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EX-32.1 - CERTIFICATION OF CEO PURSUANT TO 18 U.S.C. SECTION 1350 - MITEL NETWORKS CORPdex321.htm
EX-31.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 302 - MITEL NETWORKS CORPdex312.htm
EX-31.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 302 - MITEL NETWORKS CORPdex311.htm
EX-32.2 - CERTIFICATION OF CFO PURSUANT TO 18 U.S.C. SECTION 1350 - MITEL NETWORKS CORPdex322.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 31, 2010

OR

 

¨ 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: 001-34699

 

 

MITEL NETWORKS CORPORATION

(Exact name of Registrant as specified in its charter)

 

 

 

Canada   98-0621254

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

350 Legget Drive, Ottawa, Ontario

Canada

  K2K 2W7
(Address of principal executive offices)   (Zip Code)

(613) 592-2122

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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.    Yes  x     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  ¨     No  ¨

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” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated Filer   ¨
Non-accelerated filer   x  (do not check if a smaller reporting company)    Smaller reporting company   ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:

As of November 30, 2010, there were 52,896,194 common shares outstanding.

 

 

 


PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

2


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

CONSOLIDATED BALANCE SHEETS

(in U.S. dollars, millions)

(Unaudited)

 

     October 31,
2010
    April 30,
2010
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 90.0      $ 76.6   

Accounts receivable (net of allowance for doubtful accounts of $9.5 and $11.9, respectively)

     123.0        121.5   

Sales-type lease receivables (net) (note 3)

     32.8        33.8   

Inventories (net) (note 4)

     32.0        26.7   

Deferred tax asset

     12.5        15.0   

Other current assets (note 5)

     43.2        46.5   
                
     333.5        320.1   

Non-current portion of sales-type lease receivables (net) (note 3)

     24.8        29.2   

Deferred tax asset

     85.6        5.0   

Property and equipment (net)

     15.0        17.0   

Identifiable intangible assets (net) (note 6)

     111.8        123.1   

Goodwill

     134.5        134.5   

Other non-current assets

     9.9        12.1   
                
   $ 715.1      $ 641.0   
                

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIENCY)

    

Current liabilities:

    

Accounts payable and accrued liabilities (note 7)

   $ 116.6      $ 107.7   

Due to related parties (note 8)

     0.4        7.2   

Current portion of deferred revenue

     42.8        46.2   

Current portion of long-term debt

     4.1        4.1   
                
     163.9        165.2   

Long-term debt

     344.8        345.7   

Lease recourse liability (note 3)

     7.2        7.9   

Long-term portion of deferred revenue

     12.2        14.1   

Deferred tax liability

     59.2        70.9   

Pension liability (note 9)

     71.4        68.1   

Other non-current liabilities

     22.5        24.0   
                
     681.2        695.9   
                

Commitments, guarantees and contingencies (note 10)

    

Shareholders’ equity (deficiency):

    

Common shares, without par value—unlimited shares authorized, issued and outstanding: 52.8 at October 31, 2010 and 52.8 at April 30, 2010 (note 11)

     803.0        802.8   

Preferred shares—unlimited shares authorized, nil issued and outstanding

     —          —     

Warrants (note 12)

     55.6        55.6   

Additional paid-in capital

     10.0        7.7   

Accumulated deficit

     (742.2     (829.9

Accumulated other comprehensive loss

     (92.5     (91.1
                
     33.9        (54.9
                
   $ 715.1      $ 641.0   
                

(The accompanying notes are an integral part of these unaudited consolidated financial statements)

 

3


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

CONSOLIDATED STATEMENTS OF OPERATIONS

(in U.S. dollars, millions except per share amounts)

(Unaudited)

 

     Three Months Ended     Six Months Ended  
     October 31,
2010
    October 31,
2009
    October 31,
2010
    October 31,
2009
 

Revenues:

        

Telecommunications

   $ 141.5      $ 143.6      $ 282.3      $ 284.0   

Network services

     19.6        18.8        38.8        37.8   
                                
     161.1        162.4        321.1        321.8   
                                

Cost of revenues:

        

Telecommunications

     73.9        72.8        146.3        144.4   

Network services

     10.7        11.0        21.2        22.2   
                                
     84.6        83.8        167.5        166.6   
                                

Gross margin

     76.5        78.6        153.6        155.2   
                                

Expenses:

        

Selling, general and administrative

     55.0        53.4        108.2        106.8   

Research and development

     13.3        13.2        26.4        26.3   

Special charges and restructuring costs (note 14)

     4.4        2.3        4.3        2.7   
                                
     72.7        68.9        138.9        135.8   
                                

Operating income

     3.8        9.7        14.7        19.4   

Interest expense

     (5.1     (8.9     (10.2     (17.7

Fair value adjustment on derivative instruments (note 15)

     0.2        (23.9     1.0        (23.3

Other income (expense), net

     (0.4     1.0        (0.3     (0.4
                                

Income (loss) before income taxes

     (1.5     (22.1     5.2        (22.0

Current income tax recovery

     1.5        1.4        0.5        0.8   

Deferred income tax recovery (note 20)

     80.9        0.7        82.0        3.2   
                                

Net income (loss)

   $ 80.9      $ (20.0   $ 87.7      $ (18.0
                                

Net income (loss) per common share (note 13)

        

Basic

   $ 1.53      $ (2.23   $ 1.66      $ (2.88

Diluted

   $ 1.45      $ (2.23   $ 1.56      $ (2.88

Weighted-average number of common shares outstanding (note 13)

        

Basic

     52.8        14.3        52.8        14.3   

Diluted

     56.0        14.3        56.2        14.3   

(The accompanying notes are an integral part of these unaudited consolidated financial statements)

 

4


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIENCY)

AND COMPREHENSIVE INCOME (LOSS)

(in U.S. dollars, millions)

(Unaudited)

 

     Common Shares            

Additional

Paid-in

     Accumulated    

Accumulated

Other

Comprehensive

   

Total

Shareholders’

 
   Number     Amount      Warrants      Capital      Deficit     Income (Loss)     Deficiency  

Balance at April 30, 2010

     52.8      $ 802.8       $ 55.6       $ 7.7       $ (829.9   $ (91.1   $ (54.9
                                                           

Net income

     —          —           —           —           6.8        —          6.8   

Foreign currency translation adjustments

     —          —           —           —           —          (0.9     (0.9
                                                           

Comprehensive income

     —          —           —           —           6.8        (0.9     5.9   

Issue of shares

     —  (1)      0.1         —           —           —          —          0.1   

Stock-based compensation

     —          —           —           0.8         —          —          0.8   
                                                           

Balance at July 31, 2010

     52.8      $ 802.9       $ 55.6       $ 8.5       $ (823.1   $ (92.0   $ (48.1
                                                           

Net income

     —          —           —           —           80.9        —          80.9   

Foreign currency translation adjustments

     —          —           —           —           —          (0.5     (0.5
                                                           

Comprehensive income

     —          —           —           —           80.9        (0.5     80.4   

Issue of shares

     —  (1)      0.1         —           —           —          —          0.1   

Stock-based compensation

     —          —           —           1.5         —          —          1.5   
                                                           

Balance at October 31, 2010

     52.8      $ 803.0       $ 55.6       $ 10.0       $ (742.2   $ (92.5   $ 33.9   
                                                           

 

(1) Issue of shares was less than 0.1 for the period.

(The accompanying notes are an integral part of these unaudited consolidated financial statements)

 

5


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIENCY)

AND COMPREHENSIVE INCOME (LOSS) (continued)

(in U.S. dollars, millions)

(Unaudited)

 

     Common Shares           

Additional

Paid-in

     Accumulated    

Accumulated

Other

Comprehensive

   

Total

Shareholders’

 
   Number      Amount      Warrants     Capital      Deficit     Income (Loss)     Deficiency  

Balance at April 30, 2009

     14.3       $ 277.8       $ 56.6      $ 4.4       $ (728.0   $ (40.9   $ (430.1
                                                           

Adoption of the ASC Derivatives and Hedging Topic

     —           —           (1.0     —           1.0        —          —     
                                                           

Balance at May 1, 2009

     14.3         277.8         55.6        4.4         (727.0     (40.9     (430.1
                                                           

Net income

     —           —           —          —           2.0        —          2.0   

Unrealized derivative gain on cash flow hedges

     —           —           —          —           1.8        —          1.8   

Foreign currency translation adjustments

     —           —           —          —           —          5.0        5.0   
                                                           

Comprehensive income

     —           —           —          —           3.8        5.0        8.8   

Stock-based compensation

     —           —           —          0.6         —          —          0.6   

Accretion of interest on redeemable preferred shares

     —           —           —          —           (11.4     —          (11.4
                                                           

Balance at July 31, 2009

     14.3       $ 277.8       $ 55.6      $ 5.0       $ (734.6   $ (35.9   $ (432.1
                                                           

Net loss

     —           —           —          —           (20.0     —          (20.0

Unrealized derivative gain on cash flow hedges

     —           —           —          —           2.6        —          2.6   

Foreign currency translation adjustments

     —           —           —          —           —          (1.3     (1.3
                                                           

Comprehensive loss

     —           —           —          —           (17.4     (1.3     (18.7

Stock-based compensation

     —           —           —          1.2         —          —          1.2   

Accretion of interest on redeemable preferred shares

     —           —           —          —           (11.9     —          (11.9
                                                           

Balance at October 31, 2009

     14.3       $ 277.8       $ 55.6      $ 6.2       $ (763.9   $ (37.2   $ (461.5
                                                           

(The accompanying notes are an integral part of these unaudited consolidated financial statements)

 

6


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in U.S. dollars, millions)

(Unaudited)

 

     Three Months Ended     Six Months Ended  
     October 31,
2010
    October 31,
2009
    October 31,
2010
    October 31,
2009
 

CASH PROVIDED BY (USED IN)

        

Operating activities:

        

Net income (loss)

   $ 80.9      $ (20.0   $ 87.7      $ (18.0

Adjustments to reconcile net income to net cash from (used in) operating activities:

        

Amortization and depreciation

     8.4        8.3        17.0        16.9   

Fair value adjustment on derivative instruments

     (0.2     23.9        (1.0     23.3   

Stock-based compensation

     1.3        1.2        2.1        1.8   

Loss on disposal of assets

     —          0.6        —          1.0   

Investment impairment

     —          0.9        —          0.9   

Accretion of interest on litigation settlement obligation

     0.1        0.3        0.3        0.6   

Unrealized foreign exchange loss

     0.3        0.4        —          1.5   

Deferred income taxes

     (80.9     (3.0     (82.0     (4.4

Non-cash movements in provisions

     0.3        1.3        (2.9     0.1   

Non-cash change in operating assets and liabilities (note 17)

     (2.8     (17.4     (4.5     (18.7
                                

Net cash from (used in) operating activities

     7.4        (3.5     16.7        5.0   
                                

Investing activities:

        

Additions to property, equipment and intangible assets

     (0.6     (2.3     (1.6     (3.4

Change in restricted cash

     (0.3     1.1        0.9        1.2   

Realized foreign exchange loss on hedging activities

     —          (0.1     —          (0.1
                                

Net cash used in investing activities

     (0.9     (1.3     (0.7     (2.3
                                

Financing activities:

        

Repayment of capital lease liabilities

     (0.3     (0.8     (0.9     (1.3

Repayment of long-term debt

     (0.5     (0.5     (1.0     (1.0

Payment of litigation settlement obligation

     (1.0     (0.9     (1.9     (1.7

Issuance of shares from option exercises

     0.2        —          0.2        —     
                                

Net cash used in financing activities

     (1.6     (2.2     (3.6     (4.0
                                

Effect of exchange rate changes on cash and cash equivalents

     0.4        (0.2     1.0        1.8   
                                

Net increase (decrease) in cash and cash equivalents

     5.3        (7.2     13.4        0.5   

Cash and cash equivalents, beginning of period

     84.7        36.1        76.6        28.4   
                                

Cash and cash equivalents, end of period

   $ 90.0      $ 28.9      $ 90.0      $ 28.9   
                                

(Note 17 contains supplementary cash flow information)

(The accompanying notes are an integral part of these unaudited consolidated financial statements)

 

7


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

1. BASIS OF PRESENTATION

These unaudited interim consolidated financial statements have been prepared by Mitel Networks Corporation (“Mitel” or the “Company”) in United States (“U.S.”) dollars, unless otherwise stated, and in accordance with accounting principles generally accepted in the U.S. (“GAAP”) for interim financial statements. Accordingly, these unaudited interim consolidated financial statements do not include all information and footnotes normally included in financial statements prepared in accordance with GAAP and the rules and regulations of the U.S. Securities and Exchange Commission for complete financial statements. In the opinion of management of the Company, these unaudited interim consolidated financial statements reflect all adjustments necessary to present fairly the financial position at October 31, 2010 and the results of operations and cash flows of the Company for each of the three-month and six-month periods ended October 31, 2010 and October 31, 2009 in accordance with GAAP applied on a consistent basis. The consolidated financial statements include the accounts of Mitel and its wholly-owned subsidiaries. Inter-company transactions and balances have been eliminated.

These unaudited interim consolidated financial statements and the accompanying notes should be read in conjunction with the audited annual consolidated financial statements and notes thereto for each of the three years ended April 30, 2010, 2009 and 2008 contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on July 27, 2010 (the “audited annual consolidated financial statements”). The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year or future periods.

2. SIGNIFICANT ACCOUNTING POLICIES

The Company’s significant accounting policies are described in note 2 to the audited annual consolidated financial statements. There have been no significant changes to these policies. With the exception of the accounting pronouncements below, there have been no recent accounting pronouncements that are expected to have a significant effect on the consolidated financial statements.

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-14 to address concerns raised by constituents relating to the accounting for revenue arrangements that contain tangible products and software. The amendments in this ASU change the accounting model for revenue arrangements that include both tangible products and software elements. Tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality will no longer be within the scope of guidance in the Software—Revenue Recognition Subtopic of the FASB Accounting Standards Codification (“FASB ASC”). The amendments in this ASU will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company is required to adopt this ASU in the first quarter of fiscal 2012. The Company is currently evaluating the effect that the adoption of this ASU will have on its consolidated financial statements.

In October 2009, the FASB issued ASU 2009-13 to address the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. This ASU provides amendments to the criteria in the Revenue Recognition—Multiple-Element Arrangements Subtopic of the FASB ASC. As a result of those amendments, multiple-deliverable arrangements will be separated in more circumstances than under existing GAAP. The amendments in this ASU will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company is required to adopt this ASU in the first quarter of fiscal 2012. The Company is currently evaluating the effect that the adoption of this ASU will have on its consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20 to enhance disclosure about the credit quality of financing receivables and the related allowance for credit losses. The Company is required to adopt this ASU in the third quarter of fiscal 2011. As a result of this ASU, the Company expects to provide additional disclosures surrounding its sales-type lease receivables and its related allowances in the third quarter of fiscal 2011.

 

8


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

3. NET INVESTMENT IN SALES-TYPE LEASES

Net investment in sales-type leases represents the value of sales-type leases presently held under the TotalSolution® program. The Company currently sells the rental payments due to the Company from some of the sales-type leases. The Company maintains reserves against its estimate of potential recourse for the balance of sales-type leases (recorded net, against the receivable) and for the balance of sold rental payments remaining unbilled (recorded separately as a lease recourse liability). The following table provides detail on the sales-type leases:

 

     October 31, 2010      April 30, 2010  
     Gross      Allowance     Net      Gross      Allowance     Net  

Lease balances included in consolidated accounts receivable

   $ 14.1       $ (4.2   $ 9.9       $ 13.4       $ (4.1   $ 9.3   

Current portion of investment in sales-type leases

     34.2         (1.4     32.8         35.3         (1.5     33.8   

Non-current portion of investment in sales-type leases

     26.0         (1.2     24.8         30.5         (1.3     29.2   
                                                   

Total unsold sales-type leases (recorded as assets, net, on the consolidated balance sheets)

     74.3         (6.8     67.5         79.2         (6.9     72.3   

Sold rental payments remaining unbilled

     172.3         (7.2 )(1)      165.1         184.9         (7.9 )(1)      177.0   
                                                   

Total of sales-type leases unsold and sold

   $ 246.6       $ (14.0   $ 232.6       $ 264.1       $ (14.8   $ 249.3   
                                                   

 

(1) Allowance for sold rental payments is recorded as a lease recourse liability on the consolidated balance sheets

A sale of rental payments represents the total present value of the payment stream on the sale of the rental payments to third parties. For the three-month period ended October 31, 2010, the Company sold $12.9 of rental payments and recorded gains on sale of those rental payments of $2.1 (three-month period ended October 31, 2009—sold $7.0 and recorded gains of $0.9). For the six-month period ended October 31, 2010, the Company sold $29.4 of rental payments and recorded gains on sale of those rental payments of $4.5 (six-month period ended October 31, 2009—sold $24.5 and recorded gains of $2.8). Sold rental payments remaining unbilled at the end of the period represents the total balance of leases that are not included in our consolidated balance sheets. The Company is compensated for administration and servicing of rental payments sold.

4. INVENTORIES

 

     October 31, 2010     April 30, 2010  

Raw materials and work in process

   $ 7.3      $ 5.1   

Finished goods

     32.6        30.0   

Less: provision for obsolete inventory

     (7.9     (8.4
                
   $ 32.0      $ 26.7   
                

5. OTHER CURRENT ASSETS

 

     October 31, 2010      April 30, 2010  

Prepaid expenses and deferred charges

   $ 17.3       $ 16.5   

Unbilled receivables

     10.1         14.3   

Other receivables

     7.4         6.7   

Service inventory

     7.0         6.7   

Restricted cash

     1.4         2.3   
                 
   $ 43.2       $ 46.5   
                 

6. IDENTIFIABLE INTANGIBLE ASSETS

 

     October 31, 2010      April 30, 2010  
     Cost      Accumulated
amortization
    Net      Cost      Accumulated
amortization
    Net  

Patents, trademarks and other

   $ 13.5       $ (8.5   $ 5.0       $ 12.8       $ (7.7   $ 5.1   

Customer relationships

     99.9         (40.3     59.6         99.9         (34.0     65.9   

Developed technology

     78.8         (31.6     47.2         78.8         (26.7     52.1   

Trade name

     —           —          —           2.3         (2.3     —     
                                                   

Intangible assets, net

   $ 192.2       $ (80.4   $ 111.8       $ 193.8       $ (70.7   $ 123.1   
                                                   

 

9


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

 

     October 31, 2010      April 30, 2010  

Trade payables

   $ 31.3       $ 27.5   

Employee-related payables

     13.9         16.4   

Restructuring, warranty and other provisions

     6.4         6.2   

Other accrued liabilities

     65.0         57.6   
                 
   $ 116.6       $ 107.7   
                 

8. RELATED PARTY TRANSACTIONS

The Matthews Group

Dr. Terence Matthews (“Dr. Matthews”) and certain entities controlled by Dr. Matthews (collectively, “the Matthews Group”) are significant shareholders of the Company. In addition, the Matthews Group holds certain warrants and options of the Company. Significant transactions with companies controlled by or related to Dr. Matthews include the following:

BreconRidge manufacturing agreement

Throughout fiscal 2010, the Matthews Group had a significant interest in BreconRidge Manufacturing Solutions (“BreconRidge”), a significant supplier to Mitel. In May 2010, the Matthews Group and other BreconRidge shareholders sold their interest in BreconRidge to Sanmina–SCI. As a result, for fiscal 2011, BreconRidge is no longer a related party to Mitel. The Company does not currently anticipate significant changes to its manufacturing supply agreement as a result of this transaction.

In the three- and six-month periods ended October 31, 2009, the Company purchased $8.0 and $18.7 of products and services and sold $0.2 and $0.4 of raw material inventory, respectively, under a manufacturing supply agreement with BreconRidge. As of April 30, 2010, balances payable pursuant to this agreement amounted to $6.6 and balances receivable pursuant to this agreement amounted to $0.7.

Leased properties

The Company leases its Ottawa-based headquarter facilities from a company controlled by Dr. Matthews. During the three- and six-month periods ended October 31, 2010, Mitel recorded lease expense of $1.7 and $3.3, respectively (three- and six-month periods ended October 31, 2009—$1.7 and $3.3, respectively). At October 31, 2010, balances payable relating to the lease agreement totaled nil (April 30, 2010—$0.7). The lease expires in February 2011.

Other

During the three- and six-month periods ended October 31, 2010, other transactions with companies related to Dr. Matthews arising in the normal course consisted of sales of $0.4 and $0.8 and purchases of $0.4 and $1.1, respectively (three and six-month periods ended October 31, 2009—sales of $0.3 and $0.5 and purchases of $0.5 and $0.9, respectively). At October 31, 2010, the net balance receivable as a result of these transactions was $1.1 (April 30, 2010—$1.5) and is included in accounts receivable in the consolidated balance sheet.

In the three-month period ended October 31, 2009, the Company recorded an impairment charge of $1.1 related to its investment in Natural Convergence Inc. (“NCI”). Dr. Matthews had a significant ownership interest in NCI. The impairment charge was included in special charges and restructuring costs in the consolidated statement of operations.

The Francisco Group

Francisco Partners Management, LLC and certain of its affiliates (collectively, “the Francisco Group”) are significant shareholders of the Company. In addition, the Francisco Group holds certain warrants and options of the Company. Significant transactions with companies controlled by or related to the Francisco Group include the following:

Second Lien Debt

During the third quarter of fiscal 2010, an affiliate of the Francisco Group purchased $21.2 in principal of the outstanding second lien term debt. Interest of $0.4 and $0.8 was expensed during the first quarter and first six months of fiscal 2011, respectively, relating to the second lien debt held by an affiliate of the Francisco Group. The Matthews Group has a 40% participating interest in the second lien debt held by such affiliate of the Francisco Group, but is neither a party to nor a lender under our second lien term loan and has no contractual rights or enforcement rights against Mitel in connection with its participating interest in such second lien debt.

 

10


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

9. PENSION PLANS

The Company and its subsidiaries maintain defined contribution pension plans that cover substantially all employees. In addition, the Company’s U.K. subsidiary maintains a defined benefit pension plan. At October 31, 2010, the pension liability was $71.4 (April 30, 2010—$68.1). The Company’s net periodic benefit cost was as follows:

 

     Three months ended     Six months ended  
     October 31,
2010
    October 31,
2009
    October 31,
2010
    October 31,
2009
 

Defined Contribution

        

Current service cost

   $ 0.5      $ 0.3      $ 1.1      $ 0.6   

Defined Benefit

        

Current service cost

     0.4        0.2        0.7        0.4   

Interest cost

     2.4        1.9        4.8        3.8   

Expected return on plan assets

     (2.0     (1.6     (3.9     (3.1

Amortization of actuarial loss

     0.7        0.1        1.3        0.2   
                                

Total periodic benefit cost, net

   $ 2.0      $ 0.9      $ 4.0      $ 1.9   
                                

The Company’s annual funding requirement for its U.K. defined benefit plan is determined every three years in accordance with U.K. regulations, and is based on a calendar year. In October 2010, the Company’s annual funding requirement for the calendar year 2011 was determined to be £2.5, and will increase at an annual rate of 3% for calendar years 2012 and 2013.

10. COMMITMENTS, GUARANTEES AND CONTINGENCIES

Product warranties

The Company provides its customers with standard warranties on hardware and software for periods of up to 15 months. At October 31, 2010, the warranty accrual was $1.3 (April 30, 2010—$1.6).

Intellectual property indemnification obligations

The Company enters on a regular basis into agreements with customers and suppliers that include limited intellectual property indemnification obligations that are customary in the industry. These guarantees generally require the Company to compensate the other party for certain damages and costs incurred as a result of third party intellectual property claims arising from these transactions. The nature of these intellectual property indemnification obligations prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to its customers and suppliers. Historically, the Company has not made any significant indemnification payments under such agreements and no amount has been accrued in the consolidated financial statements with respect to these guarantees.

Bid and performance related bonds

The Company enters into bid and performance related bonds related to various customer contracts. Performance related bonds usually have a term of twelve months and bid bonds generally have a much shorter term. For the periods reported, the liability recognized related to these bid and performance related bonds was insignificant. At October 31, 2010, the total maximum potential amount of future payments the Company could be required to make under bid and performance related bonds was $3.6 (April 30, 2010—$4.8).

Contingencies

On February 27, 2008, the Company issued a statement of claim against one of its customers for non-payment of invoices arising from the provision of hardware, software and services. The customer responded with a counterclaim for a return of amounts paid plus other unquantified costs. In September 2010, the parties reached a settlement, including a consent to dismiss all outstanding claims and counterclaims in the matter.

The Company is also party to a small number of other legal proceedings, claims or potential claims arising in the normal course of business. In the opinion of the Company’s management and legal counsel, any monetary liability or financial impact of such claims or potential claims to which the Company might be subject after final adjudication would not be material to the consolidated financial position of the Company, its results of operations or its cash flows. In circumstances where the outcome of the lawsuit is expected to be unfavorable, the Company has recorded a provision for the expected settlement amount. Where the expected settlement amount is a range, the Company has provided for at least the minimum amount of the range.

 

11


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

11. SHARE CAPITAL

Share Capital

At October 31, 2010 and April 30, 2010, the Company’s authorized capital stock consisted of an unlimited number of common shares and an unlimited number of preferred shares. The holders of common shares are entitled to one vote per share and are entitled to dividends when and if declared by the Board of Directors. No preferred shares were outstanding at October 31, 2010 or April 30, 2010.

Stock Options

Following is a summary of the Company’s stock option activity (in millions, except per option amounts):

 

     Six months ended  
     October 31, 2010      October 31, 2009  
     Number of
Options
    Weighted Average
Exercise Price per
Option
     Number of
Options
    Weighted Average
Exercise Price per

Option
 

Outstanding options:

         

Balance, beginning of period:

     2.6      $ 4.02         2.1      $ 14.55   

Granted

     1.7      $ 8.39         0.7      $ 3.75   

Exercised

     —  (1)    $ 3.75         —  (1)    $ 3.75   

Forfeited

     (0.1   $ 5.76         —  (1)    $ 10.19   

Expired

     —  (1)    $ 6.58         (0.1   $ 15.06   
                                 

Balance, end of period:

     4.2      $ 5.85         2.7      $ 4.06 (2) 
                                 

Number of options exercisable

     1.5      $ 4.38         0.9      $ 4.41 (2) 
                                 

 

(1) Number of options is less than 0.1 for the period.
(2) Weighted average exercise price at October 31, 2009 reflects a July 2009 stock option modification that lowered the exercise price of substantially all outstanding stock options.

The Company used the Black-Scholes-Merton option-pricing model to determine the fair value of the stock option grants during the period. The assumptions and fair value for the three months ended are as follows:

 

     October 31, 2010     July 31, 2010     October 31, 2009     July 31, 2009  

Number of options granted

     0.3        1.4        0.2        0.5   

Risk-free interest rate

     1.43     1.76     2.38     2.30

Dividends

     0     0     0     0

Expected volatility

     55.0     55.0     85.0     85.0

Annual forfeiture rate

     10     10     10     10

Expected life of the options (1)

     4.6 years        4.6 years        5.0 years        5.0 years   

Fair value per option (2)

   $ 2.78      $ 4.45      $ 1.32      $ 1.32   

 

(1) In accordance with the Stock Compensation topic of the FASB ASC, the Company determined the expected life of the options for fiscal 2011 using a simplified method due to the Company’s short history as a publicly-traded company. As a result, the expected life was calculated using an average of the original contract term (seven years) and the vesting term, taking into account graded vesting. The expected term for options granted in the first six months fiscal 2010 was based on the contract term of the options as the Company was privately held.
(2) The fair value per option is also dependent on the exercise price and stock price on the day of grant. Options granted in the six-month period ended October 31, 2009 had an exercise price below the fair value of the stock price on day of grant. All other options granted had an exercise price that approximated the stock price on the day of grant.

The number of options (and all other security-based compensation) available for grant under the Company’s 2006 Equity Incentive Plan at October 31, 2010 was 1.4 (April 30, 2010—2.9).

Deferred Share Unit (“DSU”) Plans

At October 31, 2010, there were 0.04 million (April 30, 2010—0.04 million) DSUs outstanding with a fair value of $0.3 (April 30, 2010—$0.4) recorded as a liability in accounts payable and accrued liabilities on the consolidated balance sheets.

 

12


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

12. WARRANTS

The following table outlines the carrying value of warrants outstanding as of October 31, 2010 and April 30, 2010:

 

     October 31, 2010      April 30, 2010  

Warrants issued in connection with government funding (a)

   $ 39.1       $ 39.1   

Warrants issued in connection with Senior Secured Convertible Notes (b)

     10.5         10.5   

Warrants issued in connection with Class 1 Preferred Shares (c)

     6.0         6.0   

Warrants issued in connection with Series A Preferred Shares (d)

     —           —     
                 
   $ 55.6       $ 55.6   
                 

 

(a) At October 31, 2010, there were 2.48 million warrants outstanding that were issued in connection with government funding (April 30, 2010—2.48 million). The warrants have an exercise price of nil, are exercisable at any time at the option of the holder and have no expiry date.
(b) At October 31, 2010, there were 1.35 million warrants outstanding that were issued in connection with the issuance of the Senior Secured Convertible Notes (April 30, 2010—1.35 million). The warrants have an exercise price of $15.69 per share, are exercisable at any time at the option of the holder and expire in August 2012.
(c) At October 31, 2010, there were 1.81 million warrants outstanding that were issued in connection with the issuance of Class 1 Preferred Shares (April 30, 2010—1.81 million). The warrants have an exercise price of $16.48 per share, are exercisable at any time at the option of the holder and expire in August 2012.
(d) At October 31, 2010, there were 0.44 million warrants outstanding that were issued in connection with Series A Preferred Shares (April 30, 2010—0.44 million). The warrants have an exercise price of C$14.18 per share, are exercisable at any time at the option of the holder and expire in April 2011. As a result of the exercise price being in a currency other than U.S. dollars, the warrants are recorded as a liability at fair value in the consolidated balance sheets. The fair value at October 31, 2010 was less than $0.1 (April 30, 2010—$1.0) and was included in other long-term liabilities.

13. EARNINGS (LOSS) PER SHARE (“EPS”)

During the first six months of fiscal 2010, the Company had Class 1 Preferred Shares outstanding. Because the holders of the Class 1 Preferred Shares were entitled to dividends on a basis equivalent to holders of common shares, the Company used the two-class method to determine income attributable to common shareholders and then divided it by the weighted-average common shares outstanding for the period to determine basic EPS. The Class 1 Preferred Shares were converted into common shares in April 2010 and therefore the use of the two-class method was no longer necessary for fiscal 2011.

The following table sets forth the computation of basic and diluted EPS (in millions, except per share amounts):

 

     Three months ended     Six months ended  
     October 31,
2010
     October 31,
2009
    October 31,
2010
     October 31,
2009
 

Net income (loss), as reported

   $ 80.9       $ (20.0   $ 87.7       $ (18.0

Accreted interest on redeemable shares

     —           (11.9     —           (23.3
                                  

Net income (loss) attributable to common shareholders

   $ 80.9       $ (31.9   $ 87.7       $ (41.3
                                  

Weighted average common shares outstanding during the period, basic

     52.8         14.3        52.8         14.3   
                                  

Income (loss) per common share, basic

   $ 1.53       $ (2.23   $ 1.66       $ (2.88
                                  

Weighted average common shares outstanding during the period, basic

     52.8         14.3        52.8         14.3   

Dilutive effect of options

     0.7         —          0.9         —     

Dilutive effect of warrants

     2.5         —          2.5         —     
                                  

Weighted average common shares outstanding during the period, diluted

     56.0         14.3        56.2         14.3   
                                  

Income (loss) per common share, diluted

   $ 1.45       $ (2.23   $ 1.56       $ (2.88
                                  

 

13


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

The following securities have been excluded in the computation of diluted earnings per share because to do so would have been anti-dilutive based on the terms of the securities:

 

     Three Months Ended      Six Months Ended  

(Number outstanding, in millions)

   October 31,
2010
     October 31,
2009
     October 31,
2010
     October 31,
2009
 

Stock options

     1.7         2.7         1.6         2.7   

Warrants

     3.2         1.5         3.2         1.5   

The following securities have been excluded in the computation of diluted earnings per share because to do so would have been anti-dilutive based on having a net loss attributable to common shareholders for the three and six months ended October 31, 2009:

 

(Number outstanding, in millions)

   Three Months  Ended
October 31,
2009
     Six Months Ended
October  31,
2009
 

Warrants

     2.5         2.5   

Convertible, redeemable shares

     0.3         0.3   

Additionally, for the three and six months ended October 31, 2009, warrants to acquire 1.1 million common shares were excluded from the above tables since they were contingently issuable and the conditions for issuance had not been met by the end of the period. For the three and six months ended October 31, 2010, the warrants were excluded in the diluted EPS calculation because the exercise price exceeded the average market price of the common shares and as such, they are included in the tables above.

14. SPECIAL CHARGES AND RESTRUCTURING COSTS

The following tables summarize the change in provision for special charges and restructuring costs during the first six months of fiscal 2011 and the first six months of fiscal 2010:

 

Description

   Workforce
Reduction
    Lease
Termination
Obligation
    Total  

Balance of provision as of April 30, 2010

   $ 0.3      $ 6.5      $ 6.8   

Charges (reversals)

     0.1        (0.2     (0.1

Cash payments

     (0.4     (0.6     (1.0
                        

Balance of provision as of July 31, 2010

   $ —        $ 5.7      $ 5.7   
                        

Charges

     3.7        0.7        4.4   

Cash payments

     (1.7     (0.5     (2.2
                        

Balance of provision as of October 31, 2010

   $ 2.0      $ 5.9      $ 7.9   
                        

In the second quarter of fiscal 2011, the Company undertook additional actions to reduce its cost structure and improve operational efficiency. The charge consists primarily of $3.7 of employee severance related to workforce reductions for approximately 50 employees, which are expected to be paid within the next two years. The current portion of the workforce reduction liability of $2.0 and lease termination obligation liability of $2.9 are included in accounts payable and accrued liabilities, with the remaining balance included in other non-current liabilities.

 

Description

   Workforce
Reduction
    Lease
Termination
Obligation
    Assets Written
Off
    Total  

Balance of provision as of April 30, 2009

   $ 2.7      $ 8.1      $ —        $ 10.8   

Charges

     0.2        0.2        —          0.4   

Cash payments

     (1.3     (0.1     —          (1.4

Foreign currency impact

     0.4        0.1        —          0.5   
                                

Balance of provision as of July 31, 2009

   $ 2.0      $ 8.3      $ —        $ 10.3   
                                

Charges

     0.9        0.3        1.1        2.3   

Cash payments

     (1.5     (2.0     —          (3.5

Assets written off

     —          —          (1.1     (1.1

Foreign currency impact

     (0.1     (0.1     —          (0.2
                                

Balance of provision as of October 31, 2009

   $ 1.3      $ 6.5      $ —        $ 7.8   
                                

 

14


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

In the second quarter of fiscal 2010, the Company recorded $0.9 of restructuring charges in order to better strategically align its U.S. and European operations. In addition, the Company recorded an asset impairment related to NCI, as described in note 8.

In the first six months of fiscal 2011 and fiscal 2010, the Company made payments on previously accrued restructuring charges, as described in note 7 to the audited annual consolidated financial statements.

15. FAIR VALUE ADJUSTMENT ON DERIVATIVE INSTRUMENTS

The change in fair value of the Company’s derivative instruments that are required to be recorded as a liability is as follows:

 

     Three Months Ended     Six Months Ended  
     October 31,
2010
     October 31,
2009
    October 31,
2010
     October 31,
2009
 

Gain on change in fair value of Class 1 Preferred Shares (a)

   $ —         $ (23.7   $ —         $ (23.1

Warrants with an exercise price denominated in Canadian dollars (b)

     0.2         (0.2     1.0         (0.2
                                  
   $ 0.2       $ (23.9   $ 1.0       $ (23.3
                                  

 

(a) As further described in notes 21 and 22 to the audited annual consolidated financial statements, as a result of the features of the Class 1 Preferred Shares, the conversion option was required to be recorded at fair value each reporting period, with changes in fair value recorded in the consolidated statements of operations. The change in fair value of the derivative for the three- and six- month periods ended October 31, 2009 was an increase in the liability of $23.7 and $23.1, respectively resulting in a corresponding charge to the consolidated statements of operations. As described in note 1 to the audited annual consolidated financial statements, in connection with the April 2010 initial public offering, the Class 1 Preferred Shares were converted into common shares.
(b) At October 31, 2010 there were 0.44 million warrants outstanding with an exercise price of C$14.18 (October 31, 2009—0.44 million warrants outstanding). These warrants expire in April 2011. Since the warrants are exercisable in a currency other than U.S. dollars, the fair value of the warrants is recorded as a liability, with changes in fair value recorded in the consolidated statements of operations. For the three and six months ended October 31, 2010, the Company has recorded a gain of $0.2 and $1.0, respectively (three and six months ended October 31, 2009, loss of $0.2 and $0.2, respectively).  

16. SEGMENT INFORMATION

Mitel’s portfolio of solutions provide advanced voice, video and data communications platforms, desktop phones and Internet appliances, applications for customer relationship management and mobility, messaging and multimedia collaboration. The Company’s reportable segments are represented by the four geographic areas: United States, Canada and Caribbean and Latin America (“Canada and CALA”), Europe, Middle East and Africa (“EMEA”), and Asia Pacific. Financial information by geographic area for the three and six months ended October 31, 2010 and October 31, 2009 is summarized below.

 

     United
States
     EMEA      Canada
and
CALA
     Asia
Pacific
     Corporate
and
Other
    Total  

Three months ended—October 31, 2010

                

Revenue

                

Telecommunications

   $ 88.9       $ 38.3       $ 9.9       $ 4.4       $ —        $ 141.5   

Services and other

     19.6         —           —           —           —          19.6   
                                                    
     108.5         38.3         9.9         4.4         —          161.1   
                                                    

Contribution margin

     38.9         14.5         4.3         1.5         —          59.2   

Shared and unallocated costs

     —           —           —           —           (55.4     (55.4
                                                    

Operating income (loss)

   $ 38.9       $ 14.5       $ 4.3       $ 1.5       $ (55.4   $ 3.8   
                                                    

Three months ended—October 31, 2009

                

Revenue

                

Telecommunications

   $ 89.2       $ 39.9       $ 11.4       $ 3.1       $ —        $ 143.6   

Services and other

     18.8         —           —           —           —          18.8   
                                                    
     108.0         39.9         11.4         3.1         —          162.4   
                                                    

Contribution margin

     39.2         14.3         4.7         0.4         —          58.6   

Shared and unallocated costs

     —           —           —           —           (48.9     (48.9
                                                    

Operating income (loss)

   $ 39.2       $ 14.3       $ 4.7       $ 0.4       $ (48.9   $ 9.7   
                                                    

 

15


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

 

     United
States
     EMEA      Canada
and
CALA
     Asia
Pacific
     Corporate
and
Other
    Total  

Six months ended—October 31, 2010

                

Revenue

                

Telecommunications

   $ 178.4       $ 73.3       $ 21.0       $ 9.6       $ —        $ 282.3   

Network services

     38.8         —           —           —           —          38.8   
                                                    
     217.2         73.3         21.0         9.6         —          321.1   
                                                    

Contribution margin

     81.3         27.4         9.2         3.4         —          121.3   

Shared and unallocated costs

     —           —           —           —           (106.6     (106.6
                                                    

Operating income (loss)

   $ 81.3       $ 27.4       $ 9.2       $ 3.4       $ (106.6   $ 14.7   
                                                    

Six months ended October 31, 2009

                

Revenue

                

Telecommunications

   $ 179.5       $ 77.1       $ 20.4       $ 7.0       $ —        $ 284.0   

Network services

     37.8         —           —           —           —          37.8   
                                                    
     217.3         77.1         20.4         7.0         —          321.8   
                                                    

Contribution margin

     78.2         28.4         8.3         1.3         —          116.2   

Shared and unallocated costs

     —           —           —           —           (96.8     (96.8
                                                    

Operating income (loss)

   $ 78.2       $ 28.4       $ 8.3       $ 1.3       $ (96.8   $ 19.4   
                                                    

Geographic information

Revenues from external customers are attributed to the following countries based on location of the customers.

 

     Three months ended      Six months ended  
     October 31,
2010
     October 31,
2009
     October 31,
2010
     October 31,
2009
 

United States

   $ 108.3       $ 108.7       $ 217.2       $ 218.1   

United Kingdom

     27.0         27.2         51.5         54.6   

Canada

     7.4         7.8         16.2         14.9   

Other foreign countries

     18.4         18.7         36.2         34.2   
                                   
   $ 161.1       $ 162.4       $ 321.1       $ 321.8   
                                   

 

16


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

17. SUPPLEMENTARY CASH FLOW INFORMATION

Cash and cash equivalents at October 31, 2010 consisted of cash of $49.0 (April 30, 2010—$46.6) and cash equivalents of $41.0 (April 30, 2010—$30.0). Cash interest and cash taxes paid during three months ended October 31, 2010 were $4.6 and $2.4, respectively (three months ended October 31, 2009—$8.3 and $0.5, respectively) and for the six months ended October 31, 2010 were $9.0 and $3.7, respectively (six months ended October 31, 2009—$16.7 and $0.7, respectively). Additions to property, equipment and intangible assets for the three and six months ended October 31, 2010 are shown in the consolidated statements of cash flows net of property and equipment acquired through capital leases of $1.1 and $1.4, respectively (three and six months ended October 31, 2009—nil and $0.1, respectively).

 

     Three months ended     Six months ended  
     October 31,
2010
    October 31,
2009
    October 31,
2010
    October 31,
2009
 

Non-cash changes in operating assets and liabilities:

        

Accounts receivable and sales-type lease receivables

   $ (6.8   $ (12.2   $ 7.7      $ (11.3

Inventories

     (3.5     1.8        (4.4     2.8   

Other current assets(1)

     1.5        5.3        1.4        9.0   

Other non-current assets

     1.2        —          1.2        —     

Accounts payable and accrued liabilities

     9.3        (6.1     (1.3     (9.9

Due to related parties

     (0.4     0.9        (0.3     1.5   

Deferred revenue

     (0.8     (2.5     (5.3     (3.8

Other non-current liabilities(2)

     (3.9     (4.3     (4.0     (6.5

Change in pension liability

     0.6        (0.3     0.5        (0.5
                                
   $ (2.8   $ (17.4   $ (4.5   $ (18.7
                                

 

(1) Included in other current assets on the consolidated balance sheets is restricted cash, the change in which is presented separately on the consolidated statements of cash flows.
(2) Included in other non-current liabilities on the consolidated balance sheets are the derivative instrument liability and the litigation settlement obligation, the changes in which are presented separately on the consolidated statements of cash flows.

18. HEDGING ACTIVITIES

The Company operates globally, and therefore incurs expenses in currencies other than its various functional currencies and its U.S. dollar reporting currency. The Company utilizes forward contracts to enhance its ability to manage foreign currency exchange rate risk that exists as part of its ongoing operations. The Company does not use derivative contracts for speculative purposes. At October 31, 2010 and April 30, 2010, all of the Company’s outstanding forward contracts had a term of one month or less.

At October 31, 2010, the Company held forward option contracts to sell Canadian dollars and Australian dollars at a fixed rate on a notional amount of $6.7 U.S. dollars. As well, the Company held forward option contracts to buy Euros and British pounds sterling at a fixed rate on a total notional amount of $8.5 U.S. dollars. At October 31, 2010, the Company recorded a net unrealized gain on fair value adjustments on the outstanding forward contracts of $0.1.

At April 30, 2010, the Company held forward contracts to sell Euros and Australian dollars at a fixed rate on a notional amount of $2.8 U.S. dollars. As well, the Company held forward option contracts to buy British pounds sterling and Canadian dollars at a fixed rate on a notional amount of $12.9 U.S. dollars. At April 30, 2010, the Company had an unrealized loss on fair value adjustments on the outstanding forward contracts of $0.1.

19. FAIR VALUE MEASUREMENTS

The Fair Value Measurements and Disclosure Topic of the FASB ASC requires that financial assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

 

17


MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

NOTES TO THE UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

For the three and six months ended October 31, 2010 and October 31, 2009

(in U.S. dollars, millions except per share amounts)

 

Assets/Liabilities Measured at Fair Value on a Recurring Basis

 

     Fair Value Measurement at Reporting Date  
     Quoted Price in
Active Markets
for Identical
Instruments
     Significant
Other
Observable
Inputs
    Significant
Unobservable
Inputs
    Total  
     Level 1      Level 2     Level 3    

October 31, 2010

         

Assets

         

Cash equivalents

   $ —         $ 41.0      $ —        $ 41.0   

Restricted cash

     1.4         —          —          1.4   

Forward contracts

     —           0.1        —          0.1   

Liabilities

         

Derivative liability instrument

     —           —          —   (1)      —   (1) 

Forward contracts

     —           —   (1)      —          —   (1) 

April 30, 2010

         

Assets

         

Cash equivalents

   $ —         $ 30.0      $ —        $ 30.0   

Restricted cash

     2.3         —          —          2.3   

Liabilities

         

Derivative liability instrument

     —           —          1.0        1.0   

Forward contracts

     —           0.1        —          0.1   

 

(1) Fair value of less than $0.1.

The decrease in the derivative liability instrument (classified as a Level 3 financial liability) from April 30, 2010 to October 31, 2010 was due to a decrease in the Company’s share price and the fact that the warrants are six months closer to expiry.

20. DEFERRED TAXES

In the second quarter of fiscal 2011, the Company updated its assessment of the realizability of its deferred tax assets. Based on a number of factors, including completion of a reorganization of certain subsidiaries, cumulative income for the last 36 months and forecasted income for fiscal 2011, the Company determined that the weight of the evidence indicated that it was now more likely than not that the Company will realize a benefit from a portion of its deferred tax assets in Canada. At April 30, 2010, the Company completed an assessment of the realizability of its deferred tax assets and determined that a substantial valuation allowance was appropriate due to the uncertainty surrounding the Company’s ability to earn taxable income in certain jurisdictions. In the three months ended October 31, 2010, the Company relieved a valuation allowance of approximately $80.0, net of a provision for uncertain tax provisions, primarily relating to its deferred tax assets in Canada. At October 31, 2010, there continues to be a valuation allowance of $75.9 against deferred tax assets, primarily in Canada and the United Kingdom.

 

18


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

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the unaudited interim consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q. All amounts are expressed in U.S. dollars unless otherwise noted.

Certain information contained in this Quarterly Report, including information regarding future financial results, performance and plans, expectations, and objectives of management, constitute forward-looking information within the meaning of Canadian securities laws and forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We refer to all of these as forward-looking statements. Statements that include the words “may,” “will,” “should,” “could,” “estimate,” “continue,” “expect,” “intend,” “plan,” “predict,” “potential,” “believe,” “project,” “anticipate” and similar statements of a forward-looking nature, or the negatives of those statements, identify forward-looking statements. In particular, this Quarterly Report contains forward-looking statements pertaining to, among other matters: general global economic conditions; our business strategy; our plans and objectives for future operations; our industry; our future economic performance, profitability and financial condition; the costs of operating as a public company; and our R&D expenditures. Forward-looking statements are subject to a variety of known and unknown risks, uncertainties, assumptions and other factors that could cause actual events or results to differ from those expressed or implied by the forward-looking statements, including, without limitation:

 

   

our ability to achieve profitability in the future;

 

   

fluctuations in our quarterly and annual revenues and operating results;

 

   

fluctuations in foreign exchange rates;

 

   

current and ongoing global economic instability;

 

   

intense competition;

 

   

our ability to keep pace with technological developments and evolving industry standards;

 

   

failure of the market for unified communications and collaboration (“UCC”) to become more widespread;

 

   

risks related to the rate of adoption of IP telephony by our customers;

 

   

fluctuations in our working capital requirements and cash flows;

 

   

our ability to access additional sources of funds;

 

   

risks related to our level of indebtedness;

 

   

our ability to protect our intellectual property and our possible infringement of the intellectual property rights of third parties;

 

   

our reliance on channel partners for a significant component of our sales;

 

   

our dependence upon a small number of outside contract manufacturers to manufacture our products;

 

   

our dependence on sole source and limited source suppliers for key components;

 

   

possible delays in the delivery of, or lack of access to, software or other intellectual property licensed from our suppliers;

 

   

uncertainties arising from our foreign operations;

 

   

fluctuations in interest rates;

 

   

our ability to realize our deferred tax assets;

 

   

challenges to our transfer pricing policies by tax authorities;

 

   

our ability to sell leases derived from our managed services offering or a breach of our obligations in respect of such sales;

 

   

risks related to the financial condition of our customers;

 

   

reliance on our key personnel;

 

   

the search for and transition to a new Chief Executive Officer;

 

   

design defects, errors, failures or “bugs” in our solutions;

 

   

our ability to successfully integrate future strategic acquisitions;

 

   

problems with the infrastructure of carriers; and

 

   

our ability to successfully implement and achieve our business strategies.

 

19


These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. We operate in a very competitive and rapidly changing environment. New risks emerge from time to time. In making these statements we have made assumptions regarding, among other things: stable foreign exchange rates; no unforeseen changes occurring in the competitive landscape that would affect our industry; a stable or recovering economic environment; no significant event occurring outside the ordinary course of our business; stable interest rates; and certain other assumptions that are set out proximate to the applicable forward-looking statements contained in this Quarterly Report. While we believe our plans, intentions, expectations, assumptions and strategies reflected in these forward-looking statements are reasonable, we cannot assure you that these plans, intentions, expectations assumptions and strategies will be achieved. Our actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained in this Quarterly Report as a result of various factors, including the risks and uncertainties discussed below.

All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth in this Quarterly Report. Except as required by law, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Please refer to the section entitled “Risk Factors” included in our Annual Report on Form 10-K for the fiscal year ended April 30, 2010 (the “Annual Report”) for a further discussion of risks and uncertainties affecting our business and financial results.

Overview

We are a leading provider of integrated communications solutions focused on the small-to-medium sized enterprise, or SME, market. We also have a strong and growing presence in the large enterprise market with a portfolio of products that support up to 65,000 users. Our IP-based communications solutions consist of a combination of IP telephony platforms, which we deliver as software, appliances and desktop devices, and a suite of UCC applications that integrate voice, video and data communications with business applications. We believe that our solutions, including associated managed and network services, enable our customers to realize significant cost benefits and to conduct their business more effectively.

In April 2010, we completed our initial public offering (“IPO”) on the The NASDAQ Global Market. The net proceeds of $130.7 million were used to repay $30.0 million outstanding under our revolving credit facility and to prepay $72.0 million of our first lien term loan, with the remainder held for general corporate purposes. In conjunction with our IPO, we converted all of our outstanding Class 1 Preferred Shares into common shares.

In fiscal 2011, our operating results continue to be affected by the global economic downturn, which started in mid-calendar year 2008. Many of our current and prospective customers, particularly in the United States (“U.S.”), have responded to the financial and credit crises and general macroeconomic uncertainty by suspending, delaying or reducing their capital expenditures. These conditions have negatively impacted our sales since the second half of fiscal 2009. The tightened credit markets have also affected our sales of net rental payments under sales-type leases, resulting in lower cash flows generated from such sales, compared to historical levels. We responded to the negative effect of the downturn by implementing cost reduction programs to re-align our operating model. These programs, which were implemented during the second half of fiscal 2009 and throughout fiscal 2010, included headcount reductions, reduced discretionary spending, closure of excess facilities across our geographic regions and renegotiation of key supplier contracts. In fiscal 2009, we implemented a temporary reduced work week program, which remained in effect throughout fiscal 2010. In June 2010, we made the decision to phase out the reduced work week program gradually during fiscal 2011.

We cannot predict when the overall economy will return to stable, pre-recession conditions. We plan to monitor our cost structure so that it is appropriate for our revenue levels. Depending on the future macroeconomic climate and its impact on our revenues, we may implement additional cost reduction programs in an effort to keep operating expenses in line with revenues. Conversely, if our revenues improve above current levels we may gradually increase our expenditures while ensuring that our operating expense to revenue ratio remains within our target level. In either scenario, we plan to continue to invest in new product development and other significant R&D initiatives. However, there is no certainty that these investments will allow us to develop and introduce new IP-based communications solutions in a timely manner to allow us to compete effectively against existing and new competitors and meet customer requirements.

During fiscal 2011, we announced some changes to our senior management team. More specifically, in September 2010, Don Smith, our chief executive officer, announced his retirement. A search committee has been formed by our Board of Directors to identify a successor. Mr. Smith will continue to serve as Mitel’s chief executive officer until his successor is found. The Company expects that this role will be filled within the next two to three months. Mr. Smith will continue to serve as a director of Mitel after his retirement.

Further, in August 2010, we announced that Paul Butcher, our president and chief operating officer, in addition to his current responsibilities, and on an interim basis, has taken direct responsibility for the management and direction of Mitel’s U.S. operations. He assumed this role following the departure of the former president of our Mitel U.S. division. We do not expect that any of these changes to our senior management will have a material impact on our business, operations or financial condition.

Total revenue for the quarter ended October 31, 2010 was $161.1 million compared to $162.4 million for the quarter ended October 31, 2009. The sales decrease was the result of lower revenues in Europe, Middle East and Africa (collectively “EMEA”) due largely to changes in foreign exchange rates as well as decreased volumes in the Canada and Caribbean and Latin America

 

20


(collectively “Canada and CALA”) segment. This was partially offset by increased revenue in the Asia Pacific segment. Revenue in the U.S., our target segment, increased slightly in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010 as we had increased customers in our network services business. Our U.S. telecommunications revenues were relatively unchanged as the continued effect of the economic downturn resulted in longer sales cycles and delays in equipment purchases.

Our operating income decreased to $3.8 million in the second quarter of fiscal 2011 compared with operating income of $9.7 million in the second quarter of fiscal 2010. The decrease in operating income was largely due to increased SG&A expenses, an increase in special charges due to restructuring activity in the quarter, as well as a decrease in gross margin.

Our net income in the second quarter of fiscal 2011 included a deferred income tax recovery of $80.9 million relating primarily to a reduction of the valuation allowance we had previously recorded against certain deferred tax assets. Upon updating our assessment of the realizability of our deferred tax assets, we concluded that it was now more-likely-than-not that we would be able to realize a benefit on certain deferred tax assets, primarily in Canada.

Selected consolidated financial data

The following table sets forth our comparative results of operations, both in dollars and as a percentage of total revenues, for the three months ended October 31, 2010 and October 31, 2009:

 

     Three months ended October 31,     Change  
     2010     2009    
     Amounts     % of
Revenue
    Amounts     % of
Revenue
    Amount     %  
     (in millions, except percentages and per share amounts)  

Revenues:

            

Telecommunications

   $ 141.5        $ 143.6        $ (2.1     (1.5

Network services

     19.6          18.8          0.8        4.3   
                              
     161.1        100.0     162.4        100.0     (1.3     (0.8
                              

Cost of revenues:

            

Telecommunications

     73.9          72.8          1.1        1.5   

Network services

     10.7          11.0          (0.3     (2.7
                              
     84.6        52.5     83.8        51.6     0.8        1.0   
                              

Gross margin

     76.5        47.5     78.6        48.4     (2.1     (2.7
                              

Expenses:

            

Selling, general and administrative

     55.0        34.1     53.4        32.9     1.6        3.0   

Research and development

     13.3        8.3     13.2        8.1     0.1        0.8   

Special charges and restructuring costs

     4.4        2.7     2.3        1.4     2.1        +   
                              
     72.7        45.1     68.9        42.4     3.8        5.5   
                              

Operating income

     3.8        2.4     9.7        6.0     (5.9     (60.8

Interest expense

     (5.1     (3.2 )%      (8.9     (5.5 )%      3.8        (42.7

Fair value adjustment on derivative instruments

     0.2        0.1     (23.9     (14.7 )%      24.1        +   

Other income (expense)

     (0.4     (0.2 )%      1.0        0.6     (1.4     +   
                              

Loss before taxes

     (1.5     (0.9 )%      (22.1     (13.6 )%      20.6        +   

Income tax recovery

     82.4        51.1     2.1        1.3     80.3        +   
                              

Net income (loss)

   $ 80.9        50.2   $ (20.0     (12.3 )%    $ 100.9        +   
                              

Adjusted EBITDA, a non-GAAP measure

   $ 18.2        11.3   $ 22.0        13.5   $ (3.8     (17.3
                              

Net income (loss) per share:

            

Net income (loss) attributable to common shareholders (1)

   $ 80.9        $ (31.9      

Weighted average number of common shares outstanding—basic

     52.8          14.3         

Weighted average number of common shares outstanding—diluted

     56.0          14.3         

Net income (loss) per common share—basic

   $ 1.53        $ (2.23      

Net income (loss) per common share—diluted

   $ 1.45        $ (2.23      

 

21


 

+ The comparison is not meaningful.
(1) Included in the net loss attributable to common shareholders for the three months ended October 31, 2009 is an accreted interest charge of $11.9 on the then-outstanding Class 1 Preferred Shares. The Class 1 Preferred Shares were converted in April 2010, therefore no charge was recorded for the three months ended October 31, 2010.

The following table sets forth our comparative results of operations, both in dollars and as a percentage of total revenues, for the six months ended October 31, 2010 and October 31, 2009:

 

     Six months ended October 31,     Change  
     2010     2009    
     Amounts     % of
Revenue
    Amounts     % of
Revenue
    Amount     %  
     (in millions, except percentages and per share amounts)  

Revenues:

            

Telecommunications

   $ 282.3        $ 284.0        $ (1.7     (0.6

Network services

     38.8          37.8          1.0        2.6   
                              
     321.1        100.0     321.8        100.0     (0.7     (0.2
                              

Cost of revenues:

            

Telecommunications

     146.3          144.4          1.9        1.3   

Network services

     21.2          22.2          (1.0     (4.5
                              
     167.5        52.2     166.6        51.8     0.9        0.5   
                              

Gross margin

     153.6        47.8     155.2        48.2     (1.6     (1.0
                              

Expenses:

            

Selling, general and administrative

     108.2        33.7     106.8        33.2     1.4        1.3   

Research and development

     26.4        8.2     26.3        8.2     0.1        0.4   

Special charges and restructuring costs

     4.3        1.3     2.7        0.8     1.6        +   
                              
     138.9        43.3     135.8        42.2     3.1        2.3   
                              

Operating income

     14.7        4.6     19.4        6.0     (4.7     (24.2

Interest expense

     (10.2     (3.2 )%      (17.7     (5.5 )%      7.5        (42.4

Fair value adjustment on derivative instruments

     1.0        0.3     (23.3     (7.2 )%      24.3        +   

Other income (expense)

     (0.3     (0.1 )%      (0.4     (0.1 )%      0.1        +   
                              

Income (loss) before taxes

     5.2        1.6     (22.0     (6.8 )%      27.2        +   

Income tax recovery

     82.5        25.7     4.0        1.2     78.5        +   
                              

Net income (loss)

   $ 87.7        27.3   $ (18.0     (5.6 )%    $ 105.7        +   
                              

Adjusted EBITDA, a non-GAAP measure

   $ 38.6        12.0   $ 41.5        12.9   $ (2.9     (7.0
                              

Net income (loss) per share:

            

Net income (loss) attributable to common shareholders(1)

   $ 87.7        $ (41.3      

Weighted average number of common shares outstanding—basic

     52.8          14.3         

Weighted average number of common shares outstanding—diluted

     56.2          14.3         

Net income (loss) per common share—basic

   $ 1.66        $ (2.88      

Net income (loss) per common share—diluted

   $ 1.56        $ (2.88      

 

+ The comparison is not meaningful.
(1) Included in the net loss attributable to common shareholders for the six months ended October 31, 2009 is an accreted interest charge of $23.3 on the then-outstanding Class 1 Preferred Shares. The Class 1 Preferred Shares were converted in April 2010, therefore no charge was recorded in the six months ended October 31, 2010.

 

22


Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization (“Adjusted EBITDA”)

The following table presents a reconciliation of Adjusted EBITDA to net income, the most directly comparable U.S. GAAP measure, for the three and six months ended October 31, 2010 and October 31, 2009:

 

     Three months ended October 31     Six months ended October 31  
     2010     2009     2010     2009  
     (in millions)     (in millions)  

Net income (loss)

   $ 80.9      $ (20.0   $ 87.7      $ (18.0

Adjustments:

        

Interest expense

     5.1        8.9        10.2        17.7   

Income tax recovery

     (82.4     (2.1     (82.5     (4.0

Amortization and depreciation

     8.4        8.3        17.0        17.2   

Foreign exchange loss (gain)

     0.7        (0.5     0.8        0.8   

Fair value adjustment on derivative instruments

     (0.2     23.9        (1.0     23.3   

Special charges and restructuring costs

     4.4        2.3        4.3        2.7   

Stock-based compensation

     1.3        1.2        2.1        1.8   
                                

Adjusted EBITDA

   $ 18.2      $ 22.0      $ 38.6      $ 41.5   
                                

We believe that the use of Adjusted EBITDA provides consistency and comparability of, and facilitates, period to period comparisons, and also facilitates comparisons with other companies in our industry, many of which use similar non-GAAP financial measures to supplement their U.S. GAAP results.

We believe Adjusted EBITDA may also be useful to investors in evaluating our operating performance because securities analysts use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of companies, and our investor and analyst presentations include Adjusted EBITDA. However, we also caution you that other companies in our industry may calculate Adjusted EBITDA or similarly titled measures differently than we do, which limits the usefulness of Adjusted EBITDA as a comparative measure.

Moreover, although Adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, Adjusted EBITDA and similar non-GAAP measures have limitations as analytical tools, and you should not consider them in isolation or as a substitute for an analysis of our results of operations as reported under U.S. GAAP.

Adjusted EBITDA is not a measure calculated in accordance with U.S. GAAP. Adjusted EBITDA should not be considered as an alternative to net income, income from operations or any other measure of financial performance calculated and presented in accordance with U.S. GAAP. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. We encourage you to evaluate these adjustments and the reasons we consider them appropriate, as well as the material limitations of non-GAAP measures and the manner in which we compensate for those limitations. Our use of Adjusted EBITDA and its limitations are further discussed under Item 6 of our Annual Report.

Results of operations

Revenues and Geographic Segment Revenues

Our reportable segments are represented by the following four geographic sales regions: the United States; Europe, Middle East and Africa (collectively “EMEA”); Canada and Caribbean and Latin America (collectively “Canada and CALA”); and Asia Pacific. Our telecommunications business segment generates revenues throughout our geographic regions, while our network services business segment generates revenue solely in the United States. The following tables set forth total revenues by geographic regions and by business segment in dollars and as a percentage of total revenues:

 

     Three months ended October 31,     Change  
     2010     2009    
     Revenues      % of
Revenues
    Revenues      % of
Revenues
    Amount     %  
     (in millions, except percentages)  

Telecommunications revenues:

              

United States

   $ 88.9         55.2   $ 89.2         54.9   $ (0.3     (0.3

EMEA

     38.3         23.8     39.9         24.6     (1.6     (4.0

Canada and CALA

     9.9         6.1     11.4         7.0     (1.5     (13.2

Asia Pacific

     4.4         2.7     3.1         1.9     1.3        41.9   
                                            
     141.5         87.8     143.6         88.4     (2.1     (1.5

 

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     Three months ended October 31,     Change  
     2010     2009    
     Revenues      % of
Revenues
    Revenues      % of
Revenues
    Amount     %  
     (in millions, except percentages)  

Network services revenues:

              

United States

     19.6         12.2     18.8         11.6     0.8        4.3   
                                            
   $ 161.1         100.0   $ 162.4         100.0   $ (1.3     (0.8
                                            

 

     Six months ended October 31,     Change  
     2010     2009    
     Revenues      % of
Revenues
    Revenues      % of
Revenues
    Amount     %  
     (in millions, except percentages)  

Telecommunications revenues:

              

United States

   $ 178.4         55.6   $ 179.5         55.8   $ (1.1     (0.6

EMEA

     73.3         22.8     77.1         24.0     (3.8     (4.9

Canada and CALA

     21.0         6.5     20.4         6.3     0.6        2.9   

Asia Pacific

     9.6         3.0     7.0         2.2     2.6        37.1   
                                            
     282.3         87.9     284.0         88.3     (1.7     (0.6

Network services revenues:

              

United States

     38.8         12.1     37.8         11.7     1.0        2.6   
                                            
   $ 321.1         100.0   $ 321.8         100.0   $ (0.7     (0.2
                                            

Our revenues in fiscal 2011 continue to be affected by the global economic downturn. In the weakened economic climate, many of our existing and prospective customers reduced their capital expenditures or delayed new equipment purchases. After adjusting the EMEA region for changes in foreign exchange rates, our telecommunications revenues were down slightly or flat across most geographies for the three and six months ended October 31, 2010 versus the comparable periods of fiscal 2010. This decrease was partially offset by an increase in revenues in the Asia Pacific region, as that region has recovered more quickly from the downturn. Our revenues from network services increased in fiscal 2011 due to an increase in the number of active customers.

Telecommunication revenues in the United States decreased by $0.3 million, or 0.3%, in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010. For the first six months of fiscal 2011 compared to the first six months of fiscal 2010, revenue decreased by $1.1 million, or 0.6%. We believe that the decrease in telecommunications revenues was primarily due to the weakened economic climate in the United States, which adversely affected consumer demand.

Revenues in EMEA decreased by $1.6 million, or 4.0%, in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010 primarily as a result of the weakening of the British pound sterling against the U.S. dollar. As approximately 90% of this region’s revenues are generated in currencies other than the U.S. dollar, most significantly the British pound sterling and the Euro, our revenues, as reported in U.S. dollars, are impacted by significant changes in exchange rates. Revenues in the EMEA segment decreased 2.9% due to lower average exchange rates, primarily the British pound sterling, during the second quarter of fiscal 2011 versus the second quarter of fiscal 2010. Excluding the impact of foreign exchange, revenues in EMEA were down 1.1% quarter over quarter.

Revenues in EMEA decreased by $3.8 million, or 4.9%, in the first six months of fiscal 2011 compared to the first six months of fiscal 2010. Revenues in the EMEA segment decreased 4.4% due to lower average exchange rates, primarily the British pound sterling for the first six months of fiscal 2011. Excluding the impact of foreign exchange, revenues in EMEA were down 0.5% period over period.

Revenues in Canada and CALA decreased $1.5 million in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010. For the first six months of fiscal 2011 compared to the first six months of fiscal 2010, Canada and CALA revenues were up $0.6 million, or 2.9%. We believe the decrease in revenues in the second quarter was largely due to economic conditions coupled with the timing of certain projects.

Revenues in Asia Pacific increased by $1.3 million in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010 and increased by $2.6 million for the first six months of fiscal 2011 compared to the first six months of fiscal 2010 as we continue our efforts to grow the business in this region.

 

24


Network services revenues in the United States increased by $0.8 million, or 4.3%, in the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010 and increased by $1.0 million, or 2.6% for the first six months of fiscal 2011 compared to the first six months of fiscal 2010. The increases in revenues from network services were due to an increase in the number of customers compared to the prior periods.

Gross Margin

The following table sets forth gross margin, both in dollars and as a percentage of revenues, for the periods indicated:

 

     Three months ended October 31,     Six months ended October 31,  
     2010     2009     2010     2009  
     Gross
Margin
     Gross
Margin %
    Gross
Margin
     Gross
Margin %
    Gross
Margin
     Gross
Margin %
    Gross
Margin
     Gross
Margin %
 
     (in millions, except percentages)  

Telecommunications

     67.6         47.8     70.8         49.3     136.0         48.2     139.6         49.2

Network Services

     8.9         45.4     7.8         41.5     17.6         45.4     15.6         41.3
                                            

Total

     76.5         47.5     78.6         48.4     153.6         47.8     155.2         48.2
                                            

Gross margin percentage declined by 0.9% to 47.5% in the second quarter of fiscal 2011 from 48.4% in the second quarter of fiscal 2010, driven by a decrease in the gross margin percentage from telecommunications. Gross margin percentage declined by 0.4% to 47.8% in the first six months of fiscal 2011 from 48.2% in the first six months of fiscal 2010, also driven by a decrease in the gross margin percentage from telecommunications. Gross margin percentage on telecommunication revenues decreased in the first six months of fiscal 2011 by 1.0 % to 48.2% from 49.2% in the comparable period of fiscal 2010.

The decrease in gross margin for both the three- and six-month periods was primarily the result of an unfavorable shift in revenue mix coupled with unfavorable changes in the foreign exchange rates. The declines in margin were partially offset by a reduction in costs due to improved prices from our contract manufacturers.

Network services typically generate lower gross margins as compared to sales of software and systems. The gross margin percentage from our network services revenues improved to 45.4% in the second quarter of fiscal 2011 from 41.5% in the second quarter of fiscal 2010 and to 45.4% for the first six months of fiscal 2011 from 41.3% in the comparative period of fiscal 2010. The increase was primarily the result of lower rates negotiated with our local and long distance carriers during the third quarter of fiscal 2010.

Operating Expenses

Selling, General and Administrative (“SG&A”)

SG&A expenses increased to 34.1% of revenues in the second quarter of fiscal 2011 compared to 32.9% of revenues in the second quarter of fiscal 2010, a change of $1.6 million in absolute dollars. SG&A expenses increased to 33.7% of revenues in the first six months of fiscal 2011 compared to 33.2% of revenues in the comparable period of fiscal 2010, a change of $1.4 million in absolute dollars. Our SG&A expenditures for the three months and six months ended October 31, 2010 include certain non-cash charges, most significantly $6.0 million and $12.0 million, respectively (three and six months ended October 31, 2009 — $6.0 million and $12.3 million, respectively) for the amortization of intangible assets such as customer relationships and developed technology, primarily related to the acquisition of Inter-Tel. In addition, SG&A included $1.3 million and $2.1 million for the three and six months ended October 31, 2010 (three and six months ended October 31, 2009 —$1.2 million and $1.8 million) of non-cash compensation expense associated with employee stock options.

The increase in SG&A expenses as a percent of revenues for the second quarter and first six months of fiscal 2011 over the comparable periods of fiscal 2010 was primarily due to higher selling and marketing expenses and the phase-out of the reduced work week program during the second quarter of fiscal 2011.

Research and Development (“R&D”)

R&D expenses were $13.3 million, or 8.3% of total revenues, in the second quarter of fiscal 2011, effectively unchanged compared to the second quarter of fiscal 2010. R&D expenses were $26.4 million, or 8.2% of total revenues, in the first six months of fiscal 2011, effectively unchanged compared to the first six months of fiscal 2010. Our investment level in R&D remained consistent over both periods.

We have historically invested heavily in R&D, consistent with an aggressive R&D investment strategy that has positioned us with a broad range of feature-rich, scalable, standards-based and interoperable IP-based communication solutions. R&D expenses in absolute dollars fluctuate depending on the timing and number of development initiatives in any given quarter. R&D expenses as a percentage of revenues is highly dependent on revenue levels and varies significantly depending on actual revenues achieved.

 

25


Special Charges and Restructuring Costs

In the second quarter of fiscal 2011 we undertook certain restructuring actions to reduce our cost structure and improve operational efficiencies. We recorded a total charge of $4.4 million in the quarter relating to these activities. The charge consisted of $3.7 million relating to a workforce reduction of approximately 50 employees and $0.7 million relating to lease termination obligations. In the second quarter of fiscal 2010 we recorded a charge of $2.3 million consisting of restructuring charges of $1.2 million and a special charge of $1.1 million related to an asset impairment.

The special charges and restructuring costs of $4.3 million for the first six months of fiscal 2011 and $2.7 million for the first six months of fiscal 2010 were predominantly driven by the charges for the second quarter of fiscal 2011 and 2010, respectively.

We may take additional restructuring actions in the future to reduce our operating expenses and gain operating efficiencies. The timing and potential amount of such actions will depend on several factors, including future revenue levels and opportunities for operating efficiencies identified by management.

Operating Income

We reported operating income of $3.8 million in the second quarter of fiscal 2011 compared to operating income of $9.7 million in the second quarter of fiscal 2010. We reported operating income of $14.7 million in the first six months of fiscal 2011 compared to operating income of $19.4 million in the first six months of fiscal 2010. The decrease in operating income was due primarily to the decrease in gross margin, increase in SG&A expenses, as well as the increase in restructuring charges, as described above.

Non-Operating Expenses

Interest Expense

Interest expense was $5.1 million in the second quarter of fiscal 2011 compared to $8.9 million in the second quarter of fiscal 2010. The decrease in interest expense was due to lower debt balances during the period and a lower effective interest rate. In April 2010, in conjunction with our IPO, we repaid $30.0 million on our revolving credit facility and prepaid $72.0 million of our first lien term loan. As a result, the average long-term debt outstanding during the second quarter of fiscal 2011 was approximately $100 million lower than in the second quarter of fiscal 2010. The lower long-term debt balance resulted in a decrease in interest expense of approximately $1.0 million in the second quarter of fiscal 2011 compared to the same quarter of last fiscal year.

The remainder of the decrease was due to a lower average LIBOR, on which the interest expense on our debt is based, coupled with the expiry of an interest rate swap agreement where we had fixed a portion of our interest expense. The fixed rate under the interest rate swap agreement was higher than the variable rate, LIBOR. The interest rate swap agreement expired at the end of the second quarter of fiscal 2010 and was not renewed or replaced upon expiry.

Interest expense was $10.2 million in the first six months of fiscal 2011 compared to $17.7 million in the comparable period of fiscal 2010. The decrease in interest expense was due to same factors as for the second quarter of fiscal 2011. The lower long-term debt balance resulted in approximately $2.1 million of the decrease in interest expense in the second quarter of fiscal 2011 compared to the same quarter of last fiscal year, with the remainder due to a lower average LIBOR rate and the expiry of the interest rate swap.

Fair Value Adjustment on Derivative Instruments

Fair value adjustment on derivative instruments in the three and six months ended October 31, 2010 consisted of a fair value adjustment of $0.2 million and $1.0 million, respectively, on warrants that have an exercise price in Canadian dollars. The adjustments were due to a decrease in the fair value of the warrant liability resulting from a decrease in our stock price from April 30, 2010 to October 31, 2010 and the fact that the warrants are closer to expiry. The warrants have an exercise price of C$14.18 and expire in April 2011.

Fair value adjustment on derivative instruments in the three and six months ended October 31, 2009 consisted of a fair value adjustment of $23.7 million and $23.1 million, respectively on the embedded derivative in the Class 1 Preferred Shares, and a $0.2 million charge related to warrants that have an exercise price in Canadian dollars. The adjustment on the embedded derivative in the Class 1 Preferred Shares was due to a decrease in the fair value of the embedded derivative liability. The Class 1 Preferred Shares were converted to common shares in April 2010 in conjunction with our IPO.

Provision for Income Taxes

We recorded a net income tax recovery of $82.4 million and $82.5 million in the three and six months ended October 31, 2010 compared to a recovery of $2.1 million and $4.0 million in the three and six months ended October 31, 2009. The recovery for the second quarter 2011 was driven by the release of valuation allowance related to deferred tax assets, primarily in Canada.

In the second quarter of fiscal 2011, we updated our assessment of the realizability of the deferred tax assets. Based on a number of factors, including completion of a reorganization of certain subsidiaries, cumulative income for the last 36 months and forecasted income for fiscal 2011, we determined that the weight of the evidence indicated that it was now more likely than not that

 

26


the Company will realize a benefit from a portion of its deferred tax assets in Canada. At April 30, 2010, we completed an assessment of the realizability of our deferred tax assets and determined that a substantial valuation allowance was appropriate due to the uncertainty surrounding the Company’s ability to earn taxable income in certain jurisdictions. In the three months ended October 31, 2010, we relieved a valuation allowance of approximately $80.0 million, net of a provision for uncertain tax provisions, primarily relating to the deferred tax assets in Canada. At October 31, 2010, there continues to be a valuation allowance of $75.9 against deferred tax assets, primarily in Canada and the United Kingdom. Details of our accounting policies regarding deferred tax assets and valuation allowances are found under the “Critical Accounting Policies”—“Deferred Taxes” section below.

Net Income (Loss)

We recorded net income of $80.9 million in the second quarter of fiscal 2011 compared to a net loss of $20.0 million in the second quarter of fiscal 2010. The net income in the second quarter of fiscal 2011 was driven by a recovery of deferred taxes of $80.9 million, while the net loss in the second quarter of fiscal 2010 was driven by a $23.9 million charge for the fair value adjustment on derivative instruments. After adjusting for these items, the lower net income in the second quarter of fiscal 2011 was due to lower operating income, partially offset by lower interest expense, as discussed above.

We recorded net income of $87.7 million in the first six months of fiscal 2011 compared to a net loss of $18.0 million in the first six months of fiscal 2010. The net income in the first six months of fiscal 2011 was driven by a recovery of deferred taxes of $82.0 million, while the net loss in the first six months of fiscal 2010 was driven by a $23.3 million charge for the fair value adjustment on derivative instruments. The net income in the first six months of fiscal 2011 was consistent with the first six months of fiscal 2010, after adjusting for these items, as lower interest expense was offset by a decrease in gross margin and higher restructuring charges.

Adjusted EBITDA

Adjusted EBITDA, a non-GAAP measure, was $18.2 million in the second quarter of fiscal 2011 compared to $22.0 million in the second quarter of fiscal 2010, a decrease of $3.8 million. This decrease in Adjusted EBITDA was driven by lower revenues and gross margin, as well as the effect of the phase-out of the reduced work week program, which began in July 2010. Adjusted EBITDA was $38.6 million for the first six months of fiscal 2011 compared to $41.5 million in the first six months of fiscal 2010, a decrease of $2.9 million. The decrease in Adjusted EBITDA for the first six months of fiscal 2011 was driven by the same factors as the decrease in Adjusted EBITDA for the second quarter. For a definition and explanation of Adjusted EBITDA as well a reconciliation of Adjusted EBITDA to net income, see “Selected consolidated financial data”, above.

 

27


Cash Flows

Below is a summary of comparative results of cash flows and a discussion of the results for the three months and six months ended October 31, 2010 and October 31, 2009.

 

     Three months ended
October 31,
           Six months ended
October 31,
       
     2010     2009     Change      2010     2009     Change  
     (in millions)  

Net cash provided by (used in)

             

Operating activities

   $ 7.4      $ (3.5   $ 10.9       $ 16.7      $ 5.0      $ 11.7   

Investing activities

     (0.9     (1.3     0.4         (0.7     (2.3     1.6   

Financing activities

     (1.6     (2.2     0.6         (3.6     (4.0     0.4   

Effect of exchange rate changes on cash and cash equivalents

     0.4        (0.2     0.6         1.0        1.8        (0.8
                                                 

Increase (decrease) in cash and cash equivalents

   $ 5.3      $ (7.2   $ 12.5       $ 13.4      $ 0.5      $ 12.9   
                                                 

Cash Provided by Operating Activities

Cash generated from operating activities in the second quarter of fiscal 2011 was $7.4 million compared with cash used by operating activities of $3.5 million in the second quarter of fiscal 2010. The cash generated from operating activities for the first six months of fiscal 2011 was $16.7 million compared to $5.0 million for the first six months of fiscal 2010. The increased cash flows from operations for the fiscal 2011 periods was primarily the result of improved changes in the non-cash operating assets and liabilities. The improvement in this item was driven primarily by the timing of certain cash flows near October 31, 2010.

Cash Used in Investing Activities

Net cash used for investing activities was $0.9 million in the second quarter of fiscal 2011 compared to net cash used of $1.3 million in the second quarter of fiscal 2010. Net cash used for investing activities was $0.7 million in the first six months of fiscal 2011 compared to net cash used of $2.3 million in the first six months of fiscal 2010. The lower use of cash in the fiscal 2011 periods was due primarily to the increased financing of property and equipment purchases through capital leases. Assets purchased through capital lease in the three and six months ended October 31, 2010 were $1.1 million and $1.4 million, respectively compared to nil and $0.1 million for the three and six months ended October 31, 2009.

Cash Provided by Financing Activities

Net cash used in financing activities in the second quarter of fiscal 2011 was $1.6 million compared to cash used in financing activities of $2.2 million during the second quarter of fiscal 2010. Net cash used in financing activities in the first six months of fiscal 2011 was $3.6 million compared to cash used in financing activities of $4.0 million during the first six months of fiscal 2010. The use of cash in all periods was primarily due to repayments of long-term debt, capital leases, and payments under a fiscal 2007 litigation settlement obligation.

Effect of exchange rate changes on cash

Our overall cash position was also impacted by exchange rate changes during the period, which increased cash by $0.4 million during the second quarter of fiscal 2011 (second quarter of fiscal 2010—$0.2 million decrease) and by $1.0 million during the first six months of fiscal 2011 (first six months of 2010—$1.8 million increase).

Liquidity and Capital Resources

As of October 31, 2010, we had cash and cash equivalents of $90.0 million, increased from April 30, 2010 due primarily to cash flow from operations. In addition, we have an undrawn $30.0 million revolving facility that matures in August 2012 that provides additional liquidity. The revolving facility was not drawn during the six-month period ending October 31, 2010. At October 31, 2010 we had $344.4 million outstanding under our credit facilities, consisting of a first lien term loan due 2014 and second lien term loan due 2015, a decrease from $345.3 million outstanding at April 30, 2010 due to our scheduled repayments of principal under the first lien term loan.

We have a defined benefit pension plan in place for a number of our past and present employees in the United Kingdom. The plan has been closed to new members since 2001. At October 31, 2010, the plan had an unfunded pension liability of $71.4 million. The contributions to fund the benefit obligations under this plan are based on actuarial valuations, which themselves are based on certain assumptions about the long-term operations of the plan, including employee turnover and retirement rates, the performance of the financial markets and interest rates. In the three and six months ended October 31, 2010, we contributed $0.7 million and $2.4 million, respectively, to meet funding requirements (three and six months ended October 31, 2009—$0.7 million and $1.4 million,

 

28


respectively). The amount of required employer contributions required annually is determined every three years, in accordance with United Kingdom regulations. The 2011 contributions are the final year of this cycle. In October 2010, the Company’s annual funding requirement for the calendar year 2011 was determined to be £2.5 million and will increase at an annual rate of 3% for calendar years 2012 and 2013.

At October 31, 2010 and April 30, 2010, our cash equivalents consist of short-term, investment-grade commercial paper and government debt. We classify our cash equivalents as current based on their nature and their availability for use in current operations. We believe the overall credit quality of our portfolio is strong, with a majority of our cash equivalents invested in federal government treasury bills of Canada, the U.S. and the U.K.

We follow an investment policy where our excess cash is invested in investment-grade commercial paper and government debt, generally with a maturity of less than three months. There is no limit on the investments in the Federal Governments of Canada, the U.S. and the U.K. We diversify our portfolio by limiting the amount invested in any other single institution.

We believe that we will have sufficient liquidity to support our business operations for the next 12 months. However, we may elect to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support product development efforts and expansion of sales and marketing, the timing of introductions of new products and enhancements to existing products, and market acceptance of our products. Additional equity or debt financing may not be available on acceptable terms or at all. In addition, any proceeds from the issuance of equity or debt may be required to be used in whole or in part, to make mandatory payments under our credit agreements. We believe that our sources of liquidity beyond the next 12 months will be our then-current cash balances, funds from operations and funds available from borrowings under our revolving credit facility.

Contractual Obligations

The following table sets forth our contractual obligations as of October 31, 2010:

 

     Payments Due by Fiscal Year  

Contractual Obligations

   Total      Last
six
months
of 2011
     2012      2013      2014      2015      2016
and
beyond
 
     (in millions)  

Long-term debt obligations(1)

   $ 437.0       $ 11.8       $ 23.5       $ 23.5       $ 23.5       $ 221.6       $ 133.1   

Capital lease obligations(2)

     4.6         1.3         1.7         0.9         0.5         0.2         —     

Operating lease obligations(3)

     58.3         10.4         11.4         7.9         6.4         4.9         17.3   

Defined benefit pension plan contributions(4)

     13.4         2.0         4.0         4.2         3.2         —           —     

Other(5)

     29.9         5.5         9.1         4.6         4.3         4.1         2.3   
                                                              

Total

   $ 543.2       $ 31.0       $ 49.7       $ 41.1       $ 37.9       $ 230.8       $ 152.7   

 

(1) Represents the principal balance and interest payments for the first and second lien borrowings. Interest on the first and second lien borrowings is based on LIBOR plus 3.25%, and LIBOR plus 7.0%, respectively, as described in our consolidated financial statements. For the purposes of estimating the variable interest, the average 3-month LIBOR from the last three years, 1.58%, has been used.
(2) Represents the principal and interest payments for capital lease obligations. Interest rates on these loans range from 5.6% to 11.6%, as described in our consolidated financial statements.
(3) Operating lease obligations exclude payments to be received by us under sublease arrangements. The contractual obligation has not materially changed from those disclosed in our Annual Report.
(4) Represents the estimated contribution to our defined benefit pension plan in the United Kingdom. The Company’s annual funding requirement for its U.K. defined benefit plan is determined every three years in accordance with U.K. regulations, and is based on a calendar year. In October 2010, the Company’s annual funding requirement for the calendar year 2011 was determined to be £2.5 million, and will increase at an annual rate of 3% for calendar years 2012 and 2013. As of October 31, 2010, the unfunded status of the plan was $71.4 million.
(5) Includes payments under the fiscal 2007 litigation settlement and an Information Technology outsourcing agreement signed in November 2010.

 

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Off-Balance Sheet Arrangements

Off-balance sheet arrangements that have material changes from those disclosed in our Annual Report are as follows:

Sales-type leases

We offer our customers lease financing and other services under our managed services offering. We fund this offering, which we have branded as the TotalSolution® program, in part through the sale to financial institutions of rental payment streams under the leases. Such financial institutions have the option to require us to repurchase such income streams, subject to limitations, in the event of defaults by lease customers and, accordingly, we maintain reserves based on loss experience and past due accounts. In addition, such financial institutions have the option to require us to repurchase such income streams upon any uncured breach by us under the terms of the underlying sale agreements. At October 31, 2010, sold payments remaining unbilled net of lease recourse reserves, which represents the total balance of leases that is not included in our balance sheet, were $165.1 million (April 30, 2010—$177.0 million).

Critical Accounting Policies

The preparation of our consolidated financial statements and related disclosures in conformity with GAAP requires us to make estimates and assumptions about future events that can have a material impact on the amounts reported in our consolidated financial statements and accompanying notes. The determination of estimates requires the use of assumptions and the exercise of judgment and as such actual results could differ from those estimated. Our significant accounting policies are described in Note 2 to our audited consolidated financial statements for fiscal 2010, included in our Annual Report. The following critical accounting policies are those that we believe require a high level of subjectivity and judgment and have a material impact on our financial condition and operating performance: revenue recognition, allowance for doubtful accounts and the lease recourse liability, provisions for inventory, provisions for product warranties, long-lived asset depreciation, goodwill valuation, special charges, contingencies, deferred taxes, pension and post-retirement benefits, and the valuation of stock options, warrants and other derivative instruments. The following critical accounting policies have been updated from the disclosure provided in our Annual Report.

Sales-Type Leases, reserves

Our total reserve for losses related to the entire lease portfolio, including amounts classified as accounts receivable on our balance sheet was 5.7% of the ending aggregate lease portfolio as of October 31, 2010 approximately unchanged from 5.6% at April 30, 2010. The reserve is based on a review past write-off experience and a review of the accounts receivable aging. We believe our reserves are adequate to cover future potential write-offs. Should, however, the financial condition of our customers deteriorate in the future, additional reserves in amounts that could be material to the financial statements could be required.

Allowance for Doubtful Accounts

Our allowance for doubtful accounts is based on our assessment of the collectibility of customer accounts. A considerable amount of judgment is required in order to make this assessment including a detailed analysis of the aging of our accounts receivable, the current credit worthiness of our customers and an analysis of historical bad debts and other adjustments. If there is a deterioration of a major customer’s credit worthiness or actual defaults are higher than our historical experience, our estimate of the recoverability of amounts due could be adversely affected. We review in detail our allowance for doubtful accounts on a quarterly basis and adjust the allowance amount estimate to reflect actual portfolio performance and change in future portfolio performance expectations. As of October 31, 2010 and April 30, 2010, the provision represented 7.2% and 8.9% of gross receivables, respectively. The decrease in reserve level from April 30, 2010 was due to write-offs of accounts receivable during the first quarter of fiscal 2011. Substantially all of the write-offs in the first quarter were already fully provided for at April 30, 2010. Adjusting for the April 30, 2010 provision for the write-offs, the provision would have represented 7.5% of gross receivables, consistent with the October 31, 2010 provision.

Deferred Taxes

We have significant net deferred tax assets resulting from operating loss carryforwards, tax credit carryforwards and deductible temporary differences that may reduce taxable income in future periods. In assessing the realizability of deferred tax assets, management considers, on a periodic basis, whether it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. This assessment is based on a number of factors, including our estimate of future taxable income in each tax jurisdiction in which the Company operates, the number of years over which the deferred tax assets will be recoverable, and scheduled reversals of deferred tax liabilities. To the extent that recovery is not believed to be more-likely-than-not, a valuation allowance is recorded. Our valuation allowance may increase or decrease materially period-to-period as we update our assessment, in particular relating to our estimate of future taxable income in each tax jurisdiction.

In the three months ended October 31, 2010, we released approximately $80.0 million of valuation allowance, net of a provision for uncertain tax positions, based on our assessment that it was now more likely than not that the benefit from certain Canadian deferred tax assets will be realized. At October 31, 2010, based on uncertainty regarding the future utilization of net deferred tax assets primarily in Canada and the United Kingdom, our balance sheet contains a $75.9 million valuation allowance against $216.6 million of deferred tax assets.

 

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Numerous taxing authorities in the jurisdictions in which we do business are increasing their scrutiny of various tax positions taken by businesses. We believe that we maintain adequate tax reserves to offset the potential tax liabilities that may arise upon audit in these jurisdictions. If such amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary. If such amounts ultimately prove to be less than the ultimate assessment, a future charge to expense may result.

Stock-Based Compensation

The fair value of the stock options granted is estimated on the grant date using the Black-Scholes-Merton option-pricing model for each award, net of estimated forfeitures, and is recognized over the employee’s requisite service period, which is generally the vesting period. The assumptions used in the Black-Scholes-Merton option-pricing model for the options granted in the first quarter and second quarter of fiscal 2011 were as follows:

 

     First Quarter of
Fiscal 2011
    Second Quarter of
Fiscal 2011
 

Number of options granted (in millions)

     1.4        0.3   

Risk-free interest rate

     1.76     1.43

Dividends

     0     0