periods shown.  The results of operations for these periods are not necessarily indicative of the results expected for the full fiscal year or for any future period.  The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates and assumptions.

 

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes contained in our Annual Report on Form 10-K for the year ended December 31, 2008, which is on file with the Securities and Exchange Commission and is available at our website, www.avocent.com. The consolidated balance sheet presented in the accompanying condensed consolidated financial statements for December 31, 2008, was derived from the audited financial statements filed in our 10-K for the period ended December 31, 2008, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

 

We report our annual results based on years ending December 31.  Prior to 2009, we reported our quarterly results for the first three interim periods based on 13 week periods ending on Fridays and for the fourth interim period ending on December 31.  Beginning January 1, 2009, we began reporting our quarterly periods based on the calendar month end to better align our quarter ends with those of our customers and others within our industry.

 

Certain reclassifications have been made to the prior year’s condensed consolidated financial statements in order to conform to the 2009 presentation. These reclassifications had no effect on previously reported net income, net cash provided by operating activities, net cash provided by investing activities nor total stockholders’ equity.

 

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

 

Note 2.   Inventories

 

Inventories consisted of the following at:

 

 

 

September 30, 2009

 

December 31, 2008

 

 

 

 

 

 

 

Raw materials

 

$

2,135

 

$

525

 

Work-in-process

 

787

 

308

 

Finished goods

 

21,314

 

30,683

 

Inventories

 

$

24,236

 

$

31,516

 

 

Inventories above have been reduced by reserves for excess and obsolete inventories of $4,645 and $6,401 as of September 30, 2009 and December 31, 2008, respectively.

 

Note 3.   Equity and Treasury Stock

 

We issued common stock as a result of stock option exercise activity during the three and nine months ended September 30, 2009 and September 26, 2008 as follows:

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

 

 

 

 

 

 

 

 

 

 

Stock option exercises

 

24,000

 

73,000

 

49,000

 

138,000

 

 

6



Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

We issued common stock as a result of restricted stock unit (RSU) vesting activity during the three and nine months ended September 30, 2009 and September 26, 2008 as follows:

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Net RSUs issued

 

 

 

 

 

 

 

 

 

RSU’s vested

 

87,000

 

28,000

 

926,000

 

617,000

 

Shares withheld for tax

 

(27,000

)

(4,000

)

(274,000

)

(179,000

)

Net RSUs issued

 

60,000

 

24,000

 

652,000

 

438,000

 

 

Share repurchase activity during the three and nine months ended September 30, 2009 and September 26, 2008 was as follows:

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

 

 

 

 

 

 

 

 

 

 

Shares repurchased

 

200,000

 

 

1,200,000

 

4,000,000

 

 

We issued common stock as a result of employee stock purchase plan (ESPP) activity during the three and nine months ended September 30, 2009 and September 26, 2008 as follows:

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

 

 

 

 

 

 

 

 

 

 

ESPP activity

 

 

 

73,000

 

 

 

RSUs granted — During the first nine months of 2009, our Compensation Committee approved the grant of 1,656,000 restricted stock units to our employees, officers and directors.  Of these grants, 1,071,000 were time-based and 585,000 were based on market and performance conditions.  During the first nine months of 2008, our Compensation Committee approved the grant of 1,551,000 restricted stock units to our employees, officers and directors.  Of these grants, 963,000 were time-based and 588,000 were based on market and performance conditions.

 

Note 4.   Accumulated Other Comprehensive Income (Loss)

 

We record our foreign currency translation adjustments and unrealized gains and losses on cash flow hedges, net of tax, within accumulated other comprehensive income (loss).This comprehensive income (loss) is included as a separate component of stockholders’ equity with year to date balances for the nine months ended September 30, 2009 and September 26, 2008 as follows:

 

 

 

For the nine months ended

 

 

 

September 30,
2009

 

September 26, 2008

 

Comprehensive income (loss)

 

 

 

 

 

Net income (loss)

 

$

(56,221

)

$

15,135

 

Unrealized gains on cash flow hedge

 

471

 

430

 

Foreign currency translation adjustment

 

1,734

 

(1,871

)

Total comprehensive income (loss)

 

$

(54,016

)

$

13,694

 

 

As of September 30, 2009 and December 31, 2008, total accumulated other comprehensive income (loss) was $599 and $(1,606), respectively.

 

7



Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

Note 5.   Earnings (Loss) Per Share (share data in thousands)

 

 

 

Income (Loss) (Numerator)

 

Shares
(Denominator)

 

Per-Share
Amount

 

 

 

 

 

 

 

 

 

For the three months ended September 30, 2009

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income available to common stockholders

 

$

7,050

 

44,341

 

$

0.16

 

Effect of Dilutive Securities

 

 

 

 

 

 

 

Stock options and unvested RSUs

 

 

460

 

 

Diluted EPS

 

 

 

 

 

 

 

Net income available to common stockholders and assumed conversions

 

$

7,050

 

44,801

 

$

0.16

 

 

 

 

 

 

 

 

 

For the three months ended September 26, 2008

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income available to common stockholders

 

$

10,961

 

44,792

 

$

0.24

 

Effect of Dilutive Securities

 

 

 

 

 

 

 

Stock options and unvested restricted stock awards

 

 

675

 

 

Diluted EPS

 

 

 

 

 

 

 

Net income available to common stockholders and assumed conversions

 

$

10,961

 

45,467

 

$

0.24

 

 

 

 

 

 

 

 

 

For the nine months ended September 30, 2009

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net loss available to common stockholders

 

$

(56,221

)

44,383

 

$

(1.27

)

Effect of Dilutive Securities

 

 

 

 

 

 

 

Stock options and unvested RSUs

 

 

 

 

Diluted EPS

 

 

 

 

 

 

 

Net loss available to common stockholders and assumed conversions

 

$

(56,221

)

44,383

 

$

(1.27

)

 

 

 

 

 

 

 

 

For the nine months ended September 26, 2008

 

 

 

 

 

 

 

Basic EPS

 

 

 

 

 

 

 

Net income available to common stockholders

 

$

15,135

 

45,241

 

$

0.33

 

Effect of Dilutive Securities

 

 

 

 

 

 

 

Stock options and unvested restricted stock awards

 

 

627

 

 

Diluted EPS

 

 

 

 

 

 

 

Net income available to common stockholders and assumed conversions

 

$

15,135

 

45,868

 

$

0.33

 

 

Anti-dilutive options to purchase common stock outstanding were excluded from the calculations above.  Anti-dilutive options and anti-dilutive RSUs totaled 3,160 and 4,884 for the three and nine months ended September 30, 2009, respectively. Anti-dilutive options and anti-dilutive RSUs totaled 3,871 and 4,074 for the three and nine months ended September 26, 2008, respectively.

 

Note 6.   Segment Reporting

 

In the third quarter of 2008, we began the process of dissolving our Connectivity and Control business unit and merging its products into our remaining business units. We divided this business unit into its three product lines: the Equinox branded serial business, the Broadcast business and the Pro Audio Visual business.  We folded the broadcast product line into Management Systems in the third quarter of 2008.  We folded the Serial product line and the Pro Audio Visual product line into Management Systems during third quarter of 2009.  As a result of these actions, all revenues and costs associated with our Connectivity and Control business are included within Management Systems in the tables below.  Additionally, historical segment results for Management Systems have been changed to reflect these changes and the Connectivity and Control business unit has now been effectively dissolved.

 

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AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

We evaluate the performance of our segments based on revenue and operating profit, which are calculated before corporate and unallocated costs, amortization and impairment of intangibles, acquired in-process research and development expense, restructuring, integration and retirement expenses and stock compensation costs.  We do not track nor use assets by segment as a measure of performance, therefore, we have not presented assets by segment.  The following is a presentation of information for our two reportable segments, Management Systems and LANDesk and for Corporate and unallocated:

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Net revenue:

 

 

 

 

 

 

 

 

 

Management Systems

 

$

100,322

 

$

140,983

 

$

282,289

 

$

378,995

 

LANDesk

 

36,459

 

41,559

 

107,625

 

102,594

 

Corporate and unallocated

 

774

 

506

 

2,334

 

2,040

 

Total net revenue

 

$

137,555

 

$

183,048

 

$

392,248

 

$

483,629

 

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Operating income (loss):

 

 

 

 

 

 

 

 

 

Management Systems

 

$

23,924

 

$

38,634

 

$

57,477

 

$

93,351

 

LANDesk

 

4,931

 

7,620

 

17,152

 

12,161

 

Corporate and unallocated costs

 

(5,194

)

(6,844

)

(14,394

)

(21,515

)

Acquired research and development expense

 

 

(700

)

 

(700

)

Amortization of intangibles and other expenses

 

(11,913

)

(13,191

)

(38,666

)

(34,043

)

Impairment of goodwill

 

 

 

(80,000

)

 

Restructuring, integration and retirement expenses

 

(3,025

)

(5,446

)

(9,847

)

(10,628

)

Stock-based compensation expense

 

(6,473

)

(6,287

)

(14,595

)

(16,962

)

Total income (loss) from operations

 

$

2,250

 

$

13,786

 

$

(82,873

)

$

21,664

 

 

Sales by product line for Management Systems and LANDesk for the three and nine months ended September 30, 2009 and September 26, 2008 are as follows:

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Management Systems net revenue:

 

 

 

 

 

 

 

 

 

KVM

 

$

67,314

 

$

97,101

 

$

191,706

 

$

271,379

 

Serial management

 

7,706

 

13,517

 

22,327

 

39,572

 

Embedded software and solutions

 

7,493

 

10,229

 

19,731

 

26,981

 

Other

 

17,809

 

20,136

 

48,525

 

41,063

 

Total Management Systems net revenue

 

$

100,322

 

$

140,983

 

$

282,289

 

$

378,995

 

 

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Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

LANDesk net revenue:

 

 

 

 

 

 

 

 

 

Licenses and royalties

 

$

18,069

 

$

22,092

 

$

52,790

 

$

57,919

 

Maintenance and services

 

18,390

 

19,467

 

54,835

 

44,675

 

Total LANDesk net revenue

 

$

36,459

 

$

41,559

 

$

107,625

 

$

102,594

 

 

We sell our products internationally to customers in several countries; however no foreign country accounted for more than 10% of sales in the first nine months of 2009 or 2008.

 

Following is a presentation of long-lived assets as of September 30, 2009 and December 31, 2008:

 

 

 

September 30,
2009

 

December 31,
2008

 

Long-lived assets:

 

 

 

 

 

United States

 

$

26,951

 

$

28,176

 

International

 

8,315

 

10,021

 

Total

 

$

35,266

 

$

38,197

 

 

Note 7.   Forward Contracts, Interest Rate Swaps and Credit Facility

 

We use forward contracts to reduce our foreign currency exposure related to the net cash flows from our international operations.  The majority of these contracts are short-term contracts (three months or less) and are marked-to-market each quarter and included in trade payables, with the offsetting gain or loss included in other income (expense) in the accompanying consolidated statements of income.  As of September 30, 2009, we had five open forward contracts with an approximate fair value of $(22).  As of December 31, 2008, we had four open forward contracts with an approximate fair value of $26.

 

There was $125,000 outstanding under our credit facility, which includes both our line of credit and term loan, as of September 30, 2009.  The line of credit and term loan contain affirmative and negative covenants, including limitations on our ability to (i) make distributions, investments, and other payments unless we satisfy certain financial tests or other criteria, (ii) incur additional indebtedness, (iii) restructure our subsidiaries, and (iv) make acquisitions and capital expenditures.  The financial tests include an interest coverage ratio and a total leverage ratio.  We are in compliance with these covenants and related tests as of September 30, 2009.  Failure to comply with these covenants could result in an event of default which, if not cured or waived, could have a material adverse effect on us.  We pay a commitment fee on the unused portion of the line of credit based on the results of a leverage ratio computation. As of September 30, 2009, the commitment fee rate is 20 basis points per quarter. The fair value of our unsecured bank credit facility approximates its carrying value at September 30, 2009.

 

As of September 30, 2009, we have two interest rate swaps, which are recorded on our balance sheet.  On May 1, 2008, we entered into an interest rate swap agreement with a notional amount of $80,000.  The remaining notional amount of this interest rate swap was $20,000 as of September 30, 2009.  The swap was effective on May 1, 2008 and terminates on December 31, 2009.  The swap calls for us to make fixed rate payments of 3.05% over the term of the hedge and to receive floating rate payments based on LIBOR (matching the LIBOR rate in the line of credit above) from the counter-party.  On November 6, 2008 we entered into an additional interest rate swap agreement with a notional amount of $90,000.  The notional amount of this interest rate swap will remain at $90,000 until the termination on June 16, 2011 unless otherwise terminated by us at an earlier date.   The swap was effective on December 31, 2008.  The swap calls for us to make fixed rate payments of 2.75% over the term of the hedge and to receive floating rate payments based on LIBOR (matching the LIBOR rate in the term loan above) from the counter-party.

 

The objective of the interest rate swap agreements is to provide a hedge against LIBOR interest rate changes that could have an effect on our cash flows and borrowing costs. As of September 30, 2009, we anticipate these hedges will be settled upon maturity and they are accounted for as cash flow hedges.  The interest rate swaps are recorded at fair value each reporting period with the changes in the fair value of the hedges that take place through the date of maturity recorded in accumulated other comprehensive income (loss).

 

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Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

These interest rate swaps qualify as derivative instruments and are designated as cash flow hedges.  We do not expect any material amounts to be reclassified into earnings, as a result of interest rate swap ineffectiveness, within the next twelve months. The cash flow hedges were in a liability position as of September 30, 2009 and were included in other non-current liabilities in the consolidated balance sheet, as follows:

 

 

 

September 30,
2009

 

Cash flow hedges:

 

 

 

Interest rate swaps

 

$

2,727

 

 

For the nine months ended September 30, 2009, the activity related to our interest rate swaps designated as cash flow hedges is included in our condensed consolidated financial statements as follows:

 

 

 

September 30, 2009

 

 

 

Effective Portion
Included in OCI,
Net of Tax

 

Effective Portion
in AOCI,
Reclassified into
Earnings

 

Ineffectiveness,
Excluded from
Hedge
Effectiveness

 

Cash flow hedges:

 

 

 

 

 

 

 

Interest rate swaps

 

$

471

 

$

 

$

 

 

Note 8.   Goodwill and Other Intangible Assets

 

Other intangible assets subject to amortization were as follows:

 

 

 

September 30, 2009

 

December 31, 2008

 

 

 

Gross
Carrying
Amounts

 

Accumulated
Amortization

 

Gross
Carrying
Amounts

 

Accumulated
Amortization

 

 

 

 

 

 

 

 

 

 

 

Developed technology

 

$

84,437

 

$

43,896

 

$

86,285

 

$

31,401

 

Internally developed software for resale

 

21,900

 

11,254

 

21,900

 

8,517

 

Patents and trademarks

 

31,941

 

14,173

 

31,236

 

10,915

 

Customer base

 

110,900

 

48,103

 

116,121

 

39,388

 

Maintenance contracts

 

17,600

 

7,920

 

17,600

 

5,280

 

Non-compete agreements

 

7,225

 

6,569

 

11,325

 

8,690

 

 

 

$

274,003

 

$

131,915

 

$

284,467

 

$

104,191

 

 

For the three months ended September 30, 2009 and September 26, 2008, amortization expense for other intangible assets was $11,995 and $13,383, respectively.  For the nine months ended September 30, 2009 and September 26, 2008, amortization expense for other intangible assets was $39,002 and $34,416, respectively.  The approximate estimated annual amortization for other intangibles is as follows:

 

Years ending December 31:

 

 

 

2009, remainder

 

$

11,727

 

2010

 

$

46,504

 

2011

 

$

38,170

 

2012

 

$

29,052

 

2013

 

$

16,036

 

Thereafter

 

$

599

 

 

11



Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

We evaluate the carrying value of goodwill for potential impairment annually during the fourth quarter of each year, and on an interim basis if an event occurs or circumstances change that indicate a potential detrimental impact to the fair value of a reporting unit compared to its carrying value may have occurred.  Our fourth quarter 2008 impairment test concluded that there had been no impairment of goodwill, however, there were certain factors noted during the 2008 testing that required continued monitoring, especially related to any potential future decline in our market capitalization.  During the first quarter of 2009, we concluded that interim impairment testing was required due to the continued deterioration in the global economic environment, the resulting decrease in our market capitalization to less than the book value of our shareholders’ equity, and declining market valuations for many other companies in our peer group.  In preparation for this interim testing, we revised our five year forecast, used as a base element of this testing, in light of the continuing global recession.

 

As of September 30, 2009 we have three reporting units: Management Systems (MS), LANDesk and AESS, which is combined with MS for segment reporting purposes.   We perform our goodwill impairment test in two steps. Step one compares the fair value of each reporting unit to its carrying amount. If step one indicates that an impairment potentially exists, the second step is performed to measure the amount of impairment, if any.  Goodwill impairment exists when the estimated fair value of goodwill is less than its carrying value.

 

For purposes of the interim step one analysis prepared as of March 1, 2009, the fair values of our reporting units were determined through the use of a combination of a discounted cash flow analysis, utilizing the income approach, and the guideline public company method, utilizing a market approach.  The result of each valuation was weighted in determining each of the reporting unit’s fair value. Under the market approach, the fair value of each reporting unit is determined based upon comparisons to public companies engaged in similar businesses. Under the income approach, the fair value of each reporting unit was based on the present value of estimated future cash flows. The income approach is dependent on a number of significant management assumptions including estimated demand in each geographic market and the discount rate. The discount rate is commensurate with the risk inherent in the projected cash flows and reflects an assumed rate of return required by an investor in the current economic conditions.  Based on our assessment of the market conditions, the weighting applied to the market approach for the March 1, 2009 valuation was decreased from 50% to 40% and the weighting for the income approach was increased from 50% to 60%, as compared to the assumptions as of October 1, 2008, the date used for our most recent prior impairment testing.  We believe that this change was appropriate as it reflects our longer term view, including our revised cash flow projections based on current expectations, while continuing to reflect the impact of declining equity values in this highly volatile equity market impacting our stock price and the stock price of many of our peers.

 

The results of our step one test as of March 1, 2009 indicated that the fair value of each of our reporting units had declined from 2008, but, with the exception of LANDesk, the estimated fair values exceeded their carrying value.  We estimated the fair value of Management Systems to be $184 million higher, or approximately 35%, than its carrying value of $520 million.  Our remaining reporting units at the time were not material to our financial statements, however we estimated the combined fair value of these reporting units to be $49 million higher, or well over double, their combined carrying value of $20 million.

 

As a result of our step one testing, we then performed step two testing for potential goodwill impairment on the LANDesk business unit.  This testing focuses on the identifiable tangible and intangible assets associated with a particular business unit and estimates the fair market value a potential acquirer would assign them.  Any residual amount is considered to be applicable to goodwill and is compared to the current carrying value of the related goodwill.  Any unfavorable variance is considered as the impairment amount.  Our step two testing resulted in an $80,000 impairment charge during our three months ended March 31, 2009 and is reflected in the following table.

 

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Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

The changes in the carrying amount of goodwill (see note 11) for the nine months ended September 30, 2009, are as follows:

 

 

 

 

 

 

 

Corporate

 

 

 

 

 

Management

 

 

 

and

 

 

 

 

 

Systems

 

LANDesk

 

Other

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance as of January 1, 2009

 

$

335,096

 

$

278,709

 

$

2,521

 

$

616,326

 

 

 

 

 

 

 

 

 

 

 

Impairment loss related to LANDesk

 

 

(80,000

)

 

(80,000

)

 

 

 

 

 

 

 

 

 

 

Reallocation from segment changes

 

2,521

 

 

 

(2,521

)

 

 

 

 

 

 

 

 

 

 

 

Other adjustments

 

27

 

(824

)

 

(797

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of September 30, 2009

 

 

 

 

 

 

 

 

 

Goodwill

 

337,644

 

277,885

 

 

615,529

 

Accumulated impairment losses

 

 

(80,000

)

 

(80,000

)

 

 

$

337,644

 

$

197,885

 

$

 

$

535,529

 

 

Note 9.  Product Warranties and Deferred Revenue

 

The activity within the liability for warranty returns for the nine months ended September 30, 2009 was as follows:

 

Balance as of January 1, 2009

 

$

2,245

 

Accruals for product warranties issued during the period

 

5,247

 

Settlements and adjustments to estimates made during the period

 

(5,797

)

Balance as of September 30, 2009

 

$

1,695

 

 

We include an accrued liability for the extended warranty program in our balance sheet within deferred revenue. The activity within deferred revenue for our extended warranty program for the nine months ended September 30, 2009 was as follows:

 

Balance as of January 1, 2009

 

$

5,151

 

 

 

 

 

New extended warranty contracts

 

3,423

 

Earned revenue from amortization of deferred revenue

 

(3,100

)

 

 

 

 

Balance as of September 30, 2009

 

$

5,474

 

 

We defer revenue for subscription, service and maintenance and upgrade protection contracts until earned, which is generally over the term of the contract or when services are performed. As of September 30, 2009, deferred revenue was $72,812.  As of December 31, 2008, deferred revenue was $75,820.

 

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Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

Note 10. Income Taxes

 

The effective tax rate in the third quarter of 2009 was (193.2)% compared to an effective tax rate of 22.7% for the third quarter of 2008.  The benefit for income taxes was $4,652 for the third quarter of 2009, compared to a provision of $3,214 for the third quarter of 2008.  The effective tax rate for the first nine months of 2009 was (36)% compared to an effective tax rate of 25.6% for the first nine months of 2008.  The benefit for income taxes was $31,617 for the first nine months of 2009, compared to a provision of $5,199 for the first nine months of 2008.  The change in the effective tax rate was primarily attributable to the change in the amount and mix of our pretax book income within taxable jurisdictions and the tax benefit recognized to record a deferred tax asset associated with the goodwill impairment charge (see note 8).

 

We have considered guidance within Accounting Standards Codification (ASC) 740, the income taxes topic within the FASB ASC, which limits the amount of benefit that can be reflected in a year-to-date interim loss period to an amount equal to the anticipated benefit that would be derived from the anticipated cumulative loss for the entire reporting year.  Our loss through September 30, 2009 exceeds the anticipated loss for the year and the tax benefit recognized through September 30, 2009 has been limited to the amount that would be recognized based on the anticipated full year loss.  As of September 30, 2009, we have limited our benefit by $722.

 

As of September 30, 2009, we had total reserves for uncertain tax positions related to gross unrecognized tax benefits of $5,897, of which $4,553, if recognized, would affect the effective tax rate.  We recognize potential accrued interest and penalties related to unrecognized tax benefits from our global operations within income tax expense. We recorded $203 of such expenses in the first nine months of 2009.  As of September 30, 2009, we had accrued interest payable related to the unrecognized tax benefits of $1,050.

 

We conduct business globally, and as a result, our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions.  In the normal course of business, we are subject to examinations by taxing authorities in the U.S. and throughout the world.  With few exceptions, we are no longer subject to U.S. federal, state, local, or non-U.S. income tax examinations for periods ending before 2005.

 

The Internal Revenue Service (IRS) commenced an examination in 2006 of our U.S. income tax returns for 2004 and 2005.  During the first quarter of 2008, we reached a settlement with the IRS concerning those periods.  A payment for additional tax, including interest was made of $6,600 during the first quarter of 2008.  This payment did not result in a material change to our financial position.  The IRS is currently examining our 2006 and 2007 income tax returns.  As of September 30, 2009, we have proposed certain voluntary adjustments pursuant to the 2006 and 2007 income tax examinations.  These did not have a material impact on our financial statements.

 

Note 11. Fair Value Measurements

 

In September 2006, the FASB issued a new statement regarding fair value measurement disclosures.  The guidance was effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. We adopted the guidance as of January 1, 2008, with the exception of the application of the statement to nonfinancial assets and nonfinancial liabilities, which include those measured at fair value in goodwill impairment testing, indefinite lived intangible assets measured at fair value for impairment testing, and those initially measured at fair value in a business combination.  We adopted the provisions of the guidance that pertain to nonfinancial assets and nonfinancial liabilities as of January 1, 2009.

 

The fair value guidance established a valuation hierarchy for disclosure of inputs to the valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are observable for the asset or liability, either directly or indirectly.  If the asset or liability has a specified contractual term, a level 2 input must be observable for substantially the full term of the asset or liability. Level 3 inputs are unobservable inputs based on our own estimates on assumptions market participants would use in pricing the assets or liabilities (including assumptions about risk), used to measure assets and liabilities at fair value. An asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement in its entirety.

 

14



Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

The following table provides the financial assets and liabilities carried at fair value measured on a recurring basis as of September 30, 2009:

 

 

 

 

 

Fair value measurements

 

 

 

Total
Carrying
Value

 

Quoted
prices in
active
markets
(Level 1)

 

Significant
other
observable
inputs

(Level 2)

 

Significant
unobservable
inputs

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

42

 

$

42

 

$

 

$

 

Derivative liabilities

 

$

2,727

 

$

 

$

2,727

 

$

 

 

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

 

The fair market value of “over-the-counter” derivatives is measured at fair value using expected cash flows over the life of the trade.  The fair value measurement is prepared using the closing mid-market rate/price environment on September 30, 2009, using proprietary models, available market data and reasonable assumptions and includes a consideration of credit risk.  These fair value measurements are classified within Level 2 of the valuation hierarchy.

 

The following table provides the indefinite lived intangible assets and liabilities carried at fair value, measured on a non-recurring basis during the nine months ended September 30, 2009:

 

 

 

 

 

Fair value measurements

 

 

 

Total
Carrying
Value

 

Quoted
prices in
active
markets
(Level 1)

 

Significant
other
observable
inputs

(Level 2)

 

Significant
unobservable
inputs

(Level 3)

 

Total
Gains (Losses)

 

 

 

 

 

 

 

 

 

 

 

 

 

LANDesk goodwill

 

$

197,885

 

$

 

$

 

$

197,885

 

$

(80,000

)

 

Our impairment testing prepared on March 1, 2009 for LANDesk goodwill indicated that its implied fair value was less than its pre-adjusted carrying value of $277,885.   The fair value of LANDesk goodwill was determined through the combination of a discounted cash flow analysis, utilizing the income approach and a guideline public company method, utilizing a market approach (see note 8).

 

Note 12.  Restructuring, Integration and Retirement

 

During 2008 we began a series of restructuring actions which continued into the third quarter of 2009.  Also in 2008, we began the integration of our Ergo and Touchpaper acquisitions, each acquired in the third quarter of 2008.  The restructuring and integration actions were designed to enhance competitiveness, improve efficiency, and reduce our overall cost structure.  The restructuring and integration costs, along with costs associated with our former CEO’s retirement incurred in the first quarter of 2008, have been separately identified as “Restructuring, integration and retirement expenses” within our operating expenses.  Restructuring and integration expenses include severance charges incurred for certain workforce reductions and the costs associated with the relocation of certain functions from our Shannon, Ireland, Redmond, Washington and Shanghai, China facilities to Huntsville, Alabama.

 

We recorded $2,884 and $5,926 of such costs for the three months ended September 30, 2009 and September 26, 2008, respectively.  We recorded $9,709 and $13,627 of such costs for the nine months ended September 30, 2009 and September 26, 2008, respectively.  These costs include severance and other charges settled in cash, stock compensation adjustments and integration costs related to the Ergo and Touchpaper acquisitions. The costs in the first quarter of 2008 also include costs settled in cash related to the retirement of our former CEO.    The following table provides the amounts attributable to each element within our restructuring, integration and retirement expenses:

 

15



Table of Contents

 

AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

 

 

For the three months ended

 

For the nine months ended

 

 

 

Sept. 30,
2009

 

Sept. 26,
2008

 

Sept. 30,
2009

 

Sept. 26,
2008

 

 

 

 

 

 

 

 

 

 

 

Severance and other charges settled in cash

 

$

2,929

 

$

4,510

 

$

7,130

 

$

8,280

 

Integration

 

97

 

936

 

2,717

 

936

 

Stock compensation

 

(142

)

480

 

(138

)

2,999

 

Retirement

 

 

 

 

1,412

 

Total

 

$

2,884

 

$

5,926

 

$

9,709

 

$

13,627

 

 

As of September 30, 2009, we had accrued approximately $2,391 related to severance costs, which were included in accrued wages and commissions in our consolidated balance sheet.  All costs associated with our restructuring and integration program were carried at the corporate level and none of these costs were allocated to specific business units.  A rollforward of the liability for severance charges associated with our restructuring programs is as follows:

 

Balance as of January 1, 2009

 

$

3,585

 

Accruals for severance costs

 

6,620

 

Adjustments to accrual

 

(384

)

Settlements made during the period

 

(7,430

)

Balance as of September 30, 2009

 

$

2,391

 

 

We expect to record additional restructuring and integration expenses of approximately $900 related to these actions after the third quarter of 2009.  We expect the remaining accruals and any additional costs to be paid by the end of the fourth quarter 2009.

 

Note 13.  Legal Matters

 

In January 2007, we filed a complaint for patent infringement in the United States District Court for the Western District of Washington against Aten Technology, Inc., Aten International Co., Ltd, Belkin Corporation, Rose Electronics and its general partners, and Trippe Manufacturing Company.  The defendants filed counterclaims alleging non-infringement, unenforceability, and invalidity.  In May 2007, we entered into a Settlement and License Agreement with Trippe Manufacturing, and dismissed Trippe from the lawsuit.  In October 2007, the District Court stayed the action pending a re-examination of our patents by the Patent and Trademark Office.  The PTO has now confirmed the patentability of the patents and terminated the reexaminations.  We have asked the District Court to restart the litigation.  In July 2009, Rose filed new reexamination requests with the PTO against two of the three patents at issue in the litigation.

 

In January 2008, Avocent Redmond Corp. filed a complaint for unauthorized use of patented inventions against the United States government in the United States Court of Federal Claims.  The complaint alleges that the United States government accepted products manufactured and sold by Rose Electronics that are covered by patents held by Avocent Redmond.  The United States has answered, Rose Electronics has intervened, and a trial has been scheduled for June 2010.

 

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

 

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

 

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AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

On October 20, 2009, a purported class action complaint was filed in the Court of Chancery of the State of Delaware against us, all of our current directors, Emerson Electric, Inc. (“Emerson”) and Globe Acquisition Corp. (“Globe”).  Among other things, the complaint alleges that (i) our Board of Directors breached the fiduciary duties owed to our stockholders in connection with the approval of our proposed acquisition by Emerson (the “Merger”), (ii) our Board of Directors breached fiduciary duties owed to our stockholders by disseminating inadequate and materially misleading information in connection with the filing of our Schedule 14D-9 Solicitation/Recommendation Statement on October 15, 2009, and (iii) we, Emerson, and Globe aided and abetted our Board of Directors in such breaches.  The complaint seeks class certification, certain forms of equitable relief, including enjoining the consummation of the Merger, and unspecified damages.  A hearing on the plaintiff’s motion for a preliminary injunction has been scheduled for November 6, 2009.  The parties have commenced discovery.

 

Also on October 20, 2009, a second purported class action complaint was filed in the Circuit Court of Madison County, Alabama, against us, all of our current directors, and Emerson.  Among other things, the complaint alleges that (i) our Board of Directors breached fiduciary duties owed to our stockholders in connection with the approval of the Merger, (ii) we and our Board of Directors breached fiduciary duties owed to our stockholders by disseminating inadequate and materially misleading information in connection with our filing of the Schedule 14D-9 Solicitation/Recommendation Statement on October 15, 2009 and (iii) Emerson aided and abetted us and our Board of Directors in such breaches.  The complaint seeks class certification, unspecified damages, and such other relief as the court may find just and proper.  On October 22, 2009, plaintiff filed a motion for temporary restraining order and expedited discovery that seeks an order by the court that would temporarily restrain the consummation of the Merger until a hearing on a forthcoming motion for a preliminary injunction may be held.  On October 26, 2009, the defendants filed a motion to dismiss, a motion to stay, and an opposition to the plaintiff’s motion for a temporary restraining order and expedited discovery.  Also on October 26, 2009, the court held a hearing at which it did not rule on any of the pending motions.

 

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

 

Note 14. Recently Issued Accounting Pronouncements

 

In December 2007, the FASB issued new guidance that establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  The new business combination guidance is to be applied prospectively to business combinations for which the acquisition date is on or after an entity’s fiscal year that begins after December 15, 2008.  Since we have significant acquired deferred tax assets for which full valuation allowances were recorded at the acquisition date, this guidance could materially affect the results of operations if changes in the valuation allowances occur after adoption of the standard.  We will assess the impact of this guidance on future acquisitions, however the application will result in a significant change in accounting for any such future acquisitions.

 

In March 2008, the FASB issued new guidance that requires companies with derivative instruments to disclose information that would enable financial statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for, and how derivative instruments and related hedged items affect a company’s financial position, financial performance and cash flows. The new requirements apply to derivative instruments and non-derivative instruments that are designated and qualify as hedging instruments and related hedged items accounted for under the guidance. This guidance was effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We adopted the new guidance on January 1, 2009 and it did not have a material impact on our financial statements.

 

In April 2008, the FASB issued guidance which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of an intangible asset.  This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years.  We adopted this guidance on January 1, 2009 and it did not have a material impact on our financial statements.

 

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AVOCENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

(Unaudited, in thousands, except share data)

 

In April, 2009, the FASB issued new guidance which provides methodology for determining whether a market is inactive and a transaction is distressed in order to apply the existing fair value measurement guidance. In addition, the new guidance requires enhanced disclosures regarding financial assets and liabilities that are recorded at fair value. This guidance is effective for interim and annual reporting periods ending after June 15, 2009.  We adopted the guidance on June 15, 2009 and it did not have a material impact on our financial statements.

 

In April 2009, the FASB issued new guidance which requires disclosures about fair value of financial instruments in interim financial statements as well as in annual financial statements. This guidance is effective for interim periods ending after June 15, 2009. We adopted this guidance in the second quarter of 2009, and have provided the disclosures required.

 

In June 2009, the FASB issued new guidance which incorporates the subsequent events guidance contained in the auditing standards literature into authoritative accounting literature. It also requires entities to disclose the date through which they have evaluated subsequent events and whether the date corresponds with the release of their financial statements. This guidance is effective for all interim and annual periods ending after June 15, 2009. We adopted the guidance upon its issuance and it had no material impact on our financial statements. See Note 15 - “Subsequent Events” for this new disclosure.

 

In June 2009, the FASB issued new guidance to improve financial reporting by companies involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. The new guidance is effective for fiscal years beginning after November 15, 2009. We are currently evaluating the impact that the adoption of this guidance will have on our financial statements.

 

On July 1, 2009, the FASB issued the FASB Accounting Standards Codification (the Codification). The Codification became the single source of authoritative nongovernmental U.S. GAAP, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. The Codification eliminates the previous US GAAP hierarchy and establishes one level of authoritative GAAP. All other literature is considered non-authoritative. The Codification was effective for interim and annual periods ending after September 15, 2009.  We adopted this during the third quarter of 2009.

 

In October 2009, the FASB issued amended revenue recognition guidance for arrangements with multiple deliverables.  The new guidance eliminates the residual method of revenue recognition and requires the use of management’s best estimate of selling price for individual elements of an arrangement when vendor specific objective evidence (VSOE), vendor objective evidence (VOE) or third-party evidence (TPE) is unavailable.  This guidance is effective for all new or materially modified arrangements entered into on or after January 1, 2011 with earlier application permitted as of the beginning of a fiscal year. Full retrospective application of the new guidance is optional.  We are currently assessing our implementation of this new guidance, but do not expect a material impact on our financial statements.

 

Note 15. Subsequent Events

 

We have evaluated subsequent events for recognition or disclosure through November 4, 2009, which was the date we filed this Form 10-Q with the SEC.

 

On October 6, 2009, we announced an agreement whereby Emerson Electric Co. will acquire all the outstanding shares of Avocent.  The Avocent Board of Directors unanimously endorsed the terms of an all-cash tender offer of $25 per share, or approximately $1,100,000. The purchase is expected to close around January 1, 2010, pending customary regulatory approvals and acceptance of the offer by Avocent stockholders holding a majority of Avocent shares.  For additional information see our current reports on Form 8-K and Schedules 14D-9 filed with the U.S. Securities and Exchange Commission in October, 2009.

 

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

 

THE INFORMATION IN THIS ITEM 2 “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” AND IN OTHER PARTS OF THIS FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS, INCLUDING, WITHOUT LIMITATION, STATEMENTS RELATING TO OUR FUTURE BUSINESS PROSPECTS AND ECONOMIC CONDITIONS IN GENERAL; STATEMENTS REGARDING OUR ABILITY TO PREDICT FUTURE SALES AND MANAGE INVENTORY LEVELS; STATEMENTS REGARDING PRICING PRESSURE; STATEMENTS REGARDING THE FLUCTUATION OF OUR REVENUE GROWTH IN RELATION TO ECONOMIC CONDITIONS AND IT RELATED SPENDING TRENDS; STATEMENTS REGARDING OUR PRODUCT PLATFORMS AND OUR ABILITY TO RESUME GROWTH IN OUR OVERALL BUSINESS; STATEMENTS REGARDING INCREASED SALES OF OUR DIGITAL PRODUCTS AND EMBEDDED SOLUTIONS AND THEIR ABILITY TO OFFSET PRICE DECLINES AND COMPETITIVE FACTORS; STATEMENTS REGARDING OUR ANTICIPATED FUTURE GROSS MARGINS, RESEARCH AND DEVELOPMENT EXPENSES, AND SELLING, GENERAL AND ADMINISTRATIVE EXPENSES; AND STATEMENTS REGARDING THE OUTCOME OF, AND OUR LEGAL COSTS FOR, PATENT AND OTHER LEGAL CLAIMS, LITIGATION, AND PROCEEDINGS.  THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES THAT COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS.  FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN PART II, ITEM 1A “RISK FACTORS.”

 

Overview

 

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

 

For a more complete description of our products, technologies and markets please refer to our Form 10-K filed on February 27, 2009.

 

Most of our revenue is derived from sales to a limited number of OEMs (who purchase our products on a private-label or branded basis for integration and sale with their own products), sales through our reseller and distributor network, and sales to a limited number of direct customers.  Sales to our branded customers accounted for 71% of sales in the first nine months of 2009 and 67% of sales in the first nine months of 2008.  Sales to our OEM customers accounted for 29% of sales in the first nine months of 2009 and 33% of sales in the first nine months of 2008.  We do not have contracts with many of our branded customers, and in general, our OEM and branded business customers are obligated to purchase products from us only pursuant to binding purchase orders.  Although we are not substantially dependent on any one OEM customer, the loss of, or material decline in orders from, these customers would have a material adverse effect on our business, financial condition, results of operations, and cash flows.  Our top five customers include both OEM and branded customers, and accounted for 48% of sales in the first nine months of both 2009 and 2008.

 

We sell products to resellers, distributors, end-users, and OEMs in the United States, Canada, Europe, and Asia as well as in other foreign markets.  Sales within the United States accounted for approximately 51% and 53% of first nine months sales in 2009 and 2008, respectively.  No other country accounted for more than 10% of sales in the first nine months of 2009 or 2008.

 

With continued industry-wide initiatives to reduce all channel inventories and to shorten lead times, trends with our major customers are, generally, to reduce the number of weeks of forward-committed firm orders.  This trend continues to affect our business with certain distributors, OEMs, and other server manufacturers, and we believe that it will continue to make our future sales more difficult to predict and inventory levels more difficult to manage.  We monitor inventories of our products owned by our major distribution partners and we strive to maintain a level of inventory in our own facilities to service these customers, and monitor these levels to minimize potential exposure of having excessive inventory on hand.  A change in the amount of inventory held by a customer in any one period could adversely affect our revenues through reduced orders in that or a subsequent period which could have a material impact on our business, financial condition, results of operations, and cash flows.

 

We experience significant price competition in the market for most of our products, and we expect that pricing pressures will continue in the future.  In addition, our business and operating results depend to a significant extent on economic conditions in general and on IT spending in particular, and we expect our revenue growth rate to fluctuate in relation to economic conditions and IT related spending trends.  Any adverse change in IT spending due to adverse economic conditions, declining capital spending levels, or other factors could have a material adverse effect on our business, financial condition, and results of operations.  World-wide efforts to cut capital spending, general economic uncertainty, and a weakening global economy could have a material adverse effect on us.  For example, in recent periods global credit and other financial markets have suffered substantial stress, volatility, illiquidity, and

 

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disruption.  This financial crisis and the current global recession could have an impact on our business in a variety of ways, including insolvency of key suppliers resulting in product delays, inability of customers to obtain credit to finance purchases of our products and customer insolvencies.  As we evaluate anticipated impacts from the global economic uncertainties, we periodically adjust our spending and related headcount to mitigate the overall impact on our financial results of any anticipated negative changes.  We continually monitor the financial health of our key suppliers and customers by constant reviews of our accounts receivable aging and open purchase orders to ensure our customers are paying in a timely fashion and our suppliers are meeting our needs so that we can service our customers.

 

Many of our executive officers and directors are vested in significant amounts of options to purchase shares of our common stock and RSUs.  These officers and directors have informed us that they have sold, and may sell additional, shares of our common stock to provide liquidity and diversify their portfolios.  During the first nine months of 2009 and 2008, our Board of Directors granted both time-based and  market and performance condition-based restricted stock units (RSUs) with two and three year vesting.

 

During the first nine months of 2009, we had the following three business units:  Management Systems, which includes our branded and OEM KVM, embedded software, serial console, power control, LCD tray, and management appliance businesses; LANDesk, which includes systems, security, and service management solutions for desktops, servers, and mobile devices across the enterprise; and Connectivity and Control, which focuses on our audio-visual products, but was folded into Management Systems in the third quarter of 2009 (see further discussion below).

 

We believe our business units allow us to focus on new technology and growth opportunities and to add product and shareholder value in the future.  We believe this structure enhances customer service, speeds delivery of products to market and better focuses our research, development, and marketing resources.  In the third quarter of 2008, we began the process of dissolving the Connectivity and Control business unit and merging its products into our Management Systems business units. We divided this business unit into its three product lines: the Equinox branded serial business, the Broadcast business and the Pro Audio Visual business.  We folded the broadcast product line into Management Systems in the third quarter of 2008.  We folded the serial product line and  the Pro Audio Visual product line into Managements Systems during the third quarter of  2009.  As a result of these actions, all revenues and costs associated with our Connectivity and Control business are included within Management Systems in the relevant tables in this quarterly report.  Additionally, historical segment results for Management Systems have been changed to reflect these changes and the Connectivity and Control business unit has now been effectively dissolved.

 

Our largest business unit, Management Systems, comprised 72% of our consolidated net revenue in the first nine months of 2009 and 77% in 2008.  LANDesk contributed 27% of net revenue in the first nine months of 2009 and 21% in 2008.  Our Corporate and unallocated revenue comprised the remaining percentage of our consolidated net revenue in 2009 and 2008.  See Note 6 in the notes to the condensed consolidated financial statements contained in Part I, Item 1 of this document.

 

Results of Operations

 

The following table sets forth, for the periods indicated, selected statement of income data expressed as a percentage of net sales:

 

 

 

Three months ended

 

Nine months ended

 

 

 

Sept. 30, 2009

 

Sept. 26, 2008

 

Sept. 30, 2009

 

Sept. 26, 2008

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of sales

 

38.5

 

37.7

 

38.0

 

36.9

 

Gross profit

 

61.5

 

62.3

 

62.0

 

63.1

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development expenses

 

14.2

 

13.3

 

15.6

 

14.9

 

Acquired research and development expenses

 

 

0.4

 

 

0.1

 

Selling, general and administrative expenses

 

37.9

 

32.9

 

38.1

 

35.7

 

Restructuring, integration and retirement expenses

 

2.1

 

3.2

 

2.5

 

2.8

 

Amortization of intangible assets

 

5.7

 

4.9

 

6.6

 

5.0

 

Impairment of goodwill

 

 

 

20.4

 

 

Total operating expenses

 

59.9

 

54.7

 

83.2

 

58.5

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

1.6

 

7.6

 

(21.2

)

4.6

 

 

 

 

 

 

 

 

 

 

 

Net investment income

 

0.1

 

0.2

 

0.1

 

0.4

 

Interest expense

 

(1.3

)

(1.2

)

(1.5

)

(1.2

)

Other income (expense), net

 

1.3

 

1.2

 

0.2

 

0.6

 

Income (loss) before provision (benefit) for income taxes

 

1.7

 

7.8

 

(22.4

)

4.4

 

Provision (benefit) for income taxes

 

(3.4

)

1.8

 

(8.1

)

1.1

 

Net income (loss)

 

5.1

%

6.0

%

(14.3

)%