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EX-32.2 - CERTIFICATION BY CFO PURSUANT TO SECTION 906 - MITEL NETWORKS CORPdex322.htm
EX-21.1 - SUBSIDIARIES OF MITEL - MITEL NETWORKS CORPdex211.htm
EX-31.1 - CERTIFICATION BY CEO PURSUANT TO SECTION 302 - MITEL NETWORKS CORPdex311.htm
EX-23.1 - CONSENT OF DELOITTE & TOUCHE LLP - MITEL NETWORKS CORPdex231.htm
EX-32.1 - CERTIFICATION BY CEO PURSUANT TO SECTION 906 - MITEL NETWORKS CORPdex321.htm
EX-31.2 - CERTIFICATION BY CFO PURSUANT TO SECTION 302 - MITEL NETWORKS CORPdex312.htm
EX-10.3F - AMENDMENT NO. 6 DATED AUGUST 31, 2010 TO THE FIRST LIEN CREDIT AGREEMENT - MITEL NETWORKS CORPdex103f.htm
EX-10.16G - AMENDMENT NO. 7 TO THE R & D PROJECT AGREEMENT DATED MARCH 10, 2010 - MITEL NETWORKS CORPdex1016g.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

 

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

For the Fiscal Year Ended April 30, 2011

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   3661   98-0621254

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

350 Legget Drive

Ottawa, Ontario

Canada K2K 2W7

(613) 592-2122

(Address, including zip code, and telephone number, including area code, of

Registrant’s principal executive offices)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Shares, no par value   NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act:

None.

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

 

Large accelerated filer   ¨    Accelerated Filer   x
Non-accelerated filer   ¨  (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

As of June 15, 2011, there were 53,183,509 common shares outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

 

 


Table of Contents

EXPLANATORY NOTE

Mitel Networks Corporation (the “Company”) qualifies as a foreign private issuer for purposes of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). Instead of filing annual and periodic reports on forms available for foreign private issuers, the Company is filing this annual report on Form 10-K (this “Report” or “Annual Report”) and has been filing and expects to continue to file quarterly reports on Form 10-Q and current reports on Form 8-K. However, as a Canadian foreign private issuer, the Company prepares and files its management information circulars and related materials in accordance with Canadian corporate and securities law requirements. As the Company’s management information circular is not prepared and filed pursuant to Regulation 14A, the Company may not incorporate by reference information required by Part III of this Report from its management information circular, and accordingly has included that information in this Report on Form 10-K.

All dollar amounts quoted in this Report are provided in currency of the United States unless otherwise stated.


Table of Contents

MITEL NETWORKS CORPORATION

2011 FORM 10–K ANNUAL REPORT

TABLE OF CONTENTS

 

PART I   

Item 1.

 

Business

     2   

Item 1A.

 

Risk Factors

     7   

Item 1B.

 

Unresolved Staff Comments

     22   

Item 2.

 

Properties

     23   

Item 3.

 

Legal Proceedings

     23   
PART II   

Item 5.

 

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     24   

Item 6.

 

Selected Financial Data

     26   

Item 7.

 

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

     29   

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

     53   

Item 8.

 

Financial Statements and Supplementary Data

     55   

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     96   

Item 9A.

 

Controls and Procedures

     96   

Item 9B.

 

Other Information

     97   
PART III   

Item 10.

 

Directors, Executive Officers and Corporate Governance

     98   

Item 11.

 

Executive Compensation

     105   

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     119   

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     122   

Item 14.

 

Principal Accounting Fees and Services

     126   
PART IV   

Item 15.

 

Exhibits and Financial Statement Schedules

     127   
 

Signatures

     128   

 

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PART I

 

Item 1. Business

The Company

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 which supports up to 65,000 users. Our Internet Protocol, or 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 unified communications and collaboration, or UCC, applications that integrate voice, video and data communications with business applications. We refer to these IP telephony platforms and UCC applications as integrated communications solutions, because they meet our customers’ specific communications needs. We believe that our solutions, which can include associated managed and network services, enable our customers to realize significant cost benefits and to conduct their business more effectively.

We have delivered innovative communications solutions to our customers for over 35 years, initially through Mitel Corporation, our predecessor business. Since the introduction of our IP-based systems in 1999, we have shipped more than 150,000 IP-based appliances to support the communications needs of over 7.2 million users. Our solutions are scalable, flexible and easy to deploy, manage and use. We have designed our software and appliances to allow access to our solutions from mobile devices. Our solutions interoperate with various systems supplied by other vendors, which allows our customers to preserve their existing communications investments and gives them the flexibility to choose the solutions that best meet their particular needs. We also offer our customers the flexibility of an end-to-end solution, in which our appliances and applications are integrated with our managed services (including a combination of leasing, design and field services) and network services (including fixed and mobile voice and data connectivity, long distance and hosted applications).

For more than a decade, we have made a significant investment in developing our IP-based communications solutions and transitioning our distribution channels to take advantage of the industry’s shift from legacy systems to IP-based communications solutions, including UCC applications. Our research and development, or R&D, has produced a global portfolio of over 1,400 patents and pending applications, and provides us with the expertise to anticipate market trends and meet the current and future needs of our customers. Today, we have a direct and indirect distribution channel, which as of June 15, 2011 addresses the needs of customers in over 100 countries through our 76 offices and more than 1,600 channel partners worldwide.

Our segments for financial reporting purposes are: the United States; Europe, Middle East & Africa; Canada and Caribbean & Latin America; and Asia Pacific. Financial information about these segments is set forth in Item 7 of this Report. In addition, reference should be made to the Consolidated Financial Statements and Supplementary Data in Item 8 for further information regarding revenues, segment operating profit and loss, total assets attributable to our segments, and for financial information attributable to certain geographic areas.

We completed our initial public offering (“IPO”) of our common shares on April 27, 2010. Our common shares are listed on The Nasdaq Global Market under the symbol “MITL”.

Our Solutions

Our IP-based communications solutions include 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. These can be complemented with our network services and managed services.

We focus on ensuring that our products address a broad range of customer and geographic markets. Our solutions are scalable, flexible and easy to deploy, manage and use. We believe that our solutions, including our managed and network services, enable our customers to realize significant cost benefits and to conduct their business more effectively.

IP Telephony Platforms

Software

Our IP telephony software provides the foundation of our integrated communication solutions. In order to efficiently address specific markets, taking into account business size, operations, infrastructure, deployment and price, our IP telephony software may be deployed on virtualized data center infrastructure, industry standard servers or on functionally optimized appliances.

Our Mitel Communications Director, or MCD, is a software product suitable for small to large enterprises addressing both pure-IP telephony and hybrid IP telephony markets worldwide. This software performs a variety of functions, including multi-media call control and communications, which allow business users to reach each other, share information and collaborate. MCD can be

 

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deployed in virtualized data center environments, on industry standard servers or on the Mitel 3300 ICP appliance. Our Multi-instance Communications Director, or MiCD, uses virtualization techniques to run multiple MCDs on a single server. To address businesses that have multiple locations and geographically dispersed data centers, the MCD, and its MiCD and 3300 ICP variants, can be deployed across many different locations yet integrated to create a seamless system. This platform forms the basis of our network services offering within a hosted environment.

Appliances

Our appliances are optimized yet expandable packages combining the more popular software and hardware capabilities of their intended market. These appliances include:

 

   

Our Mitel 3300 ICP bundles MCD, certain mobility and UCC applications as well as legacy connectivity, and can be deployed, if required, as a simple IP to legacy gateway and upgraded through licensing to a fully integrated communications appliance.

 

   

Our Mitel 5000 CP is an integrated communications appliance addressing the unique feature requirements in North America and the United Kingdom for small businesses with 20 to 250 users. The Mitel 5000 CP addresses both IP and traditional communications needs through an IP-centric hybrid architecture, which allows us to leverage existing customer infrastructure.

 

   

Our Mitel 1000/3000 CS serves the two to 30 user segment of the small business market with our Mitel 1000 and 3000 integrated communications appliances. These appliances provide complete communications capability and broadband and wireless connectivity in a single unit, utilizing a common hardware and software architecture.

Desktop Devices

Our desktop devices include a broad range of IP and digital phones, specialty desktop devices and peripherals, which are recognized in the industry for ease of use, feature set and style. Our IP phones are designed to work across our IP telephony software and appliances, allowing businesses to retain their existing phones as their requirements evolve and providing our channels to market with the ability to minimize their fulfillment and training requirements. These phones also support the SIP standard, allowing them to be used with telephony products supplied by other vendors. Our mid-market and premium IP phones have large, high quality graphical displays which enable easy access to a variety of business applications and web content.

We also offer a variety of specialty desktop devices, including IP operator consoles and conference units, and peripherals that augment our desktop devices. These peripherals include cordless handsets and headsets, receptionist key modules and other modules such as Wi-Fi and gigabit Ethernet connectivity, Oracle’s Sun Ray thin client and local phone line integration that enable local enhanced 9-1-1 calling for remote workers. In addition, we partner with industry leading vendors to provide other specialized devices, such as Wi-Fi and wireless phones.

UCC Applications

We offer a broad range of UCC applications that can be deployed in a variety of ways. Our UCC suite of applications work across our MCD and Mitel 5000 platforms, and can also be deployed on industry standard servers in data centers or on our own appliances such as the 3300 ICP. Our UCC applications include:

 

   

Unified Communicator Advanced—single-user interface to access all unified communications capabilities, including desktop, web and mobile phone, with features that include soft phone capabilities and presence.

 

   

Mobility—extends business communications capabilities to mobile devices, improving the ability of employees to connect with the office and be productive.

 

   

Mitel TeleCollaboration Solution—high definition telepresence, integrated with collaboration and desktop sharing.

 

   

Customer Interaction Solutions—multi-media capable application for the operation and management of contact centers.

 

   

Unified Messaging—unified multi-media messaging, including email, fax and voicemail, with integration into messaging products such as Microsoft Exchange and IBM Lotus Notes.

 

   

Audio, Video & Web Conferencing—collaboration and conferencing tools for users including audio and video conferencing, webcasting and document sharing.

 

   

Speech Auto Attendant—automated attendant allowing incoming callers to select departments and reach employees by speaking their names.

 

   

Teleworker Solution—simple and secure Mitel and SIP telephone operation and communications for remote and home based users over the public internet.

 

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Business Dashboard—easy to use business analytics of communications system usage.

Network services

We offer connectivity and network services and hosted applications, which we refer to as network services that can be integrated with our products and delivered as part of our managed services. Our network services are offered only in the United States and are branded as NetSolutions®. We are licensed as a competitive local exchange carrier in 49 states in the U.S. and purchase network capacity wholesale from carriers, which we resell to our customers in various retail offerings. We do not operate our own network. Our network services enable us to offer our product solutions from the public network or in combination with our enterprise based products. NetSolutions® include the following types of services:

 

   

local access services;

 

   

long distance services;

 

   

mobile voice and data services;

 

   

data services such as internet access and private networking services;

 

   

hosted offerings such as network monitoring and management, audio conferencing, web conferencing, hosted secure internet access and web hosting; and

 

   

hosted IP Telephony based on our MiCD software.

Managed services

We offer a comprehensive managed services portfolio to our customers. These managed services provide our customers with flexibility in integrating our solutions with their particular financial and operational needs. Our managed services include:

 

   

lifecycle management, such as project management, installation, training, maintenance, professional services, consulting, business requirements review and disaster recovery planning;

 

   

support, including product warranty and core software upgrades;

 

   

benefits such as a guaranteed renewal option, risk of loss coverage, fixed migration pricing, upgrade and expansion flexibility; and

 

   

financing of our solutions.

We offer a comprehensive package of managed services in the United States branded as the TotalSolution® program. We also offer some combination of our managed services in certain other countries.

Partnerships

One important result of the evolution of integrated communications solutions is the simplicity with which products and services, from a variety of sources, can be easily integrated to provide a better solution for customers. By partnering with others, we can concentrate on our core areas of expertise while leveraging the capabilities of our partners for the benefit of our customers. We have four key types of partnerships: strategic alliances, operational partners, affiliates and solution alliances.

 

   

Our strategic alliances are generally with leaders in adjacent markets or complementary technologies which, when combined with our products and services, create beneficial solutions for our customers. Our strategic partners include Oracle Corporation, Research in Motion Limited, and VMware, Inc.

 

   

Our operational partners allow us to leverage their capabilities to optimize our operational expenses. These include external developers, contract manufacturers, integrators, consultants and professional services.

 

   

Our affiliate program with Wesley Clover International Corporation (“Wesley Clover”), a company controlled by Dr. Terence H. Matthews, the chairman of our Board of Directors, allows us to benefit from early investment in complementary emerging technologies by Wesley Clover and its subsidiaries.

 

   

We have a large number of solution alliance partners who offer complementary solutions and expertise in areas that are not core to our business, many of which are integrated into our applications. We also provide access to market for our partners by allowing our channel partners to purchase these third party products through our Datanet division.

Customers

Since the introduction of our IP-based systems in 1999, we have shipped more than 150,000 IP-based appliances to support the communications needs of over 7.2 million users. Our largest customer represented only 1.6% of our revenues in fiscal 2011. Our broad customer base reflects our historical strength in the SME market as well as continued penetration among large enterprises.

 

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We have also developed a comprehensive understanding of certain vertical markets such as education, government, healthcare, hospitality and retail. Our solutions can be tailored to meet the business communications needs of these and other vertical markets.

Sales and Marketing

We have a direct and indirect distribution channel, which addresses the needs of customers in over 100 countries through our 76 offices and more than 1,600 channel partners worldwide. We differentiate our solutions and enhance our channels to market through strategic relationships with innovative strategic partners.

Our distribution network includes value-added resellers, service providers, high-touch sales and direct channel. We complement and support our channel partners in selected markets using a sales model whereby our sales staff works either directly with a prospective customer or in coordination with a channel partner in defining the scope, design and implementation of the solution.

Our channel partners are supported by teams of regional account managers, systems engineers, technical account managers and support staff. To complement our channel partner network, we also provide support to independent consultants who assist companies with network design, implementation and vendor selection.

We believe our extensive channel partner network combined with our corporate and regional support allows us to scale our business for volume and sell our solutions globally, resulting in an efficient cost of sale model. We recruit our channel partners with a focus on expanding our market coverage and supporting the skills needed to successfully sell, implement and support IP-based communications solutions. Where we can benefit from operational savings, we perform our own product fulfillment and order logistics, rather than relying on a wholesale distribution network. By performing these functions ourselves, we support our strategy of ensuring global continuity of supply by leveraging in-house logistics, distribution and inventory management with our contract manufacturers. We provide a secure, internet-based distribution and licensing capability for software fulfillment and upgrades, which provides efficiency and reduced distribution costs.

Our marketing organization employs a comprehensive strategy to enhance our brand and brand attributes, generate demand, attract and retain channel partners, differentiate our product offerings and develop solutions for specific industry markets. Brand development is conducted through advertising, media articles, trade conferences, launch campaigns, analyst and public relations, social media and web content delivery. We view public relations as a key element of our marketing strategy to increase our brand awareness. Our channel marketing programs are designed and administered to provide benefits and incentives to ensure competencies, customer satisfaction and quality in the delivery of our solutions to market. Sales promotions and campaigns are conducted for channel partners and customers, to encourage the sale of specific products or in support of new product introductions. Our marketing organization conducts product launches and develops materials and programs for our portfolio of solutions. We also operate demonstration and executive briefing centers equipped with our latest solutions. These centers are used by both our channel partners and our own staff to demonstrate our solutions to existing and prospective customers.

Manufacturing and Supply Chain Management

A significant amount of our portfolio consists of appliances and desktop devices. Our objective is to deliver high quality and differentiated products to our channel partners and customers while optimizing our operational cost structure and ensuring continuity of supply. To enable this, we use a three-pronged strategy, which includes: leveraging our contract manufacturers and component suppliers; protecting supply continuity; and ensuring manufacturing portability across manufacturers.

 

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We use high volume contract manufacturers and component suppliers. We require our component suppliers to make information visible so that we can assess their performance for technical innovation, financial strength, quality, support and operational effectiveness. Our primary contract manufacturers are Flextronics International Ltd. (“Flextronics”) and Sanmina-SCI Corporation (“Sanmina”). We have had a manufacturing relationship with Flextronics since 2006 and with Sanmina (through its acquisition of BreconRidge Manufacturing Solutions Corporation (“BreconRidge”)) since 2001. We do not have any long term purchase commitments with either contract manufacturer.

In order to ensure our continuity of supply and reduce supply chain barriers, our products are designed for manufacturing portability. Approximately 95% of our hardware revenue is portable between contract manufacturers, with a lead time of typically not more than 14 weeks. We also implement portable designs by limiting the use of custom and sole source components and adhering to industry standard Design For Manufacture and Design For Test guidelines. We dual source the majority of our high volume products, including our core IP telephony platforms. Approximately 52% of our hardware is currently dual sourced, primarily between Flextronics and Sanmina. However, approximately 5% of hardware, primarily legacy systems and devices, are sole sourced.

We manage our own product distribution facilities either directly or through the use of third party logistics management specialists, and, in some regions, wholesale distributors, all of which are managed by our logistics team. This is implemented with geographically diverse points of distribution, with our principal facilities being in the United States, Canada and Europe.

Research and Development

Our history of success as an early adopter in software-based communications solutions has provided us with the foundation for continued innovation in IP-based communication solutions and UCC applications. We have invested in our R&D practices to take advantage of new methodologies, in part enabled by the technology shift itself. Our R&D efforts are focused on initiatives which we believe are highly likely to provide compelling returns. We achieve this goal through effective partnerships, lead customer engagement, operational measurement and organizational best practices.

At April 30, 2011, our R&D organization was comprised of 357 personnel. Our R&D personnel are primarily located in three locations: Ottawa, Canada; Chandler, Arizona; and Dublin, Ireland. Our center in Ottawa, Canada is responsible for our MCD platform as well as our messaging, contact center and mobility centered applications. Our center in Chandler, Arizona, near Phoenix, is responsible for our products focused on the SME market and our advanced collaboration applications. Our center in Dublin, Ireland is responsible for our small and very small business products. Please see Item 6, “Selected Financial Data”, of Part II in this Report for the amount spent during each of the last three fiscal years on R&D activities determined in accordance with U.S. generally accepted accounting principles, or GAAP.

Intellectual Property

Our intellectual property assets include patents, industrial designs, trademarks, proprietary software, copyrights, domain names, operating and instruction manuals, trade secrets and confidential business information. These assets are important to our competitiveness and we continue to expand our intellectual property portfolio in order to protect our rights in new technologies and markets. We have a broad portfolio of over 1,400 patents and pending applications, covering over 500 inventions, in areas such as Voice-over IP, or VoIP, collaboration and presence.

We leverage our intellectual property by asserting our rights in certain patented technologies. Certain companies have licensed or offered to purchase patents within our portfolio. We believe that our patent portfolio helps us counter allegations of infringement on the patents held by our competitors.

Our solutions contain software applications and hardware components that are either developed and owned by us or licensed to us by third parties. The majority of the software code embodied in each of our core call-processing software, IP-based teleworker software, wireless telephony software applications, integrated messaging and voicemail software and collaboration interfaces has been developed internally and is owned by us.

In some cases, we have obtained non-exclusive licenses from third parties to use, integrate and distribute with our products certain packaged software, as well as customized software. This third party software is either integrated into our own software applications or is sold as separate self-contained applications, such as voicemail or unified messaging. The majority of the software that we license is packaged software that is made generally available and has not been customized for our specific purpose. If any of our third party licenses were to terminate, our options would be to either license a functionally equivalent software application or develop the functionally equivalent software application ourselves.

We have also entered into a number of non-exclusive license agreements with third parties to use, integrate and distribute certain operating systems, digital signal processors and semiconductor components as part of our communications platforms. If any of these third party licenses were to terminate, we would need to license functionally equivalent technology from another supplier.

 

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It is our general practice to include confidentiality and non-disclosure provisions in the agreements entered into with our employees, consultants, manufacturers, end-users, channel partners and others to attempt to limit access to and distribution of our proprietary information. In addition, it is our practice to enter into agreements with employees that include an assignment to us of all intellectual property developed in the course of their employment.

Employees

At April 30, 2011, we had 2,199 employees and at the end of fiscal 2010 and fiscal 2009 we had 2,367 and 2,452 employees, respectively. Our future success depends in large part on our ability to attract, retain and motivate our highly skilled managerial, professional and technical resources. Our compensation programs include opportunities for regular annual salary reviews, bonuses and stock options. Many of our employees are also common shareholders and over 79.5% of our employees hold options to acquire our common shares. We continue to actively recruit skilled employees and we believe that relations with our employees are generally positive.

Competition

Our competition is primarily from two groups of vendors: traditional IP communications vendors and software vendors who are adding communications and collaboration solutions to their offerings.

We compete against many traditional IP communications vendors, including in particular Avaya Inc. and Cisco Systems, Inc., as well as Aastra Technologies Limited, Alcatel-Lucent S.A., NEC Corporation, Panasonic Corporation, ShoreTel, Inc., Siemens Enterprise Networks and Toshiba Corporation.

The second group of competitors consists of software vendors who, in recent years, have expanded their offerings to address the UCC market. These competitors include Microsoft Corporation and Google Inc.

Our industry is also experiencing significant vendor consolidation. In the recent past, Avaya Inc. acquired Nortel Network’s Enterprise Solutions business, Cisco Systems, Inc. acquired TANDBERG ASA and Hewlett-Packard Company acquired 3Com Corporation. We believe this consolidation continues to create an opportunity for vendors like us to capitalize on disruption among the channel partners of these consolidated businesses as a result of channel overlap or incompatible channel compensation arrangements.

Availability of Information

We are currently a foreign private issuer for the purposes of the Exchange Act. We have filed and expect to continue to file our annual reports on Form 10-K, our quarterly reports on Form 10-Q and current reports on Form 8-K instead of filing annual and current reports on forms available for foreign private issuers. We prepare and file our management information circulars and related materials under Canadian corporate and securities law requirements, and as a foreign private issuer we are exempt from the requirements of Regulation 14A under the Exchange Act.

We make available, through our internet website for investors (http://investor.mitel.com), our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after electronically filing such material with the SEC and with Canadian securities regulators. The reference to our website address does not constitute incorporation by reference of the information contained on the website and should not be considered part of this document.

 

Item 1A. Risk Factors

Certain information contained in this 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,” “target”, “outlook”, “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 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 sustain profitability in the future;

 

   

fluctuations in our quarterly and annual revenues and operating results;

 

   

the successful implementation of our newly announced strategic plan;

 

   

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

 

   

global economic conditions;

 

   

intense competition;

 

   

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

 

   

failure of the market for UCC to evolve as we expect;

 

   

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

 

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

 

   

our ability to access additional sources of funds;

 

   

risks related to our level of indebtedness;

 

   

fluctuations in our working capital requirements and cash flows;

 

   

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 foreign exchange rates;

 

   

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;

 

   

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

 

   

our ability to successfully integrate future strategic acquisitions;

 

   

problems with the infrastructure of carriers;

 

   

our ability to successfully implement and achieve our business strategies; and

 

   

reliance on key personnel.

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 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 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 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 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.

 

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Risks Relating to our Business

We may not be able to sustain profitability in the future.

In fiscal 2011 and fiscal 2010, we had net income of $88.1 and $37.2 million, respectively, but we incurred a net loss of $193.5 million in fiscal 2009. Although we recorded net income of $12.6 million for fiscal 2008 we recorded a net loss in each other year since our incorporation in 2001. We have incurred restructuring charges in fiscal 2011 and prior periods and may incur additional restructuring charges in the future. Our future success in sustaining our recent profitability and growing our revenues and market share for our solutions depends, among other things, upon our ability to develop and sell solutions that have a competitive advantage, to build our brand image and reputation, to attract orders from new and existing customers and to reduce our costs as a proportion of our revenues by, among other things, increasing efficiency in design, component sourcing, manufacturing and assembly cost processes. We may not be able to achieve such success or sustain our recent profitability.

Our quarterly and annual revenues and operating results have historically fluctuated, and the results of one period may not provide a reliable indicator of our future performance.

Our quarterly and annual revenues and operating results have historically fluctuated and are not necessarily indicative of results to be expected in future periods. A number of factors may cause our financial results to fluctuate significantly from period to period, including:

 

   

the fact that an individual order or contract can represent a substantial amount of revenues for that period;

 

   

the size, timing and shipment of individual orders;

 

   

changes in pricing or discount levels by us or our competitors;

 

   

changes in foreign currency exchange rates;

 

   

the mix of products sold by us;

 

   

the timing of the announcement, introduction and delivery of new products or product enhancements by us or our competitors;

 

   

the ability to execute on our strategy and operating plans;

 

   

general economic conditions;

 

   

ability to realize our deferred tax assets; and

 

   

changes in tax laws, regulations or accounting rules.

As a result of the above factors, a quarterly or yearly comparison of our results of operations is not necessarily meaningful. Prior results are not necessarily indicative of results to be expected in future periods.

If changes to our business strategy are not successfully implemented and accepted by our customers, our business could be negatively affected.

In May 2011, we announced the implementation of key changes to our business strategy involving, among other things:

 

   

Simplifying our business model to more effectively and efficiently support the sales, licensing and marketing of our communications solutions to customers;

 

   

Reallocating our spending on R&D with greater emphasis on integrated communications solutions that support the needs of customers that have between 100 and 2,500 users;

 

   

Reorganizing our U.S. sales organization by increasing investment in our indirect channel, and focusing our direct sales team on a select group of customers; and

 

   

Continuing our investment, and increasing our market leadership, in voice virtualization.

We expect to continue to shift resources to support these changes. If these changes to our business strategy are not aligned with the direction our customers take as they invest in the evolution of their networks and telephony needs, our customers may not buy our solutions or continue to use our services. Any failure by us to successfully execute on one more changes to our business strategy could adversely impact our business and results of operations.

 

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We rely on our channel partners for a significant component of our sales, and disruptions to, or our failure to effectively develop and manage, our distribution channel and the processes and procedures that support it could adversely affect our ability to generate revenues.

Our future success is highly dependent upon establishing and maintaining successful relationships with a variety of channel partners. A substantial portion of our revenues is derived through our channel partners, most of which also sell our competitors’ products. Our revenues depend in part on the performance of these channel partners. The loss of or reduction in sales to these channel partners could materially reduce our revenues. Our competitors may in some cases be effective in causing our channel partners or potential channel partners to favor their products or prevent or reduce sales of our solutions. If we fail to maintain relationships with these channel partners, fail to develop new relationships with channel partners in new markets or expand the number of channel partners in existing markets, or if we fail to manage, train or provide appropriate incentives to existing channel partners or if these channel partners are not successful in their sales efforts, sales of our solutions may decrease and our operating results would suffer.

Many potential channel partners in the voice communications business have established relationships with our competitors and may not be willing to invest the time and resources required to train their staff to effectively market our solutions and services. Potential channel partners engaged in the data and software applications communications businesses are less likely to have established relationships with our competitors, but where they are unfamiliar with the voice communications business, they may require substantially more training and other resources to be qualified to sell our solutions. The majority of our channel partners sell our solutions to the SME market. In the future, we hope to further penetrate the large enterprise market. However, our existing channel partners may not be effective in selling to large enterprises.

Global economic conditions in our key markets, particularly the United States and the United Kingdom, have adversely affected our business over the past two years and could adversely affect our revenues and harm our business in the future.

In fiscal 2009 and fiscal 2010, our operating results were affected by the global economic downturn, which started in mid calendar year 2008. Many of our customers, particularly in the United States and the United Kingdom, responded to the financial and credit crises and general macroeconomic uncertainty by suspending, delaying or reducing their capital expenditures which negatively impacted our revenues.

Despite some recent signs of economic recovery and stabilization of our revenues in fiscal 2011, global economic concerns such as the varying pace of the economic recovery and the recent sovereign debt crisis in Europe continue to create uncertainty and unpredictability for us, particularly in the United States and the United Kingdom. Unfavorable global economic conditions may negatively impact technology spending on our products and services and could materially adversely affect our business, operating results and financial condition.

We face intense competition from many competitors and we may not be able to compete effectively against these competitors.

The market for our solutions is highly competitive. We compete against many companies, including and in particular Avaya Inc. and Cisco Systems, Inc., as well as Aastra Technologies Limited, Alcatel-Lucent S.A., NEC Corporation, Panasonic Corporation, ShoreTel, Inc., Siemens Enterprise Networks and Toshiba Corporation. In addition, because the market for our solutions is subject to rapidly changing technologies, we may face competition in the future from companies that do not currently compete in our business communications market, including companies that currently compete in other sectors of the information technology, communications or software industries, such as Microsoft Corporation and Google Inc., mobile communications companies or communications companies that serve residential, rather than business, customers. Our industry has also experienced and may continue to experience consolidation that may adversely impact our competitive position. In recent years, Avaya Inc. acquired Nortel Network’s Enterprise Solutions business, Cisco Systems, Inc. acquired TANDBERG ASA and Hewlett-Packard Company acquired 3Com Corporation.

Several of our existing competitors have, and many of our future potential competitors may have, greater financial, personnel, research, project management and other resources, more well-established brands or reputations and broader customer bases than we have. As a result, these competitors may be in a stronger position to respond more quickly to potential acquisitions and other market opportunities, new or emerging technologies and changes in customer requirements. Some of these competitors may also have customer bases that are more diversified than ours and therefore may be less affected by an economic downturn in a particular region. Competitors with greater resources may also be able to offer lower prices, additional products or services or other incentives that we do not offer or cannot match. In addition, existing customers of data communications companies that compete against us may be more inclined to purchase business communications solutions from their current data communications vendor than from us. We cannot predict which competitors may enter our markets in the future, what form the competition may take or whether we will be able to respond effectively to the entry of new competitors or the rapid evolution in technology and product development that has characterized our markets.

 

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Competition from existing and potential market entrants may take many forms. Our products must interface with customer software, equipment and systems in their networks, each of which may have different specifications. To the extent our competitors supply network software, equipment or systems to our customers, it is possible these competitors could design their technologies to be closed or proprietary systems that are incompatible with our products or work less effectively with our products than their own. As a result, customers would have an incentive to purchase products that are compatible with the products and technologies of our competitors over our products. A lack of interoperability may result in significant redesign costs, and harm relations with our customers. If our products do not interoperate with our customers’ networks, installations could be delayed or orders for our products could be cancelled, which would result in losses of revenues and customers that could significantly harm our business. In addition, our competitors may provide large bundled offerings that incorporate applications and products similar to those that we offer. If our competitors offer deep discounts on certain products or services in an effort to recapture or gain market share, we may be required to lower our prices or offer other favorable terms to compete effectively, which would reduce our margins and could adversely affect our operating results and financial condition.

Our solutions may fail to keep pace with rapidly changing technology and evolving industry standards.

The markets for our solutions are characterized by rapidly changing technology, evolving industry standards, frequent new product introductions, short product life cycles and changing business models. Therefore, our operating results depend, among other things, on existing and new markets, our ability to develop and introduce new solutions and our ability to reduce the production costs of existing solutions. The process of anticipating trends and evolving industry standards and developing new solutions is complex and uncertain, and if we fail to accurately predict and respond to our customers’ changing needs, and emerging technological trends, our business could be harmed. We commit significant resources to developing new solutions before knowing whether our investments will result in solutions that the market will accept. The success of new solutions depends on several factors, including new application and product definition, component costs, timely completion and introduction of these solutions, differentiation of new solutions from those of our competitors and market acceptance of these solutions. We may not be able to successfully identify new market opportunities for our solutions, develop and bring new solutions to market in a timely manner, or achieve market acceptance of our solutions.

The evolving market for UCC is subject to market risks and uncertainties that could cause significant delays and expenses.

We have made a significant investment in developing our IP-based communications solutions and transitioning our distribution channels to take advantage of the industry’s shift from legacy systems to IP-based communications solutions, including UCC applications. The market for UCC applications is evolving rapidly and is characterized by an increasing number of market entrants. As is typical of a rapidly evolving industry, the demand for and market acceptance of UCC applications is uncertain. If the market for UCC applications fails to develop, develops more slowly than we anticipate or develops in a manner different than we expect, our solutions could fail to achieve market acceptance, which in turn could significantly harm our business.

Moreover, as UCC usage grows, the infrastructure used to support these services, whether public or private, may not be able to support the demands placed on them and their performance or reliability may decline. Even if UCC becomes more widespread in the future, our solutions may not attain broad market acceptance. The adoption of UCC applications on both desktop computers and mobile devices at a rate faster than we currently anticipate may lead to a decline in the utilization of distinct IP and digital devices and a reduction in our desktop device revenues. In addition, the evolution towards hosted IP telephony and UCC applications delivered as a service may occur faster and more extensively than currently anticipated, which may adversely impact the sale of our non-hosted communications solutions.

We are dependent on our customers’ decisions to deploy IP telephony solutions.

Our business remains dependant on customer decisions to migrate their legacy telephony infrastructure to IP telephony and other advanced service delivery methods. While these investment decisions are often driven by macroeconomic factors, customers may also delay adoption of IP telephony due to a range of other factors, including prioritization of other IT projects and weighing the costs and benefits of deploying new infrastructures and devices. IP telephony adoption among new and additional IP telephony customers may not grow at the rates we currently anticipate.

Our business may be harmed if we infringe intellectual property rights of third parties.

There is considerable patent and other intellectual property development activity in our industry. Our success depends, in part, upon our not infringing intellectual property rights owned by others. Our competitors, as well as a number of individuals, patent holding companies and consortiums, own, or claim to own, intellectual property relating to our industry. Our solutions may infringe the patents or other intellectual property rights of third parties. We cannot determine with certainty whether any existing third party patent, or the issuance of new third party patents, would require us to alter our solutions, obtain licenses, pay royalties or discontinue the sale of the affected applications and products. Our competitors may use their patent portfolios in an increasingly offensive manner in the future. We are currently and periodically involved in patent infringement disputes with third parties, including claims that have

 

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been made against us for the payment of licensing fees. We have received notices in the past, and we may receive additional notices in the future, containing allegations that our solutions are subject to patents or other proprietary rights of third parties, including competitors, patent holding companies and consortiums. Current or future negotiations with third parties to establish license or cross-license arrangements, or to renew existing licenses, may not be successful and we may not be able to obtain or renew a license on satisfactory terms, or at all. If required licenses cannot be obtained, or if existing licenses are not renewed, litigation could have a material adverse effect on our business.

Our success also depends upon our customers’ ability to use our products. Claims of patent infringement have been asserted against some of our channel partners based on their use of our solutions. We generally agree to indemnify and defend our channel partners and direct customers to the extent a claim for infringement is brought against our customers with respect to our solutions.

Aggressive patent litigation is common in our industry and can be disruptive. Infringement claims (or claims for indemnification resulting from infringement claims) have been, are currently and may in the future be asserted or prosecuted against us, our channel partners or our customers by third parties. Some of these third parties, including our competitors, patent holding companies and consortiums, have, or have access to, substantially greater resources than we do and may be better able to sustain the costs of complex patent litigation. Whether or not the claims currently pending against us, our channel partners or our customers, or those that may be brought in the future, have merit, we may be subject to costly and time-consuming legal proceedings. Such claims could also harm our reputation and divert our management’s attention from operating our business. If these claims are successfully asserted against us, we could be required to pay substantial damages (including enhanced damages and attorneys’ fees if infringement is found to be willful). We could also be forced to obtain a license, which may not be available on acceptable terms, if at all, forced to redesign our solutions to make them non-infringing, which redesign may not be possible or, if possible, costly and time-consuming, or prevented from selling some or all of our solutions.

Our success is dependent on our intellectual property. Our inability or failure to secure, protect and maintain our intellectual property could seriously harm our ability to compete and our financial success.

Our success depends on the intellectual property in the solutions that we develop and sell. We rely upon a combination of copyright, patent, trade secrets, trademarks, confidentiality procedures and contractual provisions to protect our proprietary technology. Our present protective measures may not be enforceable or adequate to prevent misappropriation of our technology or independent third-party development of the same or similar technology. Even if our patents are held valid and enforceable, others may be able to design around these patents or develop products competitive to our products but that are outside the scope of our patents.

Any of our patents may be challenged, invalidated, circumvented or rendered unenforceable. We may not be successful should one or more of our patents be challenged for any reason. If our patent claims are rendered invalid or unenforceable, or narrowed in scope, the patent coverage afforded to our solutions could be impaired, which could significantly impede our ability to market our products, negatively affect our competitive position and materially harm our business and operating results.

 

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Pending or future patent applications held by us may not result in an issued patent, or if patents are issued to us, such patents may not provide meaningful protection against competitors or against competitive technologies. We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or trade secrets by consultants, vendors, former employees and current employees, despite the existence of nondisclosure and confidentiality agreements and other contractual restrictions. Furthermore, many foreign jurisdictions offer less protection of intellectual property rights than the United States and Canada, and the protection provided to our proprietary technology by the laws of these and other foreign jurisdictions may not be sufficient to protect our technology. Preventing the unauthorized use of our proprietary technology may be difficult, time consuming and costly, in part because it may be difficult to discover unauthorized use by third parties. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of our proprietary rights, or to defend against claims of unenforceability or invalidity. Any litigation, whether successful or unsuccessful, could result in substantial costs and diversion of management resources and could have a material adverse effect on our business, results of operations and financial condition regardless of its outcome.

Some of the software used with our products, as well as that of some of our customers, may be derived from so-called “open source” software that is made generally available to the public by its authors and/or other third parties. Such open source software is often made available to us under licenses, such as the GNU General Public License, that impose certain obligations on us in the event we were to make derivative works of the open source software. These obligations may require us to make source code for the derivative works available to the public, or license such derivative works under an open source license or another particular type of license, potentially granting third parties certain rights to the software, rather than the forms of license customarily used to protect our intellectual property. Failure to comply with such obligations can result in the termination of our distribution of products that contain the open source code or the public dissemination of any enhancements that we made to the open source code. We may also incur legal expenses in defending against claims that we did not abide by such open source licenses. In the event the copyright holder of any open source software or another party in interest were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be subject to potential damages and could be required to release the source code of that work to the public, grant third parties certain rights to the source code or stop distribution of that work. Any of these outcomes could disrupt our distribution and sale of related products and materially adversely affect our business.

We rely on trade secrets and other forms of non-patent intellectual property protection. If we are unable to protect our trade secrets, other companies may be able to compete more effectively against us.

We rely on trade secrets, know-how and technology that are not protected by patents to maintain our competitive position. We try to protect this information by entering into confidentiality agreements with parties that have access to it, such as our partners, collaborators, employees and consultants. Any of these parties may breach these agreements and we may not have adequate remedies

 

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for any specific breach. In addition, our trade secrets may otherwise become known or be independently discovered by competitors. To the extent that our partners, collaborators, employees and consultants use intellectual property owned by others in their work for us, disputes may arise as to the rights in the related or resulting know-how and inventions. If any of our trade secrets, know-how or other technologies not protected by a patent were to be disclosed to, or independently developed by, a competitor, our business, financial condition and results of operations could be materially adversely affected.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers.

Many of our employees may have been previously employed at other companies which provide integrated communications solutions, including our competitors or potential competitors. We may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying money claims, we may lose valuable intellectual property rights or personnel. A loss of key personnel or their work product could hamper or prevent our ability to commercialize certain product candidates, which would adversely affect our commercial development efforts, business, financial condition and results of operations.

Our business requires a significant amount of cash, and we may require additional sources of funds if our sources of liquidity are unavailable or insufficient to fund our operations.

We may not generate sufficient cash from operations to meet anticipated working capital requirements, support additional capital expenditures or take advantage of acquisition opportunities. In order to finance our business, we may need to utilize available borrowings under our revolving credit facility. Our ability to continually access this facility in the future is conditioned upon our compliance with current and potential future covenants contained in the credit agreements governing our revolving credit facility and term loan facility. We may not be in compliance with such covenants in the future. We may need to secure additional sources of funding if our cash and borrowings under our revolving credit facility are insufficient or unavailable to finance our operations. Such funding may not be available on terms satisfactory to us, 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. If we were to incur higher levels of debt, we would require a larger portion of our operating cash flow to be used to pay principal and interest on our indebtedness. The increased use of cash to pay indebtedness could leave us with insufficient funds to finance our operating activities, such as R&D expenses and capital expenditures. In addition, any new debt instruments may contain covenants or other restrictions that affect our business operations. If we were to raise additional funds by selling equity securities, the relative ownership of our existing investors could be diluted or the new investors could obtain terms more favorable than previous investors.

We have a significant amount of debt, which contains customary default clauses, a breach of which may result in acceleration of the repayment of some or all of this debt.

As of April 30, 2011, we had $188.6 million outstanding under our first lien term loan and $129.8 million outstanding under our second lien term loan. The credit agreements relating to these loans and the revolving credit facility have customary default clauses. In the event we were to default on these credit agreements, and were unable to cure or obtain a waiver of default, the repayment of our debt owing under these credit agreements may be accelerated. If acceleration were to occur, we would be required to secure alternative sources of equity or debt financing to be able to repay the debt. Alternative financing may not be available on terms satisfactory to us, or at all. If acceptable alternative financing were unavailable, we would have to consider alternatives to fund the repayment of the debt, including the sale of part or all of the business, which sale may occur at a distressed price.

Our working capital requirements and cash flows are subject to fluctuation which could have an adverse affect on us.

Our working capital requirements and cash flows have historically been, and are expected to continue to be, subject to quarterly and yearly fluctuations, depending on a number of factors. If we are unable to manage fluctuations in cash flow, our business, operating results and financial condition may be materially adversely affected. For example, if we are unable to effectively manage fluctuations in our cash flows, we may be unable to make required interest payments on our indebtedness. Factors which could result in cash flow fluctuations include:

 

   

the level of sales and the related margins on those sales;

 

   

the collection of receivables;

 

   

the timing and volume of sales of leases to third party funding sources and the timing and volume of any repurchase obligations in respect of such sales;

 

   

the timing and size of capital expenditures;

 

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the timing and size of purchase of inventory and related components;

 

   

the timing of payment on payables and accrued liabilities;

 

   

costs associated with potential restructuring actions; and

 

   

customer financing obligations.

Because we depend upon a small number of outside contract manufacturers, our operations could be delayed or interrupted if we encounter problems with these contractors.

We do not have any internal manufacturing capabilities, and we rely primarily upon two contract manufacturers: Flextronics and Sanmina. Our ability to ship products to our customers could be delayed or interrupted as a result of a variety of factors relating to our contract manufacturers, including:

 

   

failure to effectively manage our contract manufacturer relationships;

 

   

our contract manufacturers experiencing delays, disruptions or quality control problems in their manufacturing operations;

 

   

lead-times for required materials and components varying significantly and being dependent on factors such as the specific supplier, contract terms and the demand for each component at a given time;

 

   

under-estimating our requirements, resulting in our contract manufacturers having inadequate materials and components required to produce our products, or overestimating our requirements, resulting in charges assessed by the contract manufacturers or liabilities for excess inventory, each of which could negatively affect our gross margins; and

 

   

the possible absence of adequate capacity and reduced control over component availability, quality assurances, delivery schedules, manufacturing yields and costs.

We are also exposed to risks relating to the financial viability of our contract manufacturers as a result of business and industry risks that affect those manufacturers. In order to finance their businesses during economic downturns or otherwise, Flextronics and Sanmina may need to secure additional sources of equity or debt financing. Such funding may not be available on terms satisfactory to them, or at all, which could result in a material disruption to our production requirements.

If any of our contract manufacturers are unable or unwilling to continue manufacturing our products in required volumes and quality levels, we will have to identify, qualify, select and implement acceptable alternative manufacturers, which would likely be time consuming and costly. In particular, each of Flextronics and Sanmina are sole manufacturing sources for certain of our products. A failure of either of these parties to satisfy our manufacturing needs on a timely basis, as a result of the factors described above or otherwise, could result in a material disruption to our business until another manufacturer is identified and able to produce the same products, which could take a substantial amount of time, during which our results of operations, financial condition and reputation among our customers and within our industry could be materially and adversely affected. In addition, alternate sources may not be available to us or may not be in a position to satisfy our production requirements on a timely basis or at commercially reasonable prices and quality. Therefore, any significant interruption in manufacturing could result in us being unable to deliver the affected products to meet our customer orders.

We depend on sole source and limited source suppliers for key components. If these components are not available on a timely basis, or at all, we may not be able to meet scheduled product deliveries to our customers.

We depend on sole source and limited source suppliers for key components of our products. In addition, our contract manufacturers often acquire these components through purchase orders and may have no long-term commitments regarding supply or pricing from their suppliers. Lead times for various components may lengthen, which may make certain components scarce. As component demand increases and lead-times become longer, our suppliers may increase component costs. We also depend on anticipated product orders to determine our materials requirements. Lead times for limited source materials and components can be as long as six months, vary significantly and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. From time to time, shortages in allocations of components have resulted in delays in filling orders. Shortages and delays in obtaining components in the future could impede our ability to meet customer orders. Any of these sole source or limited source suppliers could stop producing the components, cease operations entirely, or be acquired by, or enter into exclusive arrangements with, our competitors. As a result, these sole source and limited source suppliers may stop selling their components to our contract manufacturers at commercially reasonable prices, or at all. Any such interruption, delay or inability to obtain these components from alternate sources at acceptable prices and within a reasonable amount of time would adversely affect our ability to meet scheduled product deliveries to our customers and reduce margins realized by us.

 

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Delay in the delivery of, or lack of access to, software or other intellectual property licensed from our suppliers could adversely affect our ability to develop and deliver our solutions on a timely and reliable basis.

Our business may be harmed by a delay in delivery of software applications from one or more of our suppliers. Many of our solutions are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various components in our solutions. These licenses may not be available on acceptable terms, or at all. Moreover, the inclusion in our solutions of software or other intellectual property licensed from third parties on a non-exclusive basis could limit our ability to protect our proprietary rights to our solutions. Non-exclusive licenses also allow our suppliers to develop relationships with, and supply similar or the same software applications to, our competitors. Our software licenses could terminate in the event of a bankruptcy or insolvency of a software supplier or other third party licensor. Our software licenses could also terminate in the event such software infringes third party intellectual property rights. We have not entered into source code escrow agreements with every software supplier or third party licensor, and we could lose the ability to use such licensed software or implement it in our solutions in the event the licensor breaches its obligations to us. In the event that software suppliers or other third party licensors terminate their relationships with us, are unable to fill our orders on a timely basis or their licenses are otherwise terminated, we may be unable to deliver the affected products to meet our customer orders.

Our operations in international markets involve inherent risks that we may not be able to control.

We do business in over 100 countries. Accordingly, our results could be materially and adversely affected by a variety of uncontrollable and changing factors relating to international business operations, including:

 

   

macroeconomic conditions adversely affecting geographies where we do business;

 

   

foreign currency exchange rates;

 

   

political or social unrest or economic instability in a specific country or region;

 

   

higher costs of doing business in foreign countries;

 

   

infringement claims on foreign patents, copyrights or trademark rights;

 

   

difficulties in staffing and managing operations across disparate geographic areas;

 

   

difficulties associated with enforcing agreements and intellectual property rights through foreign legal systems;

 

   

trade protection measures and other regulatory requirements, which affect our ability to import or export our products from or to various countries;

 

   

adverse tax consequences;

 

   

unexpected changes in legal and regulatory requirements;

 

   

military conflict, terrorist activities, natural disasters and medical epidemics; and

 

   

our ability to recruit and retain channel partners in foreign jurisdictions.

Our financial results may be affected by fluctuations in exchange rates, and our current currency hedging strategy may not be sufficient to counter such fluctuations.

Our financial statements are presented in U.S. dollars, while a significant portion of our business is conducted, and a substantial portion of our operating expenses are payable, in currencies other than the U.S. dollar. Due to the substantial volatility of currency exchange rates, exchange rate fluctuations may have an adverse impact on our future revenues or expenses presented in our financial statements. We use financial instruments, principally forward exchange contracts, in our management of foreign currency exposure. These contracts primarily require us to purchase and sell certain foreign currencies with or for U.S. dollars at contracted rates. We may be exposed to a credit loss in the event of non-performance by the counterparties of these contracts. In addition, these financial instruments may not adequately manage our foreign currency exposure. Our results of operations could be adversely affected if we are unable to successfully manage currency fluctuations in the future.

Our financial results will be negatively impacted if we are unable to realize our deferred tax assets

As at our fiscal year end, April 30, 2011, our balance sheet contained a $71.2 million valuation allowance against deferred tax assets. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. Future losses or reduced estimates of future income may result in an increase to the partial valuation allowance or even a full valuation allowance on our deferred tax assets in future periods, which will negatively impact our results. See “Management Discussions & Analysis – Critical Accounting Policies – Deferred Taxes”.

 

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Transfer pricing rules may adversely affect our income tax expenses.

We conduct business operations in various jurisdictions and through legal entities in Canada, the United States, the United Kingdom and elsewhere. We and certain of our subsidiaries provide solutions and services to, and may from time to time undertake certain significant transactions with, other subsidiaries in different jurisdictions. The tax laws of many of these jurisdictions have detailed transfer pricing rules which require that all transactions with non-resident related parties be priced using arm’s length pricing principles. Contemporaneous documentation must exist to support this pricing. The taxation authorities in the jurisdictions where we carry on business could challenge our transfer pricing policies. International transfer pricing is an area of taxation that depends heavily on the underlying facts and circumstances and generally involves a significant degree of judgment. If any of these taxation authorities are successful in challenging our transfer pricing policies, our income tax expense may be adversely affected and we could also be subjected to interest and penalty charges. Any increase in our income tax expense and related interest and penalties could have a significant impact on our future earnings and future cash flows.

Our operating results may be impacted by our ability to sell leases derived from our managed services offering, or a breach of our obligations in respect of such sales.

We offer customers the ability to bundle all their managed service communication expense into a single monthly payment lease, which we then generally pool and sell to third party financial institutions. We derive revenues from the direct sale of pools of leases to third party financial institutions, many of whom have been impacted by challenging macroeconomic events. These leases are recurring revenue streams for us and typically produce attractive gross margins. If we are unable to secure attractive funding rates or sell these leases, our operating results would suffer. The challenging macroeconomic conditions, coupled with our level of indebtedness, have adversely impacted our ability to sell these leases in the past and may do so again in the future. Moreover, particularly in the current economic environment, the timing, volume and profitability of lease sales from quarter to quarter could impact our operating results. We have historically sold these pools of leases at least once per quarter. Furthermore, when the initial term of the lease is concluded, our customers have the option to renew the lease at a payment and term less than the original lease. We have typically held these customer lease renewals on our balance sheet, although we could also elect to sell these renewals to a third party financial institution.

In the event of defaults by lease customers under leases that have been sold, financial institutions that purchased the pool of such leases may require us to repurchase the remaining unpaid portion of such sold leases, subject to certain annual limitations on recourse for credit losses. The size of credit losses may impact our ability to sell future pools of leases.

Under the terms of the program agreements governing the sale of these pools of leases, we are subject to ongoing obligations in connection with the servicing of the underlying leases. If we are unable to perform these obligations or are otherwise in default under a program agreement, and are unable to cure or obtain a waiver of such default, we could be required by the purchaser to repurchase the entire unpaid portion of the leases sold to such purchaser, which could have an adverse effect on our cash flows and financial condition.

Credit and commercial risks and exposures could increase if the financial condition of our customers declines.

We provide or commit to financing, where appropriate, for our customers. Our ability to arrange or provide financing for our customers depends on a number of factors, including our credit rating, our level of available credit and our ability to sell off commitments on acceptable terms. Pursuant to certain of our customer contracts, we deliver solutions representing an important portion of the contract price before receiving any significant payment from the customer. As a result of the financing that may be provided to customers and our commercial risk exposure under long-term contracts, our business could be adversely affected if the financial condition of our customers erodes. Upon the financial failure of a customer, we may experience losses on credit extended and loans made to such customer, losses relating to our commercial risk exposure, and the loss of the customer’s ongoing business. If customers fail to meet their obligations to us or the recurring revenue stream from customer financings is lost, we may experience reduced cash flows and losses in excess of reserves, which could materially adversely impact our results of operations and financial position.

Design defects, errors, failures or “bugs,” which may be difficult to detect, may occur in our solutions.

We sell highly complex solutions that incorporate both hardware and software. Our software may contain “bugs” that can interfere with expected operations. Our pre-shipment testing and field trial programs may not be adequate to detect all defects in individual applications and products or systematic defects that could affect numerous shipments, which might interfere with customer satisfaction, reduce sales opportunities or affect gross margins. In the past, we have had to replace certain components and provide remediation in response to the discovery of defects or “bugs” in solutions that we had shipped. Any future remediation may have a material impact on our business. Our inability to cure an application or product defect could result in the failure of an application or product line, the temporary or permanent withdrawal from an application, product or market, damage to our reputation, inventory costs, lawsuits by customers or customers’ or channel partners’ end users, or application or product reengineering expenses. The sale

 

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and support of solutions containing defects and errors may result in product liability claims and warranty claims. Our insurance may not cover or may be insufficient to cover claims that are successfully asserted against us or our contract suppliers and manufacturers.

Our business may suffer if our strategic alliances are not successful.

We have a number of strategic alliances, including Oracle Corporation, Research in Motion Limited and VMware, Inc., and continue to pursue strategic alliances with other companies. The objectives and goals for a strategic alliance can include one or more of the following: technology exchange, product development, joint sales and marketing, or new-market creation. If a strategic alliance fails to perform as expected or if the relationship is terminated, we could experience delays in product availability or impairment of our relationships with customers, and our ability to develop new solutions in response to industry trends or changing technology may be impaired. In addition, we may face increased competition if a third party acquires one or more of our strategic alliances or if our competitors enter into additional successful strategic relationships.

We may make strategic acquisitions in the future. We may not be successful in operating or integrating these acquisitions.

As part of our business strategy, we may consider acquisitions of, or significant investments in, other businesses that offer products, services and technologies complementary to ours. Any such acquisition or investment could materially adversely affect our operating results and the price of our common shares. Acquisitions and other strategic investments involve significant risks and uncertainties, including:

 

   

unanticipated costs and liabilities;

 

   

difficulties in integrating new products, software, businesses, operations and technology infrastructure in an efficient and effective manner;

 

   

difficulties in maintaining customer relations;

 

   

the potential loss of key employees of the acquired businesses;

 

   

the diversion of the attention of our senior management from the operation of our daily business;

 

   

the potential adverse effect on our cash position as a result of all or a portion of an acquisition purchase price being paid in cash;

 

   

the potential significant increase of our interest expense, leverage and debt service requirements if we incur additional debt to pay for an acquisition;

 

   

the potential issuance of securities that would dilute our shareholders’ percentage ownership;

 

   

the potential to incur large and immediate write-offs and restructuring and other related expenses; and

 

   

the inability to maintain uniform standards, controls, policies and procedures.

Our inability to successfully operate and integrate newly acquired businesses appropriately, effectively and in a timely manner could have a material adverse effect on our ability to take advantage of future growth opportunities and other advances in technology, as well as on our revenues, gross margins and expenses.

Business interruptions could adversely affect our operations.

Our operations are vulnerable to interruption by fire, earthquake, hurricane or other natural disaster, power loss, computer viruses, security breaches, telecommunications failure, quarantines, national catastrophe, terrorist activities, war and other events beyond our control. Our disaster recovery plans may not be sufficient to address these interruptions. The coverage or limits of our business interruption insurance may not be sufficient to compensate for any losses or damages that may occur.

Problems with the infrastructure of carriers may impair the performance of our solutions and cause problems with the network services we provide to our customers.

We purchase network capacity wholesale from carriers, which we resell to our customers in various retail offerings. The infrastructures of these telecom carriers are vulnerable to interruption by fires, earthquakes, hurricanes and other similar natural disasters, as well as power loss, viruses, security breaches, acts of terrorism, sabotage, intentional acts of vandalism and similar misconduct. The occurrence of such a natural disaster or misconduct, or outages affecting these carrier networks, could impair the performance of our solutions and lead to interruptions, delays or cessation of network services to our customers. Any impairment of the performance of our solutions or problems in providing our network services to our customers, even if for a limited time, could have an adverse effect on our business, financial condition and operating results.

 

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Governmental regulation could harm our operating results and future prospects.

Governments in a number of jurisdictions in which we conduct business have imposed export license requirements and restrictions on the import or export of some technologies, including some of the technologies used in our solutions. Changes in these or other laws or regulations could adversely affect our revenues. A number of governments also have laws and regulations that govern technical specifications for the provision of our solutions. Changes in these laws or regulations could adversely affect the sales of, decrease the demand for and increase the cost of, our solutions. For example, the Federal Communications Commission may issue regulatory pronouncements from time to time that may mandate new standards for our equipment in the United States. These pronouncements could require costly changes to our hardware and software. Additionally, certain government agencies currently require VoIP products to be certified through a lengthy testing process. Other government agencies may adopt similar lengthy certification procedures, which could delay the delivery of our products and adversely affect our revenues.

We rely on carriers to provide local and long distance services, including voice and data circuits, and will rely on carriers to provide mobile voice and data services to our customers and to provide us with billing information. These services are subject to extensive and uncertain governmental regulation on both the federal and local level. An increase or change in government regulation could restrict our ability to provide these services to our customers, which may have a material adverse affect on our business.

Adverse resolution of litigation or governmental investigations may harm our operating results or financial condition.

We are a party to lawsuits in the normal course of our business. We may also be the subject of governmental investigations from time to time. Litigation and governmental investigations can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings or governmental investigations are difficult to predict. An unfavorable resolution of lawsuits or governmental investigations could have a material adverse effect on our business, operating results or financial condition. See “Litigation” in Item 3 of Part I in this Report.

We are exposed to risks inherent in our defined benefit pension plan.

We currently maintain a defined benefit pension plan for a number of our past and present employees in the United Kingdom. The plan was closed to new employees in June 2001. The contributions to fund benefit obligations under this plan are based on actuarial valuations, which themselves are based on assumptions and estimates about the long-term operation of the plan, including employee turnover and retirement rates, the performance of the financial markets and interest rates. If the actual operation of the plan differs from these assumptions, additional contributions by us may be required. As of April 30, 2011, the projected benefit obligation of $194.5 million exceeded the fair value of the plan assets of $133.1 million, resulting in a pension liability of $61.4 million. In October 2010, funding requirements under the plan were set for the three years commencing January 1, 2011 at 8.7% of current pensionable salaries for current members plus annual payments totaling 2.5 million pounds sterling towards the reduction of the accumulated deficit (increasing by 3% per annum for calendar year 2012 and 2013). Our funding requirements for future years may increase from these current levels. Changes to pension legislation in the United Kingdom may also adversely affect our funding requirements.

 

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Our future success depends on our existing key personnel.

Our success is dependent upon the services of key personnel throughout our organization, including the members of our senior management and software and engineering staff, as well as the expertise of our directors. Competition for highly skilled directors, management, R&D and other employees is intense in our industry and we may not be able to attract and retain highly qualified directors, management, and R&D personnel and other employees in the future. In order to improve productivity, a portion of our compensation to employees and directors is in the form of stock option grants, and as a consequence, a depression in the value of our common shares could make it difficult for us to motivate and retain employees and recruit additional qualified directors and personnel. All of the foregoing may negatively impact our ability to retain or attract employees, which may adversely impact our ability to implement a management succession plan as and if required and on a timely basis. We currently do not maintain corporate life insurance policies on the lives of our directors or any of our key employees.

The risks associated with Sarbanes-Oxley regulatory compliance may have a material adverse effect on us.

We are required to document and test our internal control over financial reporting pursuant to Section 404 of the United States Sarbanes-Oxley Act of 2002, so that our management can certify as to the effectiveness of our internal controls and, commencing with our annual report for the fiscal year ended April 30, 2011, our independent registered chartered accountants can render an opinion on the effectiveness of our internal controls over financial reporting. If our independent registered chartered accountants cannot render a favorable opinion or if material weaknesses in our internal control are identified, we could be subject to regulatory scrutiny and a loss of public confidence.

Risks Related to our Common Shares

Our stock price in the past has been volatile, and may continue to be volatile or may decline regardless of our operating performance, and investors may not be able to resell shares at or above the price at which they purchased the shares.

Our stock has been publicly traded on The Nasdaq Global Market for approximately one year. At times the stock price has become extremely volatile. For example, on September 3, 2010, our stock price increased from $5.35 per share to $6.42 per share and on August 10, 2010 our stock price decreased from $8.86 per share to $7.95 per share. The market price of our common shares may fluctuate significantly in response to numerous factors, many of which are beyond our control and which may be accentuated due to the relatively low average daily trading volume in our common shares. The factors include:

 

   

fluctuations in the overall stock market;

 

   

our quarterly operating results;

 

   

sales of our common shares by principal security holders;

 

   

the exercise of options and subsequent sales of shares by option holders, including those held by our senior management and other employees;

 

   

departures of key personnel;

 

   

future announcements concerning our or our competitors’ businesses;

 

   

the failure of securities analysts to cover our company and/or changes in financial forecasts and recommendations by securities analysts;

 

   

a rating downgrade or other negative action by a ratings organization;

 

   

actual or anticipated developments in our competitors’ businesses or the competitive landscape generally;

 

   

litigation involving us, our industry or both;

 

   

general market, economic and political conditions;

 

   

regulatory developments; and

 

   

natural disasters, terrorist attacks and acts of war.

In addition, the stock markets, and in particular the Nasdaq Global Market, have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have initiated securities class action litigation following declines in stock prices of technology companies. Any future litigation may subject us to substantial costs, divert resources and the attention of management from our business, which could harm our business and operating results.

 

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Each of the Francisco Partners Group and the Matthews Group is a significant security-holder and each has the potential to exercise significant influence over matters requiring approval by our shareholders and, in the case of the Francisco Partners Group, over matters requiring approval by our board.

As of June 15, 2011, Francisco Partners Management, LLC and certain of its affiliates, or the Francisco Partners Group, and Dr. Matthews and certain entities controlled by Dr. Matthews, or the Matthews Group, beneficially controlled approximately 42.1% and 23.2%, respectively, of the voting power of our share capital. Pursuant to a shareholders’ agreement, or the Shareholders’ Agreement, between the Company, the Francisco Partners Group and the Matthews Group dated as of April 27, 2010, the Francisco Partners Group and the Matthews Group collectively have the right to nominate 50% of our directors, provided certain criteria are met. The Shareholders’ Agreement also provides that we may not take certain significant actions without the approval of the Francisco Partners Group, so long as they own at least 15% of our outstanding common shares. These actions include:

 

   

amendments to our articles or by-laws;

 

   

issuance of any securities that are senior to our common shares in respect of dividend, liquidation preference or other rights and privileges;

 

   

issuance of equity securities or rights, options or warrants to purchase equity securities, with certain exceptions where we issue securities pursuant to our 2006 Equity Incentive Plan, in connection with acquisitions that involve the issuance of less than $25 million of our securities, upon the conversion of our currently outstanding warrants, as consideration paid to consultants for services provided to us, or in connection with technology licensing or other non-equity interim financing transactions;

 

   

declaring or paying any dividends or making any distribution or return of capital, whether in cash, in stock or in specie, on any equity securities;

 

   

incurring, assuming or otherwise becoming liable for debt obligations, other than refinancing our debt obligations following the closing of this offering and the application of the intended use of proceeds, incurring additional indebtedness in connection with our leasing program, or incurring up to $50 million in new indebtedness;

 

   

mergers, acquisitions, sales of assets or material subsidiaries, or the entering into any joint venture, partnership or similar arrangement that have a value of more than $25 million per such transaction;

 

   

any change in the number of directors that comprise our board of directors;

 

   

an amalgamation, merger or other corporate reorganization by the Company with or into any other corporation (other than a short-form amalgamation with a wholly-owned subsidiary), an agreement to sell or sale of all or substantially all of the assets of the Company or other transaction that has the effect of a change of control of the Company; and

 

   

any liquidation, winding up, dissolution or bankruptcy or other distribution of the assets of the Company to its shareholders.

Such powers held by the Francisco Partners Group could have the effect of delaying, deterring or preventing a change of control, business combination or other transaction that might otherwise be beneficial to our shareholders. Also, each of the Francisco Partners Group and the Matthews Group may have interests that differ from the interests of our other shareholders.

The Francisco Partners Group and the Matthews Group and the persons whom they nominate to our board of directors may have interests that conflict with our interests and the interests of our other shareholders.

The Francisco Partners Group and the Matthews Group and the persons whom they nominate to our board of directors may have interests that conflict with, or are divergent from, our own interests and those of our other shareholders. Conflicts of interest between our principal investors and us or our other shareholders may arise. Our articles of incorporation do not contain any provisions designed to facilitate resolution of actual or potential conflicts of interest, or to ensure that potential business opportunities that may become available to our principal investors and us will be reserved for or made available to us. In addition, our significant concentration of share ownership may adversely affect the trading price of our common shares because investors may perceive disadvantages in owning shares in companies with controlling shareholders.

Some of our directors have interests that may be different than our interests.

We do business with certain companies that are related parties, such as Wesley Clover International Corporation and its subsidiaries. Wesley Clover International Corporation is controlled by Dr. Matthews. Our directors owe fiduciary duties, including the duties of loyalty and confidentiality, to us. Our directors that serve on the boards of companies that we do business with also owe similar fiduciary duties to such other companies. The duties owed to us could conflict with the duties such directors owe to these other companies.

 

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Ownership of our common shares by the Francisco Partners Group and the Matthews Group as well as provisions contained in our articles of incorporation and in certain anti-trust and foreign investment legislation, may reduce the likelihood of a change of control occurring and, as a consequence, may deprive shareholders of the opportunity to sell their common shares at a control premium.

The voting power of the Francisco Partners Group and the Matthews Group, respectively, under certain circumstances could have the effect of delaying or preventing a change of control and may deprive our shareholders of the opportunity to sell their common shares at a control premium. In addition, provisions of our articles of incorporation and Canadian and U.S. law may delay or impede a change of control transaction. Our articles of incorporation permit us to issue an unlimited number of common and preferred shares. Limitations on the ability to acquire and hold our common shares may be imposed under the Hart-Scott-Rodino Act, the Competition Act (Canada) and other applicable antitrust legislation. Such legislation generally permits the relevant governmental authorities to review any acquisition of control over or of significant interest in us, and grants the authority to challenge or prevent an acquisition on the basis that it would, or would be likely to, result in a substantial prevention or lessening of competition.

In addition, the Investment Canada Act subjects an “acquisition of control” of a “Canadian business” (as those terms are defined therein) by a non-Canadian to government review if the book value of the Canadian business’ assets as calculated pursuant to the legislation exceeds a threshold amount. A reviewable acquisition may not proceed unless the relevant minister is satisfied that the investment is likely to be of net benefit to Canada. Any of the foregoing could prevent or delay a change of control and may deprive our shareholders of the opportunity to sell their common shares at a control premium.

You may be unable to bring actions or enforce judgments against us or certain of our directors and officers under U.S. federal securities laws.

We are incorporated under the laws of Canada, and our principal executive offices are located in Canada. A majority of our officers and certain of our directors named in this Report reside principally in Canada and a substantial portion of our assets and all or a substantial portion of the assets of these persons are located outside the United States. Consequently, it may not be possible for you to effect service of process within the United States upon us or those persons. Furthermore, it may not be possible for you to enforce judgments obtained in U.S. courts based upon the civil liability provisions of the U.S. federal securities laws or other laws of the United States against us or those persons. There is doubt as to the enforceability in original actions in Canadian courts of liabilities based upon the U.S. federal securities laws, and as to the enforceability in Canadian courts of judgments of U.S. courts obtained in actions based upon the civil liability provisions of the U.S. federal securities laws.

 

Item 1B. Unresolved Staff Comments

None.

 

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Item 2. Properties

We do not own any real property. The following table outlines significant properties that we currently lease:

 

Location

  

Purpose

   Area
(In Square Feet)
     Expiration
Date of Lease
 

Ottawa, Canada

   Corporate Head Office/Sales/R&D      226,096         February 15, 2016   

Ottawa, Canada

   Warehouse      9,005         February 15, 2016   

Caldicot, United Kingdom

   U.K. and EMEA Regional Headquarters      26,101         March 9, 2021   

Chandler, AZ

   Office/Sales/R&D      97,000         June 30, 2012   

Tempe, AZ

   Warehouse/Office      68,000         June 30, 2012   

Reno, NV

   Office      74,000         November 14, 2018   

The Ottawa facilities are leased from Kanata Research Park Corporation, (“KRPC”), a company controlled by Dr. Matthews, under terms and conditions reflecting what management believed were prevailing market conditions at the time the lease was entered into.

In addition to these significant properties, we also lease a number of regional sales offices throughout the world, including offices:

 

   

throughout the United States and Canada, including sales-service offices and distribution, demonstration and training centers across both countries;

 

   

in Ireland (Dublin) and throughout the United Kingdom, including England (London, Birmingham, Kettering and Northampton) and Scotland (Strathclyde and Glasgow) ;

 

   

throughout Europe, the Middle East and Africa (“EMEA”), including Belgium, France, Germany, the Netherlands, Saudi Arabia, Dubai and South Africa;

 

   

in Asia-Pacific, including Hong Kong, Shanghai, Beijing (China), Singapore and Sydney (Australia); and

 

   

in the Caribbean and Latin America, including in Mexico City (Mexico), Guaynabo (Puerto Rico) and Rio de Janeiro (Brazil).

 

Item 3. Legal Proceedings

We are a party to a small number of legal proceedings, claims or potential claims arising in the normal course of business. We believe any monetary liability or financial impact of such claims or potential claims to which we might be subject after final adjudication would not be material to our consolidated financial position, results of operations or cash flows.

 

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PART II

 

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common shares are traded on The Nasdaq Global Market (trading symbol: MITL). The Company completed its IPO on April 27, 2010; as a result, we have set forth quarterly information with respect to the high and low prices for our common shares for the most recent fiscal year and the first quarter of our current fiscal year (to June 30, 2011):

 

Year ended April 30, 2012

   High      Low  

First quarter,(to June 30, 2011)

     5.74         4.11   

First quarter

     12.13         7.58   

Second quarter

     9.43         5.11   

Third quarter

     7.77         4.98   

Fourth quarter

     5.94         4.01   

On June 30, 2011, the last reported sales price of our common shares on The Nasdaq Global Market was $4.38 per share.

Shareholders

As of June 15, 2011, we had 1,281 shareholders of record (as registered shareholders), as determined by the Company based on information supplied by Mellon Investor Services LLC.

Because many of our common shares are held by brokers and other institutions on behalf of shareholders, we are unable to estimate the total number of beneficial shareholders represented by these record holders.

Dividend Policy

We have never declared or paid cash dividends on our common shares. We currently intend to retain any future earnings to fund the development and growth of our business and we do not currently anticipate paying dividends on our common shares. Any determination to pay dividends to holders of our common shares in the future will be at the discretion of our board of directors and will depend on many factors, including our financial condition, earnings, legal requirements and other factors as our board of directors deems relevant. In addition, our outstanding credit agreements limit our ability to pay dividends and we may in the future become subject to debt instruments or other agreements that further limit our ability to pay dividends.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table sets forth, as of the end of our last fiscal year, (a) the number of securities that could be issued upon exercise of outstanding options and vesting of outstanding restricted stock units and restricted stock awards under our equity compensation plans, (b) the weighted average exercise price of outstanding options under such plans, and (c) the number of securities remaining available for future issuance under such plans, excluding securities that could be issued upon exercise of outstanding options.

 

Plan Category

   Number of securities to be
issued upon exercise of
outstanding options,
warrants and rights (a)
     Weighted-average exercise
price of outstanding options,
warrants and rights (b)
     Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a)) (c)
 

Equity compensation plans approved by security-holders (1)

     5,275,049       $ 5.77         1,590,689   

Equity compensation plans not approved by security-holders (2)

     515,175         5.16         —     
                          

Total

     5,790,224       $ 5.72         1,590,689   
                          

 

(1)

As of April 30, 2011, 5,790,224 common shares were issuable upon exercise of stock options, including options to acquire 614,944 common shares granted under the employee stock option plan adopted in March 2001 (the “2001 Stock Option Plan”) and options to acquire 4,660,105 common shares granted under our second employee stock option plan adopted September 7,

 

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2006 (the “2006 Equity Incentive Plan). An additional 1,590,689 common shares were reserved for issuance under our equity incentive plans. Effective September 7, 2006, shares subject to outstanding awards under the 2001 Stock Option Plan which lapse, expire or are forfeited or terminated will no longer become available for grants under this plan. Instead, new stock options and other equity grants will be made under the 2006 Equity Incentive Plan. The aggregate number of common shares that may be issued under the 2006 Equity Incentive Plan and all other security-based compensation arrangements is 5,600,000 common shares provided that an additional number of common shares of up to three percent of the number of our common shares then outstanding may be added to such initial maximum each year for three years ending in fiscal 2014 at the discretion of the compensation committee. Effective March 5, 2011, our compensation committee approved an increase in the number of common shares issuable by 1,588,298 common shares for a total of 7,188,298 common shares. Common shares subject to outstanding awards under our 2006 Equity Incentive Plan which lapse, expire or are forfeited or terminated will, subject to plan limitations, again become available for grants under this plan.

(2) Options to acquire 515,175 common shares granted as inducement options to Richard McBee as a component of his employment compensation. These options are outside of the pool of stock options available for grant under the 2006 Equity Incentive Plan and all other security-based compensation arrangements of the Company, and were approved by our Board of Directors on January 19, 2011.

 

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Item 6. Selected Financial Data

The following tables present our selected historical consolidated financial and other data and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical Consolidated Financial Statements and notes thereto included elsewhere in this Report. Our historical consolidated financial information may not be indicative of our future performance. Our consolidated financial statements are reported in U.S. dollars and have been prepared in accordance with U.S. GAAP.

 

     Fiscal Year Ended April 30,  
     2011     2010     2009     2008(1)     2007  
     (in millions, except per share data)  

Consolidated Statement of Operations Data

          

Revenues

   $ 649.7      $ 647.9      $ 735.1      $ 692.0      $ 384.9   

Cost of revenues

     338.2        334.0        390.6        367.9        225.1   
                                        

Gross margin

     311.5        313.9        344.5        324.1        159.8   

Selling, general and administrative

     221.5        211.3        248.5        246.6        123.5   

Research and development

     54.1        51.7        60.1        62.6        41.7   

Special charges and restructuring costs

     15.5        5.2        23.3        16.0        9.3   

Other operating charges (2)

     —          —          —          6.0        2.3   

Loss (gain) on litigation settlement

     1.0        (5.5     —          —          16.3   

Impairment of goodwill

     —          —          284.5        —          —     
                                        

Operating income (loss)

     19.4        51.2        (271.9     (7.1     (33.3

Other income (expense), net (3)

     1.2        7.3        99.4        42.7        9.2   

Interest expense

     (20.0     (29.8     (40.1     (34.7     (9.1

Income tax recovery (expense)

     87.5        8.5        19.1        11.7        (1.8
                                        

Net income (loss)

   $ 88.1      $ 37.2      $ (193.5   $ 12.6      $ (35.0
                                        

Net income (loss) attributable to common shareholders

   $ 88.1      $ (107.3   $ (234.5   $ (83.5   $ (42.3

Net income (loss) per common share:

          

basic

   $ 1.66      $ (7.30   $ (16.38   $ (6.73   $ (5.41

diluted

   $ 1.57      $ (7.30   $ (16.38   $ (6.73   $ (5.41

Weighted average number of common shares outstanding:

          

basic

     52.9        14.7        14.3        12.4        7.8   

diluted

     56.0        14.7        14.3        12.4        7.8   

Other Financial Data

          

Adjusted EBITDA (6)

   $ 76.1      $ 89.8      $ 78.7      $ 50.2      $ 5.0   
     As of April 30,  
     2011     2010     2009     2008     2007  
     (in millions)  

Consolidated Balance Sheet Data

          

Cash and cash equivalents

   $ 73.9      $ 76.6      $ 28.4      $ 19.5      $ 33.5   

Working capital (4)

   $ 128.1      $ 154.9      $ 49.5      $ 58.9      $ 26.6   

Total assets

   $ 672.2      $ 641.0      $ 623.1      $ 982.2      $ 202.2   

Total debt, including capital leases

   $ 323.3      $ 349.8      $ 454.8      $ 435.6      $ 54.7   

Redeemable shares (5)

   $ —        $ —        $ 249.5      $ 208.5      $ 71.5   

Common shares

   $ 805.5      $ 802.8      $ 277.8      $ 277.1      $ 189.1   

Warrants

   $ 55.6      $ 55.6      $ 56.6      $ 56.7      $ 62.9   

Total shareholders’ equity (deficiency)

   $ 49.5      $ (54.9   $ (430.1   $ (244.7   $ (202.6

 

(1) As a result of the August 2007 acquisition of Inter-Tel (Delaware), Incorporated (“Inter-Tel”), our financial results for the fiscal year ended April 30, 2008 include eight and a half months of financial results from Inter-Tel.
(2) Other operating charges for fiscal 2008 and fiscal 2007 include loss (gain) on sale of manufacturing operations and expenses for in-process research and development acquired as part of the Inter-Tel acquisition.

 

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(3) Other (income) expense, net includes: fair value adjustment on derivative instruments; other income (expense), which is comprised of foreign exchange gains (losses), net, amortization on gain on sale of assets and other expenses; and debt and warrant retirement costs, including the write-off of deferred financing charges.
(4) Working capital is total current assets less total current liabilities.
(5) The redeemable common shares in this footnote do not reflect the common share reverse share split on April 16, 2010. For fiscal 2007, redeemable shares consisted of 10.0 million redeemable common shares, 20.0 million Series A Preferred Shares, and 67.8 million Series B Preferred Shares. In fiscal 2008 and 2009, redeemable shares consisted of 0.3 million Class 1 Preferred Shares issued in connection with the acquisition of Inter-Tel. The Class 1 Preferred Shares were converted into common shares in conjunction with the April 2010 IPO.
(6) Adjusted EBITDA

The following table presents a reconciliation of Adjusted EBITDA to net income (loss), the most directly comparable U.S. GAAP measure, for each of the periods indicated:

 

     Fiscal Year Ended April 30,  
     2011     2010     2009     2008     2007  
     (in millions)  

Net income (loss)

   $ 88.1      $ 37.2      $ (193.5   $ 12.6      $ (35.0

Adjustments:

          

Amortization and depreciation

     34.0        34.4        38.0        32.6        9.2   

Stock-based compensation

     4.7        3.3        2.4        1.7        0.3   

Special charges and restructuring costs

     15.5        5.2        23.3        16.0        9.3   

Loss (gain) on litigation settlement

     1.0        (5.5     —          —          16.3   

Interest expense

     20.0        29.8        40.1        34.7        9.1   

Debt and warrant retirement costs

     0.6        1.0        —          20.8        —     

Fair value adjustment on derivative instruments

     (1.0     (7.4     (100.2     (61.9     (8.6

Foreign exchange loss (gain)

     0.7        0.3        3.2        (0.6     0.3   

Income tax expense (recovery)

     (87.5     (8.5     (19.1     (11.7     1.8   

Impairment of goodwill

     —          —          284.5        —          —     

In-process research and development

     —          —          —          5.0        —     

Initial public offering costs

     —          —          —          —          3.3   

Loss (gain) on sale of manufacturing operations

     —          —          —          1.0        (1.0
                                        

Adjusted EBITDA

   $ 76.1      $ 89.8      $ 78.7      $ 50.2      $ 5.0   
                                        

We define Adjusted EBITDA as net income (loss) adjusted for the items as noted in the above table. 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.

We use Adjusted EBITDA:

 

   

as a measure of operating performance;

 

   

for planning purposes, including the preparation of our annual operating budget;

 

   

to allocate resources to enhance the financial performance of our business; and

 

   

in communications with our board of directors concerning our financial performance.

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. Our investor

 

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and analyst presentations also 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.

Some of the limitations of Adjusted EBITDA are that it does not reflect:

 

   

interest income or interest expense;

 

   

cash requirements for income taxes;

 

   

foreign exchange gains or losses;

 

   

significant cash payments made in connection with restructuring, litigation settlements and transaction expenses;

 

   

employee stock-based compensation;

 

   

cash requirements for the replacement of assets that have been depreciated or amortized;

 

   

acquired in-process research and development charges; and

 

   

losses or gains related to the sale of manufacturing operations and other assets.

We compensate for the inherent limitations associated with using Adjusted EBITDA through disclosure of such limitations, presentation of our financial statements in accordance with U.S. GAAP and reconciliation of Adjusted EBITDA to the most directly comparable U.S. GAAP measure, net income (loss).

 

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Item 7. 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 April 30, 2011 Consolidated Financial Statements and accompanying Notes included elsewhere in this Report. All amounts are expressed in U.S. dollars unless otherwise noted. The following discussion includes forward-looking statements that are not historical facts but reflect our current expectation regarding future results. Actual results may differ materially from the results discussed in the forward-looking statements because of a number of risks and uncertainties, including the matters discussed below. Please refer to “Risk Factors” included elsewhere in this Report for a further description of risks and uncertainties affecting our business and financial results. Historical trends should not be taken as indicative of future operations and financial results.

Overview

We are a leading provider of integrated communications solutions focused on the 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.

We have delivered innovative communications solutions to our customers for over 35 years, initially through Mitel Corporation, our predecessor business. We have invested heavily in the research and development (“R&D”) of our IP-based communications solutions to take advantage of the telecommunications industry shift from traditional PBX systems to IP-based communications solutions. We believe our early and sustained R&D investment in IP-based communications solutions have positioned us well to capitalize on the industry shift to IP-based communications solutions. As a result of this strategic focus, for the last four years substantially all of our system shipments have been IP-based communication solutions.

Significant Events and Recent Developments

In fiscal 2008 (August 2007), we completed the acquisition of Inter-Tel, which significantly enhanced our ability to target SME customers with our IP solutions by expanding our U.S. distribution and managed service capabilities. The total purchase price of $729.9 million was funded with a combination of equity and debt financing plus cash held by Inter-Tel.

In April 2010, we completed an initial public offering (“IPO”) on The Nasdaq Global Market. Under the IPO, we sold 10.5 million common shares at $14.00 per share. Our net proceeds from the IPO were $130.7 million after underwriting commissions of $10.3 million and other associated costs of $6.3 million. The net proceeds of the IPO were used to repay $30.0 million outstanding under the revolving credit facility and $72.0 million to prepay amounts outstanding under our first lien term loan, with the remainder to be used for general corporate purposes. In conjunction with the IPO, all of the 0.3 million Class 1 Preferred Shares were converted into common shares.

Until the end of the second quarter of fiscal 2011, the Company leased its Ottawa-based headquarter facilities from the Matthews Group under a 10-year lease which was to expire in February 2011. During the third quarter of fiscal 2011, the Company negotiated a new lease with the Matthews Group under terms and conditions which management believes reflect current market rates. The new lease has a term of 5 years and 3 months, and can be renewed at the option of the Company for an additional 5 years.

In March 2011, we made a prepayment of $25.0 million against our outstanding first lien term loan. In connection with the prepayment, the maximum consolidated debt to EBITDA covenant under our first lien credit agreement was increased for the fourth quarter of fiscal 2011 and for subsequent quarters up to and including the second quarter of fiscal 2014.

During fiscal 2011, we announced changes to our senior management team. In January 2011, Richard McBee became our new Chief Executive Officer (“CEO”), following the retirement of Don Smith. Mr. Smith continues to serve as a director of Mitel. In addition, Mr. McBee has taken on the role of President following the departure of Paul Butcher, our former President and Chief Operating Officer, in April 2011. The Chief Operating Officer title has been eliminated.

In May 2011, we announced certain organizational changes, creating an organization comprised of two geographical sales organizations and three key business units. We anticipate that these organizational changes will result in a change in our segmented presentation, beginning in the first quarter of fiscal 2012.

Operating Results

Our total revenues for the year ended April 30, 2011 were $649.7 million, as compared to $647.9 million for the year ended April 30, 2010. The increase in revenues is due to an increase in sales from our network services segment. Our operating income

 

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decreased to $19.4 million in fiscal 2011 from $51.2 million in fiscal 2010. The decrease in operating income was largely due to an increase in special charges resulting from restructuring activity during the year and an increase in sales, general and administrative (“SG&A”) expenses and R&D expenses as a result of the phase-out of the reduced work-week program, as described below.

In fiscal 2010 and 2009, our operating results were affected by the global economic recession, which started in mid-calendar year 2008 (our fiscal 2009). We responded to the negative effect of the recession by implementing cost reduction programs to re-align our operating model. These programs, which were implemented during the second half of fiscal 2009 and 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. The reduced work-week program was phased out gradually in fiscal 2011. While our revenues declined as a result of the economic conditions, our cost reduction programs contributed positively to our operating performance, resulting in a significant improvement in both operating income and Adjusted EBITDA in fiscal 2010 as compared to fiscal 2009.

We plan to continue to monitor our cost structure so that it remains 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.

Trends

Businesses are migrating from legacy telephony networks to IP-based environments, which can address their voice, data, video and business applications requirements within a single converged network. The transition to IP-based communications solutions provides significant benefits to businesses, including enhanced workforce productivity, reduced infrastructure costs, the creation of highly functional applications that can be distributed easily, and the use of open standards. We have invested heavily and continue to innovate in IP-based solutions and therefore believe we are well positioned to benefit from this transition.

The evolution to converged IP-based networks has given rise to two important trends: the transition from hardware-based to software-based communications solutions and the ability to deliver integrated UCC applications. The transition to software-based communications solutions provides operational cost benefits and the ability to integrate communications with other business processes and applications. UCC allows business customers to move beyond basic fixed telephony and disparate communications tools toward integrated multi-media communications and collaboration between users, wherever they may be located. UCC includes the integrated use of various media and messaging, such as voice, video and data. Our history of success as an early adopter in software-based communications solutions has provided us with the foundation for continued innovation in IP-based communications and UCC. We believe our comprehensive, integrated IP-based communications offering provides our customers with significant flexibility, cost efficiency and enhanced employee productivity as they transition to converged IP-based environments and UCC.

Corporate data centers have experienced a significant increase in the use of virtualization technology as a strategy to reduce capital and operating expenses as well as providing improved business continuity solutions through new high availability architectures. Virtualization technology is also serving as the base for both private and public cloud computing solutions enabling businesses to benefit from data center outsourcing and data center elasticity where data center resources may be acquired and dispensed with, depending on a business’s needs. We believe that businesses can significantly benefit from the virtualization of all UCC and IP based communication solutions by allowing these products to integrate fully with the data center infrastructure and related management processes and eliminating telecommunication specific infrastructure and processes. Our early investment in this technology across our product portfolio allows our customers to benefit using either our products on VMWare or with our MiCD product.

SMEs are increasingly interested in outsourcing management of their communications requirements through managed service offerings. Managed services may include equipment, installation, ongoing support, network services, or various professional services. Managed services offerings allow businesses to focus on their core expertise and, in some cases, substitute what would otherwise be a large capital expenditure for a predictable operating expense. We believe that we are well positioned to benefit from this trend through the combination of our existing managed service program and our network services offerings in the United States. We believe these solutions also provide an opportunity to achieve operational savings by giving us the flexibility to place equipment and services either on the customer’s premises or as a hosted solution.

 

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Key Performance Indicators

Key performance indicators that we use to manage our business and evaluate our financial results and operating performance include: revenues, gross margins, operating costs, operating income (loss), net income (loss), cash flows from operations and Adjusted EBITDA.

Revenue performance is evaluated from both a geographical perspective, in accordance with our reportable segments, and from a revenue source perspective, that is telecommunications and network services. We evaluate revenue performance by comparing the results to management forecasts and prior period performance.

Gross margins, operating costs, operating income (loss) and net income (loss) are each evaluated in a similar manner as our actual results are compared against both management forecasts and prior period performance.

Cash flow from operations is the key performance indicator with respect to cash flows. As part of monitoring cash flow from operations, we also monitor our days sales outstanding, our inventory turns and our days expenses in payables outstanding.

Adjusted EBITDA, a non-GAAP measure, is evaluated by comparing actual results to management forecasts and prior period performance. For a definition and explanation of Adjusted EBITDA, as well as a reconciliation of Adjusted EBITDA to net income (loss), see Item 6, “Selected Financial Data”.

In addition to the above indicators, from time to time, we also monitor performance in the following areas:

 

   

status of key customer contracts;

 

   

the achievement of expected milestones of our key R&D projects; and

 

   

the achievement of our key strategic initiatives.

In an effort to ensure we are creating value for and maintaining strong relationships with our customers, we monitor the status of key customer contracts to monitor customer service levels. With respect to our R&D projects, we measure content, quality and timeliness against project plans.

Sources of Revenues and Expenses

The following describes our sources of revenues and expenses.

Revenues

We generate our revenues principally from the sale of integrated communications solutions to business customers, with these revenues being classified as telecommunications revenues or network services revenues. Telecommunications revenues are comprised of revenues generated from the sales of platforms, including software, appliances and desktop devices, UCC applications and managed services. Network services are comprised of local and long distance and network resale services.

Our distribution network includes value-added resellers, service providers, high-touch sales and direct channel. We complement and support our channel partners in selected markets using a sales model whereby our sales staff works either directly with a prospective customer or in coordination with a channel partner in defining the scope, design and implementation of the solution. Our direct and indirect distribution channel addresses the needs of customers in over 100 countries through our 76 offices and more than 1,600 channel partners worldwide.

Because we have multiple revenue streams, our revenue recognition policy varies depending on the revenue stream and type of customer transaction.

Revenue for hardware is recognized when persuasive evidence of an arrangement exists, delivery has occurred in accordance with the terms and conditions of the contract, title and risk of loss have been transferred to the customer, the fee is fixed or determinable, and collection is reasonably assured.

Software revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred in accordance with the terms and conditions of the contract, the fee is fixed or determinable, and collection is reasonably assured. For software arrangements involving multiple elements, revenue is allocated to each element based on the relative fair value or the residual method, as applicable, and using vendor specific objective evidence (“VSOE”) of fair value, which is based on prices charged when the element is sold separately. Revenue related to post-contract support (“PCS”), including technical support and unspecified when-and-if available software upgrades, is recognized ratably over the PCS term for contracts that are greater than one year. For contracts where the post-contract period is one year or less, the costs are deemed insignificant and the unspecified software upgrades are expected to

 

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be and historically have been infrequent, revenue is recognized together with the initial licensing fee and the estimated costs are accrued.

We make sales to resellers and channel partners based on contracts that typically expire at the end of our fiscal year, with automatic renewals for one year periods thereafter. For products sold through these distribution channels, revenues are recognized at the time the risk of loss is transferred to resellers and channel partners according to contractual terms and if all contractual obligations have been satisfied. These arrangements usually involve multiple elements, including PCS and training. Costs related to insignificant technical support obligations, including second-line phone support for certain products, are accrued. For other technical support and training obligations, revenues from product sales are allocated to each element based on VSOE of relative fair values, generally representing the prices charged when the element is sold separately, with any discount allocated proportionately. Revenues attributable to undelivered elements are deferred and recognized upon performance or ratably over the contract period.

Our standard warranty period extends 15 months from the date of sale and extended warranty periods are offered on certain products. At the time product revenues are recognized, an accrual for estimated warranty costs is recorded as a component of cost of revenues based on prior claims experience. Sales to our channel partners do not provide for return or price protection rights while sales to distributors provide for these rights. Product return rights for distributors are typically limited to a percentage of sales over a maximum three month period. A reserve for estimated product returns and price protection rights based on past experience is recorded as a reduction of sales at the time product revenues are recognized. For new resellers, we estimate the product return provision using past return experience with similar partners operating in the same regions. We offer various cooperative marketing programs to assist our channels to market our products. Allowances for these programs are recorded as marketing expenses at the time of shipment based on contract terms and prior claims experience.

We also sell solutions, including installation and related maintenance and support services, directly to end-user customers. For solutions sold directly to end-user customers, revenues are recognized at the time of delivery and at the time risk of loss is transferred, based on prior experience of successful compliance with customer specifications. Revenues from installation are recognized when services are rendered and when contractual obligations, including customer acceptance, have been satisfied. Revenues are also derived from professional service contracts with terms that typically range from two to six weeks for standard solutions and for longer periods for customized solutions. Revenues from customer support, professional services and maintenance contracts are recognized ratably over the contractual period, generally one year. Billings in advance of services are included in deferred revenues. Revenues from installation services provided in advance of billing are included in unbilled accounts receivable.

Certain arrangements with end-user customers provide customer support and maintenance services extending 12 months from the date of installation at no charge. Customer support and maintenance contracts are also sold separately. When customer support or maintenance services are provided at no charge, these amounts are unbundled from the product and installation revenues at their fair market value based on the prices charged when the element is sold separately and recognized ratably over the contract period. Consulting and training revenues are recognized upon performance.

We provide long term outsourcing services of communication systems. Under these arrangements, systems management services (“managed services”) and communication equipment are provided to end-user customers typically over a five-year period. Revenues from managed services are recognized ratably over the contract period. We retain title and risk of loss associated with the equipment utilized in the provision of the managed services. Accordingly, the equipment is capitalized as part of property and equipment and is amortized to cost of sales over the contract period.

In a transaction containing a sales-type lease, hardware revenues are recognized at the present value of the payments allocated to the hardware lease element at the time of system sale in accordance with the Leases Topic of the United States Financial Accounting Standards Board Accounting Standard Codification (“FASB ASC”). With respect to the software lease elements included in the sales-type lease, which are comprised of software, including applications, upgrades, software support, and embedded software, prior to the Company establishing VSOE for these elements, revenues from the software elements were deferred and recognized over the period of support in accordance with the Software Topic of the FASB ASC. Where the Company has now established VSOE for these elements, revenue is recognized upon delivery, based on their VSOE, in accordance with the Software Topic of the FASB ASC. Revenues from sales-type leases are allocated between hardware and software elements based on management’s best estimate of relative fair values. We regularly sell the net rental payments from sales-type leases to financial institutions with the income streams discounted at prevailing rates at the time of sale. Gains or losses resulting from the sale of net rental payments from leases are recorded as net sales within telecommunications revenues.

We also provide network services to our customers, which includes local and long-distance voice services, internet access and data network offerings on our partners’ networks, which we bill on a monthly basis. Revenues from network services are recognized as the services are provided.

 

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Cost of Revenues

Cost of revenues is comprised of product costs and service costs. Product cost of revenues is primarily comprised of cost of goods purchased from third party electronics manufacturing services and inventory provisions, engineering costs, warranty costs and other supply chain management costs. Product cost of revenues also includes a small component related to software comprised of royalty payments and licensing fees to third parties. Service cost of sales is primarily comprised of costs associated with managed services, which include labor costs associated with maintenance and support, installation and other professional services, and costs associated with network services, which includes the cost of acquisition of local and long-distance voice services, internet access and data network services from major carriers in the United States. Depreciation of property and equipment relating to cost of revenues are also included in cost of revenues expense.

We use high-volume contract manufacturers and component suppliers and we require them to give us full visibility of component supply, manufacturing process and portability. We measure and benchmark the performance of our component suppliers and manufacturers for technical innovation, financial strength, quality, support and operational effectiveness.

Sales, General and Administrative Expenses

SG&A expenses consist primarily of costs relating to our sales and marketing activities, including salaries and related expenses, advertising, trade shows and other promotional activities and materials, administrative and finance functions, legal and professional fees, insurance and other corporate and overhead expenses. Following the acquisition of Inter-Tel in fiscal 2008, SG&A also includes significant amounts recorded for the amortization of purchased intangible assets.

Research and Development Expenses

R&D expenses consist primarily of salaries and related expenses for engineering personnel, materials and consumables and subcontract service costs. Depreciation and amortization of R&D assets are included in R&D expenses.

Special Charges and Restructuring Costs

Special charges relate to restructuring activities, product line exits and other loss accruals undertaken to improve our operational efficiency. Special charges consist primarily of workforce reduction costs, lease termination obligations and asset write-offs. We reassess the accruals at each reporting period to reflect changes in the timing or amount of estimated restructuring and termination costs on which the original estimates were based. New restructuring accruals or reversals of previous accruals are recorded in the period of change.

Comparability of Periods

Our functional currency is the U.S. dollar and our consolidated financial statements are prepared with U.S. dollar reporting currency using the current rate method. Assets and liabilities of non-U.S. operations are translated from foreign currencies into U.S. dollars at the exchange rates in effect at the balance sheet date while revenue and expense items are translated at the monthly weighted-average exchange rates for the relevant period. The resulting unrealized gains and losses have been included as part of the cumulative foreign currency translation adjustment which is reported as other comprehensive income. As a result, changes in foreign-exchange rates from period to period can have a significant impact on our results of operations and financial position, which also makes the comparability of periods complex.

 

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Results of Operations—Fiscal 2011 Compared to Fiscal 2010

The following table sets forth our comparative results of operations, both in dollars and as a percentage of total revenues, for fiscal 2011 and 2010:

 

     Fiscal Year Ended April 30,     Change  
     2011     2010    
     Amounts     % of
Revenue
    Amounts     % of
Revenue
    Amount     %  
     (in millions, except percentages)  

Revenues

   $ 649.7        100.0   $ 647.9        100.0   $ 1.8        0.3   

Cost of revenues

     338.2        52.1     334.0        51.6     4.2        1.3   
                              

Gross margin

     311.5        47.9     313.9        48.4     (2.4     (0.8

Selling, general and administrative

     221.5        34.1     211.3        32.6     10.2        4.8   

Research and development

     54.1        8.3     51.7        8.0     2.4        4.6   

Special charges and restructuring costs

     15.5        2.4     5.2        0.8     10.3        +   

Loss (gain) on litigation settlement

     1.0        0.2     (5.5     (0.8 )%      6.5        +   
                              

Operating income

     19.4        3.0     51.2        7.9     (31.8     (62.1

Interest expense

     (20.0     (3.1 )%      (29.8     (4.6 )%      9.8        (32.9

Debt retirement costs, including write-off of related deferred financing costs

     (0.6     (0.1 )%      (1.0     (0.2 )%      0.4        +   

Fair value adjustment on derivative instruments

     1.0        0.2     7.4        1.1     (6.4     +   

Other income

     0.8        0.1     0.9        0.1     (0.1     +   

Income tax recovery

     87.5        13.5     8.5        1.3     79.0        +   
                              

Net income

   $ 88.1        13.6   $ 37.2        5.7   $ 50.9        +   
                              

Adjusted EBITDA (a non-GAAP measure)

   $ 76.1        11.7   $ 89.8        13.9   $ (13.7     (15.3
                              

 

+ The comparison is not meaningful.

Revenues

Our reportable segments are represented by the following four geographic sales regions:

 

   

the United States;

 

   

Europe, Middle East & Africa (collectively “EMEA”);

 

   

Canada and Caribbean & Latin America (collectively “Canada and CALA”); and

 

   

Asia Pacific.

These reportable segments were determined in accordance with how our management views and evaluates our business. The following table sets forth total revenues by geographic regions both in dollars and as a percentage of total revenues:

 

     Fiscal Year Ended April 30,     Change  
     2011     2010    
     Revenues      % of
Revenues
    Revenues      % of
Revenues
    Amount     %  
     (in millions, except percentages)  

Telecommunications revenues:

              

United States

   $ 353.9         54.5   $ 355.6         54.8   $ (1.7     (0.5

EMEA

     153.0         23.6     159.5         24.6     (6.5     (4.1

Canada and CALA

     45.0         6.9     44.0         6.8     1.0        2.3   

Asia Pacific

     18.9         2.9     13.3         2.1     5.6        42.1   
                                            

 

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     Fiscal Year Ended April 30,     Change  
     2011     2010    
     Revenues      % of
Revenues
    Revenues      % of
Revenues
    Amount     %  
     (in millions, except percentages)  

Network services revenues:

              
   $ 570.8         87.9   $ 572.4         88.3   $ (1.6     (0.3

United States

   $ 78.9         12.1   $ 75.5         11.7   $ 3.4        4.5   
                                            
   $ 649.7         100.0   $ 647.9         100.0   $ 1.8        0.3   
                                            

Our telecommunications revenues in fiscal 2011 remained consistent with fiscal 2010 as decreased revenues in the U.S. and EMEA were largely offset by increased revenue in the Asia Pacific region. Our network services revenues increased, however, due to an increased spend per customer compared to fiscal 2010.

Telecommunications revenues in the U.S. decreased by $1.7 million, or 0.5%, in fiscal 2011 compared to fiscal 2010. We believe that the decrease in telecommunications revenues was primarily due to the lower sales from direct selling offices.

Revenues in EMEA decreased by $6.5 million, or 4.1%, in fiscal 2011 compared to fiscal 2010, as a result of the global recession and 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 region decreased 2.4% due to a lower average exchange rate of the British pound sterling during fiscal 2011 versus fiscal 2010. Excluding the impact of foreign exchange, revenues in EMEA were down 1.7% principally as a result of lower volumes through our channel partners in Europe.

Revenues in Canada and CALA increased by $1.0, or 2.3%, million in fiscal 2011 compared to fiscal 2010, driven primarily by the higher average exchange rate of the Canadian dollar during fiscal 2011 versus fiscal 2010.

Revenues in Asia Pacific increased by $5.6 million, or 42.1%, due to strong performance in the South Pacific as we continue our efforts to grow the business in the region.

Networks services revenues in the U.S. increased by $3.4 million, or 4.5%, in fiscal 2011 compared to fiscal 2010. The increase in revenues from network services in fiscal 2011 was due to increased spending per customer compared to the prior period.

Gross Margin

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

 

     Fiscal Year Ended April 30,  
     2011     2010  
     Gross
Margin
     Gross
Margin %
    Gross
Margin
     Gross
Margin %
 
     (in millions, except percentages)  

Telecommunications

   $ 276.0         48.4   $ 281.3         49.1

Network services

     35.5         45.0     32.6         43.2
                      

Total

   $ 311.5         47.9   $ 313.9         48.4
                      

Gross margin percentage declined by 0.5% to 47.9% in fiscal 2011 from 48.4% in fiscal 2010, driven by a decrease from telecommunications.

Gross margin percentage on telecommunication revenues decreased in fiscal 2011 by 0.7% to 48.4% from 49.1% in fiscal 2010. This decrease 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.

 

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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 45.0% in fiscal 2011 from 43.2% in fiscal 2010 predominantly as the result of lower rates negotiated with our local and long distance carriers at the beginning of the third quarter of fiscal 2010.

We expect gross margins to improve slightly in the near term as a result of continuing implementation of our cost reduction initiatives described above and trend to higher margin software products; however, margins could be higher or lower as a result of a number of factors including variations in revenue mix, competitive pricing pressures, foreign currency movements in regions where revenues are denominated in currencies other than the U.S. dollar, utilization of our professional services personnel and efficiencies in installing our products, and global economic conditions, among other factors.

Operating Expenses

Selling, General and Administrative

SG&A expenses increased to 34.1% of revenues in fiscal 2011 from 32.6% of revenues in fiscal 2010 an increase of $10.2 million in absolute dollars. Our SG&A expenses for fiscal 2011 included certain non-cash charges, most significantly $22.3 million (2010—$22.2 million) for the amortization of customer relationships and developed technology intangible assets related to the acquisition of Inter-Tel in fiscal 2008. In addition, SG&A included $4.7 million (2010—$3.3 million) of non-cash compensation expense associated with employee stock options.

The increase in SG&A expenses as a percent of revenues for fiscal 2011 compared to fiscal 2010 was primarily due to higher selling and marketing expenses, higher stock-based compensation and the phase-out of the reduced work-week program, which began in July 2010.

We will continue to monitor our cost base closely in an effort to keep our operating expenditures in line with revenue levels achieved in future quarters. SG&A expenses as a percentage of revenues is highly dependent on revenue levels and could vary significantly depending on actual revenues achieved.

Research and Development

R&D expenses increased to 8.3% of total revenues in fiscal 2011 from 8.0% of total revenues in fiscal 2010, an increase of $2.4 million in absolute dollars. The increase in our investment level in R&D in fiscal 2011 was due to the phase-out of the reduced work-week program in fiscal 2011.

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. Our R&D expenses in absolute dollars can 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 could vary significantly depending on actual revenues achieved.

Special Charges and Restructuring Costs

We recorded pre-tax special charges of $15.5 million in fiscal 2011 as a result of actions taken to lower our operating cost structure. The components of the special charges consisted of $10.2 million of employee severance and benefits incurred in the termination of approximately 100 employees around the world and $5.3 million related to additional lease terminations and accreted interest on lease terminations. We expect all of the workforce reduction liability to be settled within the next two years. The lease termination obligations incurred in the current and prior fiscal years will be reduced over the remaining term of the leases, with $3.9 million of the outstanding $7.0 million balance to be paid in fiscal 2012.

We recorded pre-tax special charges of $5.2 million in fiscal 2010 as a result of actions taken to lower our operating cost structure. The components of the special charges included $2.5 million of employee severance and benefits incurred in the termination of approximately 20 employees around the world, $1.4 million related to additional lease terminations and accreted interest on lease terminations, and $1.2 million in assets written off related to the termination of a product line. Substantially all of the workforce reduction liability at April 30, 2010 was settled in fiscal 2011. Also included in special charges in fiscal 2010 was $0.1 million of costs related to integration activities following our acquisition of Inter-Tel.

 

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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.

Litigation Settlement

In the fourth quarter of fiscal 2011, we adjusted our estimate of the expected payments under our litigation settlements and recorded a $1.0 million charge. In the fourth quarter of fiscal 2010 we recorded pre-tax income of $5.5 million primarily related to a settlement of litigation, as described in the “Results of Operations – Fiscal 2010 Compared to Fiscal 2009”, below.

Operating Income (Loss)

We reported operating income of $19.4 million in fiscal 2011 compared to $51.2 million in fiscal 2010. The decrease in operating income was due primarily due to an increase in SG&A and R&D expenses largely the result of the phase-out of the reduced work-week program, an increase in special charges and restructuring costs and an increased litigation settlement expense, as described above.

Non-Operating Expenses

Interest Expense

Interest expense was $20.0 million in fiscal 2011 compared to $29.8 million in fiscal 2010. Our interest expense relates predominantly to two credit agreements bearing interest based on LIBOR that were entered into to finance a portion of the Inter-Tel acquisition in fiscal 2008. The decrease in interest expense was due to lower debt balances as well as a lower effective interest rate.

In April 2010, we used a portion of the proceeds from our IPO to repay the $30.0 million outstanding on our revolving credit facility and prepaid $72.0 million of our first lien term loan. In March 2011, we prepaid an additional $25.0 million of our first lien term loan. In connection with such prepayment, the maximum consolidated debt to EBITDA covenant under our credit agreement governing the first lien term loan was increased for the fourth quarter of fiscal 2011 and for subsequent quarters up to and including the second quarter of fiscal 2014. We did not draw any amounts on our revolving credit facility during fiscal 2011. The lower average long-term debt balance resulted in approximately $4.1 million of the decrease in interest expense in fiscal 2011 compared to fiscal 2010.

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. For fiscal 2011, we paid an average LIBOR rate of 0.4% (fiscal 2010, excluding the unfavorable swap agreement – 0.5%).

Our interest expense will fluctuate from period to period depending on the movement in the LIBOR.

Debt and Warrant Retirement Costs, Including Write-Off of Related Deferred Costs.

In April 2010, we prepaid $72.0 million of our outstanding first lien term loan, at par. As a result, we wrote-off $1.0 million of unamortized deferred financing charges representing a pro-rata portion of the unamortized deferred charges related to the first lien term loan.

In March 2011, we prepaid an additional $25.0 million of our outstanding first lien term loan, at par. As a result, we expensed $0.2 million of unamortized deferred financing charges and $0.4 of related expenses.

Fair Value Adjustment on Derivative Instruments

In fiscal 2011, the fair value adjustment on derivative instruments consists of the mark-to-mark adjustment on warrants that have an exercise price in Canadian dollars. As a result of Derivatives and Hedging Topic of the FASB ASC, we are required to record an adjustment for the change in fair value of our warrants that are denominated in a currency (Canadian dollars) other than our functional currency. At April 30, 2010, these warrants had a fair value of $1.0 million. In fiscal 2011, these warrants expired out-of-the-money. As a result, we recorded the $1.0 million change in fair value as income during fiscal 2011.

In fiscal 2010, the fair value adjustment on derivative instruments consists of two items; the mark-to-market adjustment on the embedded derivative in the Class 1 Preferred Shares and the mark-to-mark adjustment on the warrants that have an exercise price in Canadian dollars.

The holders of Class 1 Preferred Shares, issued in connection with the acquisition of Inter-Tel, had the right to redeem the preferred shares and receive cash equal to the value of our common shares into which the instrument would convert after seven years.

 

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As a portion of the redemption price of the preferred shares was indexed to our common share price, an embedded derivative was accounted for separately and was marked to market in each reporting period. In April 2010, in conjunction with the IPO, the preferred shares were converted. As a result, a mark-to-market non-cash gain of $8.4 million was recorded in fiscal 2010.

For the year ended April 30, 2010, due primarily to an increase in the fair value of our common stock as a result of the IPO, we recorded a loss of $1.0 million for the fair value adjustment on warrants that had an exercise price in Canadian dollars. These warrants expired in April 2011.

Other Income

In fiscal 2011, other income was $0.8 million compared to $0.9 million during fiscal 2010. Other income in both fiscal years consisted of interest income and amortization of the deferred gain on sale of land and building in the U.K. in fiscal 2006, partially offset by a foreign exchange loss.

Income Tax Recovery

In fiscal 2011, we updated our assessment of the realizability of our deferred tax assets. Based on a number of factors, including completion of a reorganization of certain subsidiaries, cumulative income for the previous 36 months and forecasted income (excluding non-recurring items), we determined that it was now more-likely-than-not that the Company would realize a benefit from a significant portion of its deferred tax assets in Canada. As a result, we relieved a valuation allowance of $87.2 million primarily relating to the deferred tax assets in Canada. Future changes in estimates of taxable income could result in a significant change to the valuation allowance. At April 30, 2011, there continues to be a valuation allowance of $71.2 against deferred tax assets, primarily in Canada and the United Kingdom.

During fiscal 2010, there was no change in the assessment of the realizability of our deferred tax assets. At April 30, 2010 we concluded that a substantial valuation allowance was appropriate due to the uncertainty surrounding the Company’s ability to earn taxable income in certain jurisdictions.

Excluding changes in valuation allowance, we recorded a net income tax benefit of $0.3 million in fiscal 2011 compared to $8.5 million in fiscal 2010. The fiscal 2011 tax recovery was due primarily to the use of losses not previously recognized, which was partially offset by the tax effect of temporary differences, related to differences in accounting and tax treatment pertaining primarily to the leasing portfolio and other accruals. The fiscal 2010 tax benefit primarily resulted from a benefit of timing differences in accounting and tax treatment pertaining primarily to the leasing portfolio and other accruals, which more than offset the expected tax expense on our pre-tax income at statutory rates.

Net Income

In fiscal 2011, our net income was driven by a reduction in our valuation allowance, as described above. Excluding taxes, our net income decreased from fiscal 2010 due to a non-recurring fair value adjustment of $7.4 million recorded in fiscal 2010, coupled with lower operating income, as described above. This was partially offset by lower interest expense during the year.

Adjusted EBITDA

Adjusted EBITDA, a non-GAAP measure, was $76.1 million in fiscal 2011 compared to $89.8 million in fiscal 2010, a $13.7 million, or 15.3% decrease. This decrease in Adjusted EBITDA was driven by lower gross margin, as well as the effect of the phase-out of the reduced work-week program, which began in July 2010. For a definition and explanation of Adjusted EBITDA as well a reconciliation of Adjusted EBITDA to net income, see Item 6, “Selected Financial Data”.

 

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Results of Operations—Fiscal 2010 Compared to Fiscal 2009

The following table sets forth our comparative results of operations, both in dollars and as a percentage of total revenues, for fiscal 2010 and 2009:

 

     Fiscal Year Ended April 30,     Change  
     2010     2009    
     Amounts     % of
Revenue
    Amounts     % of
Revenue
    Amount     %  
     (in millions, except percentages)  

Revenues

   $ 647.9        100.0   $ 735.1        100.0   $ (87.2     (11.9

Cost of revenues

     334.0        51.6     390.6        53.1     (56.6     (14.5
                              

Gross margin

     313.9        48.4     344.5        46.9     (30.6     (8.9

Selling, general and administrative

     211.3        32.6     248.5        33.8     (37.2     (15.0

Research and development

     51.7        8.0     60.1        8.2     (8.4     (14.0

Special charges and restructuring costs

     5.2        0.8     23.3        3.2     (18.1     (77.7

Litigation settlement

     (5.5     (0.8 )%      —          0.0     (5.5     *   

Impairment of goodwill

     —          —          284.5        38.7     (284.5     *   
                              

Operating income (loss)

     51.2        7.9     (271.9     (37.0 )%      323.1        +   

Interest expense

     (29.8     (4.6 )%      (40.1     (5.5 )%      10.3        (25.7

Debt and warrant retirement costs, including write-off of related deferred charges

     (1.0     (0.2 )%      —          —          (1.0     *   

Fair value adjustment on derivative instruments

     7.4        1.1     100.2        13.6     (92.8     +   

Other income (expense)

     0.9        0.1     (0.8     (0.1 )%      1.7        +   

Income tax recovery (expense)

     8.5        1.3     19.1        2.6     (10.6     (55.5
                              

Net income (loss)

   $ 37.2        5.7   $ (193.5     (26.3 )%    $ 230.7        +   
                              

Adjusted EBITDA (a non-GAAP measure)

   $ 89.8        13.9   $ 78.7        10.7   $ 11.1        14.1   
                              

 

* No comparison to other period.
+ The comparison is not meaningful.

Revenues

The following table sets forth revenues from our telecommunications and network services business segments.

 

     Fiscal Year Ended April 30,              
     2010     2009     Change  
     (in millions, except percentages)  
     Revenues      % of
Revenues
    Revenues      % of
Revenues
    Amount     %  

Telecommunications

   $ 572.4         88.3     662.0         90.1   $ (89.6     (13.5

Network services

     75.5         11.7     73.1         9.9     2.4        3.3   
                                            
   $ 647.9         100.0     735.1         100.0   $ (87.2     (11.9
                                            

Revenues in fiscal 2010 decreased 11.9% to $647.9 million compared to $735.1 million in fiscal 2009, with telecommunications revenues decreasing 13.5% to $572.4 million from $662.0 million and network revenues increasing 3.3% to $75.5 million from $73.1 million.

Our revenues in fiscal 2010 and fiscal 2009 were adversely affected by the global recession. In the weakened economic climate, many of our existing and prospective customers reduced their capital expenditures or delayed new equipment purchases, which resulted in lower telecommunications revenues. Our revenues from network services increased, however, due to an increase in both the number of active customers and the number of services we billed to those customers compared to fiscal 2009.

 

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Geographic Segment Revenues

Our reportable segments are represented by the following four geographic sales regions:

 

   

the United States;

 

   

EMEA;

 

   

Canada and CALA; and

 

   

Asia Pacific.

These reportable segments were determined in accordance with how our management views and evaluates our business. The following table sets forth total revenues by geographic regions both in dollars and as a percentage of total revenues:

 

     Fiscal Year Ended April 30,     Change  
     2010     2009    
     Revenues      % of
Revenues
    Revenues      % of
Revenues
    Amount     %  
     (in millions, except percentages)  

United States

   $ 431.1         66.5   $ 486.7         66.2   $ (55.6     (11.4

EMEA

     159.5         24.6     184.7         25.1     (25.2     (13.6

Canada and CALA

     44.0         6.8     50.4         6.9     (6.4     (12.7

Asia Pacific

     13.3         2.1     13.3         1.8     (0.0     (0.0
                                            
   $ 647.9         100.0   $ 735.1         100.0   $ (87.2     (11.9
                                            

Revenues in the United States decreased by $55.6 million, or 11.4%, in fiscal 2010 compared to fiscal 2009, comprised of a $58.0 million decrease in sales from our telecommunications products and a $2.4 million increase in sales from our network services products. 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. The increase in revenues from network services in fiscal 2010 was due to an increase in the number of customers and the number of services we billed to those customers compared to the prior periods.

Revenues in EMEA decreased by $25.2 million, or 13.6%, in fiscal 2010 compared to fiscal 2009, as a result of the global recession and 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 region decreased 13.6% year over year, of which 6.8% was attributed to the effects of the recession which reduced revenues across all regions; with the remainder of the decrease due to a lower average exchange rate of the British pound sterling during fiscal 2010 versus fiscal 2009.

Revenues in Canada and CALA decreased $6.4 million in fiscal 2010 compared to fiscal 2009 primarily as a result of the global recession. Revenues in Asia Pacific remained stable during fiscal 2010.

Gross Margin

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

 

     Fiscal Year Ended April 30,  
     2010     2009  
     Gross
Margin
     Gross
Margin %
    Gross
Margin
     Gross
Margin %
 
     (in millions, except percentages)  

Telecommunications

   $ 281.3         49.1   $ 313.1         47.3

Network services

     32.6         43.2     31.4         43.0
                      

Total

   $ 313.9         48.4   $ 344.5         46.9
                      

Gross margin percentage improved in fiscal 2010, increasing by 1.5% to 48.4% from 46.9% in fiscal 2009. The decline in revenues in fiscal 2010 as a result of the global recession was offset by lower costs to sell our products. Lower costs were driven by lower labor and other overhead charges resulting from headcount and salary reductions. These cost saving actions and an increase in sales of higher margin products aided in maintaining our gross margin as a percentage of revenues.

 

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Gross margin percentage on telecommunication revenues increased in fiscal 2010 by 1.8% to 49.1% from 47.3% in fiscal 2009. This increase in gross margin was primarily the result of initiatives we undertook commencing in the latter half of fiscal 2009 to streamline product costs and lower our overall cost of sales. These initiatives included renegotiating supply agreements to reduce product costs, reductions in headcount and salaries to better align labor and overhead costs with current market demand, improved inventory management to lower our excess and obsolete inventories and other general cost saving measures.

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 43.2% in fiscal 2010 from 43.0% in fiscal 2009 predominantly as a result of lower rates negotiated with our local and long distance carriers.

Operating Expenses

Research and Development

R&D expenses decreased to 8.0% of total revenues in fiscal 2010 from 8.2% of total revenues in fiscal 2009, a decrease of $8.4 million in absolute dollars. The decrease in R&D expenses is primarily due to reductions in headcount and salaries and other cost saving measures implemented during the year.

Selling, General and Administrative

SG&A expenses decreased to 32.6% of revenues in fiscal 2010 from 33.8% of revenues in fiscal 2009 a decrease of $37.2 million in absolute dollars. The decrease was a result of proactive cost cutting measures undertaken during the latter half of fiscal 2009 and fiscal 2010, most notably reductions in headcount and salaries and consolidation of facilities across the globe. Our SG&A expenditures for fiscal 2010 included certain non-cash charges, most significantly $23.6 million (2009—$25.4 million) for the amortization of intangible assets such as customer relationships, developed technology and trade name, primarily related to the acquisition of Inter-Tel. In addition, SG&A included $3.3 million (2009—$2.4 million) of non-cash compensation expense associated with employee stock options.

Special Charges, Integration and Merger-Related Expenses

We recorded pre-tax special charges of $5.2 million in fiscal 2010 as a result of actions taken to lower our operating cost structure. The components of the special charges included $2.5 million of employee severance and benefits incurred in the termination of approximately 20 employees around the world, $0.5 million of accreted interest related to lease termination obligations, $0.9 million related to additional lease terminations in the period and $1.2 million in assets written off related to the termination of a product line. Payment of workforce reduction liabilities is expected to be complete by the end of fiscal 2011. The lease termination obligations incurred in the current and prior fiscal years will be reduced over the remaining term of the leases, with $3.5 million of the outstanding $6.5 million balance to be paid in fiscal 2011. Also included in special charges was $0.1 million of costs related to integration activities following our acquisition of Inter-Tel.

Litigation Settlement

In the fourth quarter of fiscal 2010 we recorded pre-tax income of $5.5 million primarily related to a settlement of litigation. Upon the acquisition of Inter-Tel in August 2007, the Company assumed liability for a lawsuit brought forward by certain former independent distributors of products of a manufacturing company whose partial assets were purchased by Inter-Tel in 2000. The lawsuit asserted that Inter-Tel was liable for, among other things, breaches of the underlying dealer agreements between the plaintiffs and the seller. In April 2010, we negotiated a settlement with the plaintiffs in this suit, which included a cash payment to the plaintiffs. The difference between the initial provision and the settlement was recorded as income in the fourth quarter of fiscal 2010.

Impairment of Goodwill

In accordance with GAAP, goodwill is tested for impairment at least annually at the reporting unit level. The fair value of each reporting unit is estimated using a combination of the market approach and the income approach. Under the market approach, a multiple of earnings before interest, taxes, depreciation and amortization of each reporting unit is calculated and compared to marketplace participants to corroborate the results of the calculated fair value. Under the income approach, discounted cash flows for each reporting unit are used to estimate the fair value of the reporting unit. We generally use the average of the results under the two approaches as the fair value of the reporting unit.

In the fourth quarter of 2010, we performed our annual impairment test of goodwill and determined that goodwill was not impaired.

In fiscal 2009, we recorded a goodwill impairment charge of $284.5 million on the goodwill initially recorded as part of the Inter-Tel acquisition. Due to the economic downturn and its impact on consumer spending, we lowered our expected cash flow

 

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forecasts and this, combined with significantly lower market multiples as a result of the general decline in global capital markets, resulted in a decline in the fair value of our U.S. reporting unit. Accordingly, the carrying amount of the goodwill exceeded the implied fair value and an impairment charge of $284.5 million was recorded in fiscal 2009. This non-cash goodwill impairment charge did not affect our liquidity, cash flows or future operations.

Operating Income (Loss)

We reported operating income of $51.2 million in fiscal 2010 compared to an operating loss of $271.9 million in fiscal 2009. The fiscal 2009 loss was driven by the $284.5 million impairment of goodwill, as described above. Absent the impairment of goodwill, our fiscal 2009 results would have shown operating income of $12.6 million. Despite the effect of the recession on our sales, operating income increased in fiscal 2010 as a result of proactive measures we undertook to control expenses and achieve operational efficiencies in our business. In addition the lower level of restructuring charges recorded in fiscal 2010 coupled with the litigation settlement gain drove a portion of the increase in operating income.

Non-Operating Expenses

Interest Expense

Interest expense was $29.8 million in fiscal 2010 compared to $40.1 million in fiscal 2009. Our interest expense relates predominantly to two credit agreements bearing interest based on LIBOR that were entered into to finance a portion of the Inter-Tel acquisition in fiscal 2008. The decrease in interest is due to a lower average LIBOR during the year, coupled with the expiry during the year of an interest rate swap agreement.

In August 2007 we entered into an interest rate swap agreement, which effectively swapped the LIBOR rate for a fixed rate of 4.85% on a notional amount of $215.0 million for the period from October 2007 to October 2009. The agreement was not renewed or replaced upon expiry. As a result, for a portion of the third quarter and all of the fourth quarter of fiscal 2010, our interest expense was recorded based solely on LIBOR, plus a margin, rather than a portion of the interest expense being recorded at the 4.85% swap rate, plus a margin. For fiscal 2010, LIBOR ranged from 0.25% to 1.06% versus a range of 1.19% to 3.44% during fiscal 2009.

In April 2010, using a portion of the proceeds from our IPO, we repaid $30.0 million on our revolving credit facility and prepaid $72.0 million of our first lien term loan. As the payments occurred at the end of the fiscal year, the repayments did not have a significant effect on the interest expense for fiscal 2010.

Debt and Warrant Retirement Costs, Including Write-Off of Related Deferred Costs.

In April 2010, we prepaid $72.0 million of our outstanding first lien term loan, at par. As a result, we wrote-off $1.0 million of unamortized deferred financing charges representing a pro-rata portion of the unamortized deferred charges related to the first lien term loan. No prepayments were made in fiscal 2009.

Fair Value Adjustment on Derivative Instruments

Fair value adjustment on derivative instruments consists of two items in fiscal 2010; the mark-to-market adjustment on the embedded derivative in the Class 1 Preferred Shares and the mark-to-mark adjustment on the warrants that have an exercise price in Canadian dollars.

The holders of Class 1 Preferred Shares had the right to redeem them and receive cash equal to the value of our common shares into which the instrument would convert after seven years. As a portion of the redemption price of the preferred shares was indexed to our common share price, an embedded derivative was accounted for separately and was marked to market in each reporting period. In April 2010, in conjunction with the IPO, the preferred shares were converted. As a result, a mark-to-market non-cash gain of $8.4 million was recorded in fiscal 2010. In fiscal 2009, we recorded a non-cash gain of $100.2 million representing the mark-to-market adjustment on the derivative liability embedded in the Class 1 Preferred Shares.

As a result of adopting the Derivatives and Hedging Topic of the FASBASC on May 1, 2009, we were required to record an adjustment for the change in fair value of our warrants that are denominated in a currency (Canadian dollars) other than our functional currency. For the year ended April 30, 2010, we recorded a loss of $1.0 million, due primarily to an increase in the fair value of our common stock as a result of the IPO. No mark to market adjustment was recorded in the prior year as the standard was not required to be adopted at that time.

Other (Income) Expense

Other (income) expense, on a net basis, consists of foreign exchange rate losses, interest income and amortization of the deferred gain on sale of the United Kingdom land and building in fiscal 2006. Other income, on a net basis, amounted to $0.9 million

 

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of income in fiscal 2010 compared to $0.8 million of expense during fiscal 2009. The $1.7 million increase in other income was driven by lower foreign exchange losses recorded in fiscal 2010 as a result of a more stable foreign exchange rates on fiscal 2010 transactions than on fiscal 2009 transactions. The lower foreign exchange loss was partially offset by a decrease in interest income caused by a decrease in interest rates.

Provision for Income Taxes

We recorded a net income tax benefit of $8.5 million in fiscal 2010 compared to $19.1 million in fiscal 2009. The net income tax benefit for fiscal 2010 reflects a current income tax expense of $4.1 million, which was more than offset by a deferred income tax benefit of $12.6 million. The fiscal 2010 current tax expense was a result of taxable income in certain jurisdictions where we do not have net operating loss carry-forwards available to offset taxable income. The fiscal 2010 deferred income tax benefit resulted from recognition of net operating losses as well as differences in accounting and tax treatment pertaining primarily to the leasing portfolio and other accruals. The net income tax benefit for fiscal 2009 reflects a current income tax benefit of $0.7 million and a deferred tax benefit of $18.4 million resulting from differences in accounting and tax treatment pertaining to revenue recognition, the leasing portfolio and other accruals.

In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or none of the deferred tax assets will be realized. During fiscal 2010, there was no change in the assessments of the realizability of the deferred tax assets by entity. During fiscal 2009, we recognized a tax benefit of $5.8 million to reflect a change in the valuation allowance because it was determined that it was more likely than not that tax assets in certain subsidiaries would be realized.

Net Income (Loss)

In fiscal 2010, our net income was driven by a number of the factors discussed above. In particular, despite the effect of the recession on our sales, net income increased in fiscal 2010 as a result of proactive measures we undertook to control expenses and achieve operational efficiencies in our business.

In fiscal 2009 our net loss was predominantly impacted by the $284.5 million impairment of goodwill, partially offset by a $100.2 million gain from fair value adjustments on our embedded derivatives and a $18.4 million deferred tax benefit.

Adjusted EBITDA

Adjusted EBITDA, a non-GAAP measure, was $89.8 million in fiscal 2010 compared to $78.7 million in fiscal 2009, a $11.1 million, or 14.1% improvement. This improvement in Adjusted EBITDA, despite the global recession, was driven by proactive cost cutting measures we took during fiscal 2009, from which the full benefit was realized in fiscal 2010, plus additional cost-cutting measures taken in early fiscal 2010. For a definition and explanation of Adjusted EBITDA as well a reconciliation of Adjusted EBITDA to net income (loss), see Item 6, “Selected Financial Data”.

Share Capital

The change in the Company’s preferred share and common share capital was as follows:

 

     Preferred
Shares
    Common
Shares
 

Balance, April 30, 2008

   $ 208.5      $ 277.1   

Accretion on preferred shares

     41.0        —     

Other

     —          0.7   
                

Balance, April 30, 2009

     249.5        277.8   

Accretion on preferred shares

     48.3        —     

Amended conversion of preferred shares

     96.2        —     

Conversion of preferred shares

     (394.0     394.0   

Initial public offering, net of underwriting commissions and costs

     —          130.7   

Other

     —          0.3   
                

Balance, April 30, 2010

     —          802.8   

Issue of shares from exercise of options

     —          2.7   
                

Balance, April 30, 2011

     —          805.5   
                

In April 2010, we sold 10.5 million common shares in the IPO at a price of $14.00 per share. Our net proceeds from the IPO were $130.7 million after underwriting commissions of $10.3 million and other associated costs of $6.3 million. The net proceeds of

 

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the IPO were used to repay $30.0 million outstanding under the revolving credit facility and $72.0 million to prepay amounts outstanding under the first lien term loan, with the remainder to be used for general corporate purposes.

In conjunction with the IPO, all of the 0.3 million Class 1 Preferred Shares, which were redeemable for cash at the option of the holder in August 2012, were converted into common shares. The original terms of the Class 1 Preferred Shares included the right of the Class 1 Preferred Share holders to redeem the Class 1 Preferred Shares for their full accreted value in August 2012. In addition, the Class 1 Preferred Shares included a conversion feature at the option of the holder. Subsequent to the IPO, had the Class 1 Preferred Shares not converted, the common shares issuable upon conversion would have been the accreted value divided by $18.56 per share. The amended terms resulted in conversion of the Class 1 Preferred Shares into common shares based on the accreted value at the time of conversion ($1,235.03 per share) divided by the IPO offering price of $14.00 per share. As the amended terms resulted in a conversion, the difference between the original conversion terms and the amended conversion terms was recorded as $96.2 million increase to share capital.

Liquidity and Capital Resources

As of April 30, 2011, our liquidity consisted primarily of cash and cash equivalents of $73.9 million and an undrawn $30.0 million revolving facility that matures in August 2012. Historically, our primary source of funds has been proceeds from financing activities, including the issuance of share capital and long-term debt. At April 30, 2011, we had $318.4 million of liability outstanding under our credit facilities, consisting of a first lien term loan and second lien term loan and had stated common share capital of $805.5 million.

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 April 30, 2011, the plan had an unfunded pension liability of $61.4 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. The amount of annual employer contributions required to fund the pension deficit annually 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 to fund the pension deficit for the 2011 calendar year was determined to be $4.2 million (£2.5 million), and will increase at an annual rate of 3% for the calendar years 2012 and 2013. In fiscal year 2011, we contributed $5.0 million (£3.2 million) to the U.K. pension plan for currency service and deficit funding. We expect to contribute $5.2 million (£3.1 million) in fiscal 2012 for current service and deficit funding.

Borrowings under the first and second lien term loans are repayable in full on their respective maturity dates. In addition, the first lien term loan requires annual repayments of $2.0 million payable in quarterly installments, plus excess annual cash flows (as defined in the credit agreement) due 100 days after fiscal year end. We expect to pay approximately $12.0 million in August 2011 relating to the excess cash flows for fiscal 2011. Proceeds from the issuance of equity or debt, and proceeds from the sale of our assets, may also be required to be used, in whole or in part, to make mandatory prepayments under the first and second lien term loans. The credit agreements relating to the first and second lien term loans have customary default clauses, wherein repayment of one or more of the credit agreements may be accelerated in the event of an uncured event of default. Each of the credit agreements contains affirmative and negative covenants, including: (a) periodic financial reporting requirements, (b) maintaining a maximum ratio of Consolidated Total Debt (as calculated under our first and second lien credit agreements) to Consolidated EBITDA (as calculated under our first and second lien credit agreements) as specified in our first and second lien credit agreements, (c) limitations on the incurrence of subsidiary indebtedness and also the borrowers themselves, (d) limitations on liens, (e) limitations on investments, (f) limitations on the payment of dividends and (g) limitations on capital expenditures. In connection with the March 2011 $25.0 million prepayment, the maximum Consolidated Total Debt to Consolidated EBITDA ratio under the first lien credit agreement was increased for the fourth quarter of fiscal 2011 and for subsequent quarters up to and including the second quarter of fiscal 2014. As of April 30, 2011, we were in compliance with all of the applicable covenants included in our current credit agreements.

Our source for cash in the future is expected to come from existing operations, and borrowings under our revolving credit facility, which expires in August 2012. Our most significant source of cash from operations is expected to be the collection of accounts receivable from our customers and the sale of future rental payments associated with sales leases which we provide to our customers to finance their purchases as part of our managed services offering program. The primary use of cash is expected to include funding operating expenses, working capital, capital expenditures, debt service and other contractual obligations.

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

 

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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.

Cash Flows—Comparison of Fiscal 2011 to Fiscal 2010

Below is a summary of comparative results of cash flows and a more detailed discussion of results for fiscal 2011 and fiscal 2010.

 

     Fiscal Year Ended
April 30,
    Change  
     2011     2010    
     (in millions)  

Net cash provided by (used in)

      

Operating activities

   $ 32.5      $ 34.4      $ (1.9

Investing activities

     (5.3     (6.5     1.2   

Financing activities

     (31.4     20.5        (51.9

Effect of exchange rate changes on cash and cash equivalents

     1.5        (0.2     1.7   
                        

Increase (decrease) in cash and cash equivalents

   $ (2.7   $ 48.2      $ (50.9
                        

Cash and cash equivalents, end of period

   $ 73.9      $ 76.6      $ (2.7
                        

Cash Provided by Operating Activities

Cash generated from operating activities in fiscal 2011 was $32.5 million compared with $34.4 million in fiscal 2010. The decreased cash flows from operations was the result of lower operating performance as discussed above under “Results of Operations—Fiscal 2011 compared to Fiscal 2010—Operating Income”, which was partially offset by cash from changes in working capital due to collections from accounts receivable and sales-type leases.

Cash Used in Investing Activities

Net cash used for investing activities was $5.3 million in fiscal 2011 compared to net cash used of $6.5 million in fiscal 2010. The primary use of cash in fiscal 2011 and fiscal 2010 was additions to capital assets of $6.2 million and $7.1 million, respectively.

Cash Provided by Financing Activities

In fiscal 2011 net cash used by financing activities was $31.4 million, compared to cash provided by financing activities of $20.5 million during fiscal 2010. Fiscal 2011 cash used by financing activities was driven primarily by repayments of long-term debt, including the $25.0 million first lien prepayment made in March 2011.

Fiscal 2010 cash provided by financing activities related primarily to the April 2010 IPO. The IPO provided cash proceeds of $137.0 million, net of underwriting commissions. This cash was used to repay $30.0 million outstanding under the revolving credit facility and $72.0 million of amounts outstanding under the first lien term loan. In addition, costs relating to the IPO of $6.3 million were paid. The net proceeds from this transaction of $28.7 million were partially offset by $3.7 million of payments of a litigation settlement obligation, $2.5 million for repayments of capital leases and $2.1 million for regular, quarterly principal repayments of the first lien term loan.

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 $1.5 million during fiscal 2011 (2010—$0.2 million decrease).

Cash Flows—Comparison of Fiscal 2010 to Fiscal 2009

Below is a summary of comparative results of cash flows and a more detailed discussion of results for fiscal 2010 and fiscal 2009.

 

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     Fiscal Year Ended
April 30,
    Change  
     2010     2009    
     (in millions)  

Net cash provided by (used in)

      

Operating activities

   $ 34.4      $ 8.8      $ 25.6   

Investing activities

     (6.5     (6.4     (0.1

Financing activities

     20.5        11.5        9.0   

Effect of exchange rate changes on cash and cash equivalents

     (0.2     (5.0     4.8   
                        

Increase in cash and cash equivalents

   $ 48.2      $ 8.9      $ 39.3   
                        

Cash and cash equivalents, end of period

   $ 76.6      $ 28.4      $ 48.2   
                        

Cash Provided by Operating Activities

Cash generated from operating activities in fiscal 2010 was $34.4 million compared with $8.8 million in fiscal 2009. The increased cash flows from operations was the result of improved operating performance as discussed above under “Results of Operations—Fiscal 2010 compared to Fiscal 2009—Operating Loss”, which was partially offset by decreases in accounts payable and accrued liabilities and deferred revenue.

Cash Used in Investing Activities

Net cash used for investing activities was $6.5 million in fiscal 2010 compared to net cash used of $6.4 million in fiscal 2009. The primary use of cash in fiscal 2010 and fiscal 2009 was additions to capital assets of $7.1 million and $6.6 million, respectively.

Cash Provided by Financing Activities

In fiscal 2010 net cash provided by financing activities was $20.5 million, compared to $11.5 million during fiscal 2009.

Fiscal 2010 cash provided by financing activities related primarily to the April 2010 IPO. The IPO provided cash proceeds of $137.0 million, net of underwriting commissions. This cash was used to repay $30.0 million outstanding under the revolving credit facility and $72.0 million of amounts outstanding under the first lien term loan. In addition, costs relating to the IPO of $6.3 million were paid. The net proceeds from this transaction of $28.7 million were partially offset by $3.7 million of payments of a litigation settlement obligation, $2.5 million for repayments of capital leases and $2.1 million for regular, quarterly principal repayments of the first lien term loan.

Fiscal 2009 cash provided by financing activities related primarily to an increase of $17.7 million in bank indebtedness caused by an increase of amounts outstanding under the revolving facility. This was partially offset by $3.7 million of payments for a litigation settlement obligation and $2.7 million for repayments of capital leases.

Effect of exchange rate changes on cash

Our overall cash position was also impacted by exchange rate changes during the period, which decreased cash slightly by $0.2 million during fiscal 2010 (2009—$5.0 million decrease).

Contractual Obligations

The following table sets forth our contractual obligations as of April 30, 2011:

 

     Payments Due by Fiscal Year  

Contractual Obligations

   Total      2012      2013      2014      2015      2016      After 5
Years
 
     (in millions)  

Long-term debt obligations (1)

   $ 389.0       $ 34.4       $ 20.4       $ 20.6       $ 181.1       $ 132.5       $ —     

Capital lease obligations (2)

     5.2         2.5         1.4         0.9         0.4         —           —     

Operating lease obligations (3)

     71.6         17.4         14.7         11.3         9.4         7.6         11.2   

Defined benefit pension plan contributions (4)

     14.1         5.2         5.2         3.7         —           —           —     

Other (5)

     24.7         9.7         4.6         4.3         4.1         2.0         —     
                                                              

Total

   $ 504.6       $ 69.2       $ 46.3       $ 40.8       $ 195.0       $ 142.1       $ 11.2   
                                                              

 

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(1) Represents the principal balance and interest payments for the first and second lien term loans. Interest on the first and second lien term loans 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, 1.00%, has been used. Included in fiscal 2012 is an estimated $12.0 million of first lien term loan repayment relating to excess cash flow from fiscal 2011, as described the “Liquidity and Capital Resources” section, above.
(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.
(4) Represents the estimated contribution to our defined benefit pension plan in the United Kingdom over the next 12 months. The amount of annual employer contributions required to fund the deficit 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 to fund the pension deficit for the calendar year 2011 was determined to be $4.2 million (£2.5 million), and will increase at an annual rate of 3% for calendar years 2012 and 2013. We expect to contribute $5.2 million (£3.1 million) in fiscal 2012 for current service and deficit funding. Future funding requirements after fiscal 2013 are highly dependent on the unfunded pension liability and the time period in which the deficit is amortized. Liabilities arising from the remaining unfunded deficit in our defined benefit pension plan are not included in the above table. As of April 30, 2011, the projected benefit obligation of $194.5 million exceeded the fair value of the plan assets of $133.1 million, resulting in an unfunded liability of $61.4 million.
(5) Represents payments under the fiscal 2007 litigation settlement and an information technology outsourcing agreement.

Total contractual obligations listed do not include contractual obligations recorded on the balance sheet as current liabilities, except for those associated with a long-term liability. Contractual obligations also exclude $11.9 million of liabilities relating to uncertain tax positions due to the uncertainty of the timing of any potential settlement.

Obligations arising from R&D spending commitments under an agreement, dated as of October 10, 2002, among us, Mitel Knowledge Corporation, March Networks and Her Majesty the Queen in Right of Canada are not included in the above table. The agreement, as last amended on March 10, 2010, requires us to spend at least 3.5% of our annual revenues in R&D in Canada each year, and to make at least 50% of our total R&D expenditures in Canada each year, until an aggregate of C$366.5 million worth of R&D has been spent in Canada since April 1, 2006.

Purchase orders or contracts for the purchase of raw materials and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements.

Off-Balance Sheet Arrangements

We have the following significant off-balance sheet arrangements:

Letters of Credit

We had $1.1 million in letters of credit outstanding as of April 30, 2011 (April 30, 2010—$0.6 million).

Bid and Performance Related Bonds

We enter into bid and performance related bonds related to various customer contracts. Potential payments due under these may be related to our performance and/or our channel partners’ performance under the applicable contract. The total maximum potential amount of future payments we could be required to make under bid and performance related bonds, excluding letters of credit, was $1.6 million as of April 30, 2011 (April 30, 2010—$4.8 million). Of this amount, the amount relating to guarantees of our channel partners’ performance was nil as of April 30, 2011 (April 30, 2010—$1.3 million). Historically, we have not made any payments and we do not anticipate that we will be required to make any material payments under these types of bonds.

Intellectual Property Indemnification Obligations

We enter into agreements on a regular basis with customers and suppliers that include limited intellectual property indemnification obligations that are customary in the industry. These obligations generally require us 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 us from making a reasonable estimate of the maximum potential amount we could be required to pay to our customers and suppliers. Historically, we have not made any significant indemnification payments under such agreements and no amount has been accrued in the consolidated financial statements with respect to these obligations.

 

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Off-balance sheet lease obligations

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 April 30, 2011, 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 $158.8 million (April 30, 2010—$177.0 million).

Critical Accounting Policies

The preparation of our consolidated financial statements and related disclosures in conformity with U.S. 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 2011. 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.

Revenue Recognition

For products sold through our network of wholesale distributors, solution providers, system integrators, authorized channel partners, and other technology providers, arrangements usually involve multiple elements, including post-contract technical support and training. We also sell products and installation and related maintenance and support services directly to customers. Due to the complexity of our sales agreements, judgment is routinely applied principally in the areas of customer acceptance, product returns, unbundling of multiple element arrangements, and collectability.

Our sales arrangements frequently include a contractual acceptance provision that specifies certain acceptance criteria and the period in which a product must be accepted or returned. We make an assessment of whether or not these acceptance criteria will be met by referring to prior experience in successfully complying with customer specifications. In those cases where experience supports that acceptance will be met, we recognize revenue once delivery is complete, title and risk of loss has passed, the fee is fixed and determinable and persuasive evidence of an arrangement exists.

The provision for estimated sales returns is recorded as a reduction of revenues at the time of revenue recognition. If our estimate of sales returns is too low, additional charges will be incurred in future periods and these additional charges could have a material adverse effect on our results of operations. As a percentage of annual revenues, the provision for sales returns was 0.16% as of April 30, 2011 compared to 0.09% as of April 30, 2010.

Direct revenue sales are comprised of multiple elements which consist of products, maintenance and installation services. We unbundle these products, maintenance and installation services based on VSOE with any discounts allocated across all elements on a pro-rata basis.

Collectability is assessed based primarily on the credit worthiness of the customer as determined by credit checks and analysis, as well as customer payment history. Different judgments or different contract terms could adversely affect the amount and timing of revenues recorded.

Sales-Type Leases

In a transaction containing a sales-type lease, hardware revenues are recognized at the present value of the payments allocated to the hardware lease element at the time of system sale in accordance with the Leases Topic of the United States Financial Accounting Standards Board Accounting Standard Codification (“FASB ASC”). With respect to the software lease elements included in the sales-type lease, which are comprised of software, including applications, upgrades, software support, and embedded software, prior to the Company establishing VSOE for these elements, revenues from the software elements were deferred and recognized over the period of support in accordance with the Software Topic of the FASB ASC. Where the Company has now established VSOE for these elements, revenue is recognized upon delivery, based on their VSOE, in accordance with the Software Topic of the FASB ASC. Revenues from sales-type leases are allocated between hardware and software elements on a relative fair value basis. The application of the relative fair value allocation method is based on management’s best estimate of relative fair values and requires the use of professional judgment in obtaining evidence of fair value for the various elements.

 

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The costs of systems installed under these sales-type leases are recorded as costs of sales. The net rental streams are sold to financial institutions on a regular basis with the income streams discounted by prevailing like-term rates at the time of sale. Gains or losses resulting from the sale of net rental payments from such leases are recorded as net sales. Furthermore, when the initial term of the lease is concluded, customers have the option to renew the lease at a payment and term less than the original lease. We establish and maintain reserves against potential recourse following the resales based upon historical loss experience, past due accounts and specific account analysis. The allowance for uncollectible minimum lease payments and recourse liability at the end of the year represents reserves against the entire lease portfolio. Management reviews the adequacy of the allowance on a regular basis and adjusts the allowance as required. These reserves are either netted in the accounts receivable, netted in the current and long term components of “Net investments in sales-type leases” on the balance sheet, or, for off-balance sheet leases, recorded as a lease recourse liability and included in long term liabilities on our balance sheet.

Our total reserve for losses related to the entire lease portfolio, including amounts classified as accounts receivable on our balance sheet was 5.3% of the ending aggregate lease portfolio as of April 30, 2011 compared to 5.6% at April 30, 2010. The reserve is based on a review past write-off experience and a review of the accounts receivable ageing as of April 30, 2011. 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 collectability 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 and 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 April 30, 2011 and April 30, 2010, the provision represented 5.4% and 8.9% of gross receivables, respectively. The decrease in reserve level at April 30, 2011 was due primarily to timing of write-offs of accounts receivable in fiscal 2011 that were provided for at April 30, 2010.

Inventory Obsolescence

In order to record inventory at the lower of cost or net realizable value, we must assess our inventory valuation, which requires judgment as to future demand. We adjust our inventory balance based on economic considerations, historical usage, inventory turnover and product life cycles through the recording of a write-down which is included in the cost of revenue. Assumptions relating to economic conditions and product life cycle changes are inherently subjective and have a significant impact on the amount of the write-down.

If there is a sudden and significant decrease in demand for our products, or a higher risk of inventory obsolescence because of rapidly changing technology and customer requirements, we may be required to increase our inventory write-downs and our gross margin could be adversely affected.

 

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Warranty Provision

We accrue warranty costs, as part of cost of revenues, based on expected material and labor support costs. The cost to service the warranty is estimated on the date of sale based upon historical trends in the volume of product returns within a warranty period and the cost to repair or replace the equipment. If we experience an increase in warranty claims that is higher than our past experience, or an increase in actual costs to service the claims is experienced, gross margin could be adversely affected. Our provision for warranty costs has decreased in fiscal 2011 and fiscal 2010 as a result of improved claims experience. The following table provides a continuity of the warranty provision over the past two years.

 

     Fiscal Year Ended
April 30,
 
     2011     2010  
     (in millions)  

Balance, beginning of year

   $ 1.6      $ 2.3   

Warranty costs incurred

     (0.4     (1.0

Warranties issued

     0.4        1.3   

Change in estimated warranty costs

     (0.7     (1.0
                

Balance, end of year

   $ 0.9      $ 1.6   
                

Long-Lived Assets

We have recorded property, plant and equipment and intangible assets at cost less accumulated amortization. The determination of useful lives and whether or not these assets are impaired involves significant judgment. We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

In response to changes in industry and market conditions, we may strategically realign our resources and consider restructuring or disposing of our existing businesses, which could result in an impairment charge. We have not recorded any impairment charges in fiscal 2011, fiscal 2010 or fiscal 2009.

Goodwill

We assess goodwill for impairment on an annual basis, or more frequently if circumstances warrant, as required by the Intangibles—Goodwill and Other Topic of the FASB ASC. An impairment charge is recorded if the implied fair value of goodwill of a reporting unit is less than the book value of goodwill for that unit. We have four geographic units that have assigned goodwill of $134.5 million in total as of April 30, 2011 (April 30, 2010—$134.5 million): the U.S., Canada and CALA, EMEA and Asia Pacific. Quoted stock market prices are not available for these individual reporting units. Accordingly, consistent with this Topic, our methodology for estimating the fair value of each reporting unit primarily considers estimated future revenues and cash flows for those reporting units along with many other assumptions.

Our U.S. geographic unit represented 96% of our total goodwill value and 67% of our total revenue in fiscal 2011. Our valuation approach therefore recognizes the significant concentration of goodwill in the U.S. reporting unit. Our valuation approach includes a detailed valuation analysis of both the Company as a whole and the U.S. reporting unit.

In performing the annual goodwill impairment test we considered three generally accepted approaches for valuing a business: the income, market and cost approaches. Based on the nature of our business and the U.S. reporting unit’s current and expected financial performance, we determined that the income and market approaches were the most appropriate methods for estimating the fair value of the U.S. reporting unit under the first step of the analysis. For the income approach we used the discounted cash flow method, and considered such factors as revenue and earnings before interest, taxes, depreciation and amortization, cash flow adjustments, terminal value, discount rate, tax rate, and tax amortization benefit. For the market approach, we analyzed the valuation indicators that our market capitalization implies, including enterprise value to EBITDA. Consideration of these factors inherently involves a significant amount of judgment, and significant movements in revenues or changes in the underlying assumptions used may result in fluctuations in the value of goodwill that is supported.

The result of the most recent annual impairment test, performed in the fourth quarter of fiscal 2011 resulted in no impairment charge. The fair values of each reporting unit exceeded its carrying value. The fiscal 2010 annual impairment test also resulted in no impairment charge.

In fiscal 2009, due to the economic downturn, we lowered our expected cash flow forecasts and this, combined with significantly lower market multiples as a result of the general decline in global capital markets, resulted in a decline in the fair value of our U.S. reporting unit in fiscal 2009. Accordingly, the carrying amount of the goodwill exceeded the implied fair value and an impairment charge of $284.5 million was recorded on the consolidated statement of operations for the year ended April 30, 2009.

 

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Erosion in capital markets, material reductions in our expected cash flow forecasts, significant reductions in our market capitalization or a significant decline in economic conditions, in addition to changes to the underlying assumptions used in our valuation approach described above, could all lead to future impairment in goodwill.

Special Charges

We record restructuring, exit and other loss accruals when the liability has been incurred. We reassess the accruals on a regular basis to reflect changes in the timing or amount of estimated restructuring and termination costs on which the original estimates were based. New restructuring accruals or reversals of previous accruals are recorded in the period of change. Additional accruals for fiscal 2011, fiscal 2010 and fiscal 2009 resulted from new restructuring activities and primarily relate to lease terminations and severance costs. No significant additions or reversals were made in fiscal 2011, 2010 or 2009 as a result of changes in estimates.

Estimates used to establish reserves related to real estate lease obligations have been reduced for sublease income that we believe is probable. Certain assumptions have been made as to the timing, availability and amount of sublease income that we expect to receive. Because we are required to project sublease income for many years into the future, estimates and assumptions regarding the commercial real estate market that were used to calculate future sublease income may be different from actual sublease income. As of April 30, 2011, the liability relating to lease termination obligations was $7.0 million, with $3.9 million recorded as current (April 30, 2010—total of $6.5 million, with $3.5 million recorded as current). This estimate will change as a result of actual results, the passage of time and changes in assumptions regarding vacancy, market rate, and operating costs.

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. Valuation allowances have been established for deferred tax assets based on a “more likely than not” threshold. We assess the likelihood that our deferred tax assets will be recovered from our ability to generate sufficient future taxable income, and to the extent that recovery is not believed to be more likely than not, a valuation allowance is recorded. Future changes in estimates of taxable income could result in a significant change to the valuation allowance.

In fiscal 2011, we updated our assessment of the realizability of our deferred tax assets. Based on a number of factors, including completion of a reorganization of certain subsidiaries, cumulative income for the previous 36 months and forecasted income (excluding non-recurring items), we determined that the weight of the evidence indicated that it was now more–likely-than-not that we would realize a benefit from a significant portion of our deferred tax assets in Canada. As a result, we relieved a valuation allowance of approximately $87.2 million, primarily relating to the deferred tax assets in Canada. At April 30, 2011, as a result of uncertainty regarding the future utilization of certain deferred tax assets, there continues to be a valuation allowance of $71.2 million, against deferred tax assets primarily in Canada and the United Kingdom.

At April 30, 2010, based on our circumstances and uncertainty regarding the future utilization of net deferred tax assets on certain jurisdictions relating to most areas of the business, we recorded a $127.6 million valuation allowance.

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 would result.

Pension Costs

We currently maintain a defined benefit pension plan for a number of our past and present employees in the United Kingdom. The plan was closed to new employees in June 2001. Our defined benefit pension costs are developed from actuarial valuations. Inherent in these valuations are key assumptions provided by us to the actuaries, including discount rates, expected return on plan assets and rate of compensation increases. In estimating the rates and returns, we consider current market conditions and anticipate how these will affect discount rates, expected returns and rates of compensation increases. Material changes in our pension benefit costs may occur in the future as a result of changes to these assumptions or from fluctuations in our related headcount or market conditions.

In fiscal 2011, our pension liability decreased by $6.7 million to $61.4 million from $68.1 million at April 30, 2010. This decrease was the result our funding contributions and actual return on plan assets being higher than the expected return, partially offset by a strengthening of the British pound sterling against the U.S. dollar. We did not make any significant changes in our actuarial assumptions in fiscal 2011.

 

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In fiscal 2010, our pension liability recorded on our balance sheet increased from $20.1 million to $68.1 million due to an increase in projected benefit obligation. This increase in the projected benefit obligation is largely attributable to changes in valuation assumptions in fiscal 2010, in particular a decrease in the discount rate used to present value the future obligation, which produced an unfavorable impact on the pension’s projected benefit obligation.

During fiscal 2009 the pension liability recorded on our balance sheet decreased from $76.4 million to $20.1 million due to a decrease in the projected benefit obligation. This decrease in the projected benefit obligation is largely attributable to changes in valuation assumptions in fiscal 2009, in particular an increase in the discount rate used to present value the future obligation, which produced a favorable impact on the plan’s projected benefit obligations.

Actuarial gains or losses arise from assumption changes in the obligations and from the difference between expected and actual return on assets. The following assumptions were used in valuing the liabilities and benefits under the pension plan:

 

     Fiscal Year Ended
April 30,
 
     2011     2010  

Discount rate

     5.30     5.60

Compensation increase rate

     3.30     3.50

Inflation rate

     3.30     3.00

Average remaining service life of employees

     18 years        18 years   

Stock-Based Compensation

We recognize stock-based compensation expense in accordance with the Stock Compensation Topic of the FASB ASC. The fair value of the stock options granted is estimated on the grant date using the Black-Scholes 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. We have estimated the volatility of our common shares using historical volatility of comparable public companies. We expect to continue to use the historical volatility of comparable companies until our historical volatility as a publicly-traded company is sufficiently established to measure expected volatility for option grants.

The assumptions used in the Black-Scholes option-pricing model are summarized as follows:

 

     April 30,
2011
    April 30,
2010
    April 30,
2009
 

Risk-free interest rate

     1.8     2.3     3.8

Dividends

     0.0     0.0     0.0

Expected volatility

     55.0     80.0     85.0

Annual forfeiture rate

     10.0     10.0     10.0

Expected life of the options

     5 years        5 years        5 years   

Fair value per option

   $ 3.15      $ 1.35      $ 3.30   

As of each stock option grant date, we considered the fair value of the underlying common shares in order to establish a minimum option exercise price. As of each stock option grant date, we reviewed an average of the disclosed year-end volatility of a group of companies that we considered peers based on a number of factors including, but not limited to, similarity to us with respect to industry, business model, stage of growth and financial risk, along with considering the future plans of our company to determine the appropriate volatility. The expected life was based on our historical stock option activity. The risk-free interest rate was determined by reference to the United States treasury rates with the remaining term approximating the expected life assumed at the date of grant. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those options expected to vest. To the extent our actual forfeiture rate is different from our estimate, stock-based compensation expense is adjusted accordingly.

For stock option modifications, such as the fiscal 2010 repricing and the fiscal 2009 and 2010 extension of option terms, we calculate the fair value of the options before the modification and the fair value of the options immediately after the modification, using the same principles as described above. We recognize immediately as compensation expense the incremental fair value for vested options. For unvested options we recognize as compensation expense the incremental fair value over the remaining vesting period.

Based on these assumptions, stock-based compensation expense reduced our results of operations by $4.7 million for the year ended April 30, 2011 (year ended April 30, 2010—$3.3 million, 2009—$2.4 million). Changes in the subjective input assumptions can, however, materially affect the fair value estimate.

 

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As of April 30, 2011, there was approximately $10.4 million of unrecognized stock-based compensation expense related to non-vested stock option awards (April 30, 2010—$4.3 million). We expect these to be recognized over a weighted average period of 3.1 years (April 30, 2010—1.9 years).

Derivative Instruments

In fiscal 2011, our change in fair value of derivative instruments was $1.0 million due the change in fair value of certain warrants that are required to be recorded as a liability. These warrants expired in fiscal 2011.

In connection with the Inter-Tel acquisition an embedded derivative was identified on the Class 1 Preferred Shares, since holders had the ability to receive cash equal to the value of shares into which the instrument converted after seven years. Accordingly, the embedded derivative was recorded at fair value, and marked to market at each reporting period with changes in value recorded in the Consolidated Statements of Operations. In conjunction with the IPO, the Class 1 Preferred Shares were converted into common shares. As a result, in fiscal 2010, we recorded an $8.4 million gain due to the change in fair value. This was partially offset by a $1.0 million expense due to the change in value of certain warrants that are required to be recorded as a liability.

In fiscal 2009, a fair value gain of $100.2 million was recorded as a result of re-measuring the derivative instrument. The gain in fiscal 2009 was primarily driven by the reduction in the fair value of our shares.

Recent Accounting Pronouncements

In October 2009, the 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 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. We are required to adopt this ASU in fiscal 2012. We are currently evaluating the effect that the adoption of this ASU will have on our 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. We are required to adopt this ASU in fiscal 2012. We are currently evaluating the effect that the adoption of this ASU will have on our 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. We adopted this ASU in the third quarter of fiscal 2011. As a result of this ASU, we provided additional disclosures surrounding our sales-type lease receivables and the related allowances within note 3 to the consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04 to achieve common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”). We are required to adopt this ASU in the fourth quarter of fiscal 2012. We do not expect to the adoption to have a material impact on our consolidated financial statements.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of loss in our future earnings due to adverse changes in financial markets. We are exposed to market risk from changes in our common share price, foreign exchange rates and interest rates. Inflation has not had a significant impact on our results of operations.

Equity Price Risk

Under our deferred share unit plan, adopted December 9, 2004, when a participant ceases to be an executive of ours, the deferred share unit plan participant will receive a cash amount equal to the number of deferred share units in his or her account multiplied by the price of a common share as of the date the deferred share unit plan participant ceases to be an executive of ours, or on a later date selected by the deferred share unit plan participant, which shall in any event be a date prior to the end of the following calendar year. The obligation to pay the cash amount is recorded as a liability in our financial statements and is marked-to-market in each reporting

 

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period, with changes in the obligation recorded in our consolidated statement of operations. A $1.00 increase in our common share price would have decreased our net incomes for fiscal 2011 and fiscal 2010 by less than $0.1 million.

Foreign Currency Risk

We are exposed to currency rate fluctuations related primarily to our future net cash flows from operations in Canadian dollars, British pounds sterling and Euros. When possible, we use foreign currency forward contracts to minimize the short-term impact of currency fluctuations on foreign currency receivables, payables and intercompany balances. These contracts are not entered into for speculative purposes, and are not treated as hedges for accounting purposes. Foreign currency contracts are recorded at fair market value. The fair value of our foreign currency forward contract is sensitive to changes in foreign currency exchange rates. As of April 30, 2011, a 5.0% appreciation in the U.S. dollar against all currencies would have resulted in an additional unrealized loss of $0.4 million on those foreign currency forward contracts. As at April 30, 2010, a 5.0% appreciation in the U.S. dollar against all currencies would have resulted in an additional unrealized loss of $0.5 million on those foreign currency forward contracts.

Interest Rate Risk

In accordance with our corporate policy, cash equivalent and short-term investment balances are primarily comprised of high-grade commercial paper and money market instruments with original maturity dates of less than three months. Due to the short-term maturity of these investments, we are not subject to significant interest rate risk.

We are exposed to interest rate risk on our $30.0 million revolving credit facility, which currently bears interest at a rate of LIBOR plus 3.25%. If the entire revolving credit facility were utilized, each adverse change in the LIBOR rate of 1.0% would currently result in an additional $0.3 million in interest expense per year. At April 30, 2011, no amount was outstanding under the revolving facility.

We are exposed to interest rate risk on $188.6 million outstanding on April 30, 2011 under our first lien term loan which matures on August 16, 2014 and bears interest at a rate of LIBOR plus 3.25% and $129.8 million outstanding on April 30, 2011 under our second lien term loan which matures on August 16, 2015 and bears interest at a rate of LIBOR plus 7.0%.

The impact of each adverse change in the LIBOR rate of 1.0% on the first lien term loan and the second lien term loan, in aggregate, would result in an additional $3.2 million in interest expense per year.

The interest rates on our obligations under capital leases are fixed and therefore not subject to interest rate risk.

Credit Risk

Our financial assets that are exposed to credit risk consist primarily of cash equivalents, accounts receivable and other receivables. Cash equivalents are invested in government and commercial paper with investment grade credit rating. We are exposed to normal credit risk from customers. However, we have a large number of diverse customers to minimize concentrations of credit risk.

As part of the TotalSolution® program, we offer sales-type leases to our customers to fund their purchases. As of April 30, 2011, we had $59.5 million (April 30, 2010—$72.3 million) of sales-type lease receivables, net of reserves for uncollectible lease repayments, on our balance sheet. We regularly sell the net rental streams from sales-type leases to financial institutions. Recourse on the sold rental payments is contractually limited to the lesser of (i) the net credit losses in a given period and (ii) a percentage of the sum of the portfolio balance for a specific portfolio of sold leases at the beginning of the period plus the purchase price paid for leases acquired during the given period. As of April 30, 2010 and 2011, we were subject to limited recourse on rental streams sold to financial institutions with such recourse in any year varying from 9.9% to 15.0% of the net book value of sold rental streams. We maintain reserves against our estimate of potential recourse for the balance of sales-type leases and for the balance of sold rental payments remaining unbilled. Reserve levels are established based on portfolio size, loss experience, levels of past due accounts and periodic detailed reviews of the portfolio. The aggregate reserve for uncollectible lease payments and recourse liability represents the reserve for the entire lease portfolio. We believe our current reserve levels are sufficient given our historic loss rates. The following table provides detail on the total net balances in sales-type leases:

 

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     April 30,
2011
     April 30,
2010
     April 30,
2009
 
     millions  

Lease balances included in consolidated accounts receivable, net of allocated allowances of $2.9 (April 2010—$4.1, April 2009—$3.3)

   $ 9.4       $ 9.3       $ 10.5   

Net investment in Sales-Type Leases:

        

Current portion, net of allowances of $0.9 (April 2010—$1.5, April 2009—$1.5)

     20.0         33.8         30.2   

Long-term portion, includes residual amounts of $6.0 (April 2010—$4.9, April 2009—$2.7); net of allowances of $1.3 (April 2010—$1.3, April 2009—$1.4)

     30.1         29.2         29.2   
                          

Total investment in Sales-Type Leases, net of allowances of $5.1 (April 2010—$6.9, April 2009—$6.2)

     59.5         72.3         69.9   

Sold rental payments remaining unbilled (subject to limited recourse provisions), net of lease recourse liability reserves of $7.1 (April 2010—$7.9, April 2009—$9.9)

     158.8         177.0         205.8   
                          

Total balance of sales-type leases and sold rental payments remaining unbilled, net of allowances and reserves

   $ 218.3       $ 249.3       $ 275.7   
                          

Total allowances and reserves for entire lease portfolio (including lease recourse liabilities)

   $ 12.2       $ 14.8       $ 16.1   

 

Item 8. Financial Statements and Supplementary Data

Management is responsible for preparation of the Consolidated Financial Statements and other related financial information included in this Report. The Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States, incorporating management’s reasonable estimates and judgments, where applicable.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page  

Reports of Independent Registered Chartered Accountants

     56   

Consolidated Balance Sheets—Years ended April 30, 2011 and April 30, 2010

     58   

Consolidated Statements of Operations—Years ended April 30, 2011, April  30, 2010 and April 30, 2009

     59   

Consolidated Statements of Shareholders’ Equity (Deficiency) and Comprehensive Income (Loss)—Years ended April 30, 2011, April 30, 2010 and April 30, 2009

     60   

Consolidated Statements of Cash Flows—Years ended April 30, 2011, April  30, 2010 and April 30, 2009

     61   

Notes to the Consolidated Financial Statements

     62   

Schedule II of the Consolidated Financial Statements

     95   

 

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Report of Independent Registered Chartered Accountants

To the Board of Directors and Shareholders of Mitel Networks Corporation

We have audited the accompanying consolidated balance sheets of Mitel Networks Corporation and its subsidiaries (the “Company”) as of April 30, 2011 and 2010, and the related consolidated statements of operations, shareholders’ equity (deficiency) and comprehensive income (loss) and cash flows for each of the three years in the period ended April 30, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Mitel Networks Corporation and subsidiaries as of April 30, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of April 30, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 1, 2011 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

Independent Registered Chartered Accountants

Licensed Public Accountants

Ottawa, Canada

July 1, 2011

 

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Report of Independent Registered Chartered Accountants

To the Board of Directors and Shareholders of Mitel Networks Corporation

We have audited the internal control over financial reporting of Mitel Networks Corporation and subsidiaries (the “Company”) as of April 30, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of April 30, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended April 30, 2011 of the Company and our report dated July 1, 2011 expressed an unqualified opinion on those financial statements and financial statement schedule.

/s/ Deloitte & Touche LLP

Independent Registered Chartered Accountants

Licensed Public Accountants

Ottawa, Canada

July 1, 2011

 

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MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

CONSOLIDATED BALANCE SHEETS

(in U.S. dollars, millions)

 

     April 30,
2011
    April 30,
2010
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 73.9      $ 76.6   

Accounts receivable (net of allowance for doubtful accounts of $7.3 and $11.9, respectively)

     127.5        121.5   

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

     20.0        33.8   

Inventories (net) (note 4)

     27.1        26.7   

Deferred tax asset (note 22)

     5.9        15.0   

Other current assets (note 5)

     37.1        46.5   
                
     291.5        320.1   

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

     30.1        29.2   

Deferred tax asset (note 22)

     91.1        5.0   

Property and equipment (net) (note 6)

     15.7        17.0   

Identifiable intangible assets (net) (note 7)

     100.6        123.1   

Goodwill (note 8)

     134.5        134.5   

Other non-current assets

     8.7        12.1   
                
   $ 672.2      $ 641.0   
                

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIENCY)

    

Current liabilities:

    

Accounts payable and accrued liabilities (note 9)

   $ 106.8      $ 107.7   

Due to related parties (note 10)

     0.2        7.2   

Current portion of deferred revenue

     40.0        46.2   

Current portion of long-term debt (note 11)

     16.4        4.1   
                
     163.4        165.2   

Long-term debt (note 11)

     306.9        345.7   

Lease recourse liability (note 3)

     7.1        7.9   

Long-term portion of deferred revenue

     13.2        14.1   

Deferred tax liability (note 22)

     50.5        70.9   

Pension liability (note 23)

     61.4        68.1   

Other non-current liabilities

     20.2        24.0   
                
     622.7        695.9   
                

Commitments, guarantees and contingencies (notes 12 and 13)

    

Shareholders’ equity (deficiency):

    

Common shares, without par value—unlimited shares authorized, issued and outstanding: 53.1 at April 30, 2011 and 52.8 at April 30, 2010 (note 14)

     805.5        802.8   

Preferred shares—unlimited shares authorized, nil issued and outstanding (note 15)

     —          —     

Warrants (note 16)

     55.6        55.6   

Additional paid-in capital

     10.8        7.7   

Accumulated deficit

     (741.8     (829.9

Accumulated other comprehensive loss

     (80.6     (91.1
                
     49.5        (54.9
                
   $ 672.2      $ 641.0   
                

(The accompanying notes are an integral part of these Consolidated Financial Statements)

 

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MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

CONSOLIDATED STATEMENTS OF OPERATIONS

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

 

     Year Ended
April 30, 2011
    Year Ended
April 30, 2010
    Year Ended
April 30, 2009
 

Revenues:

      

Telecommunications

   $ 570.8      $ 572.4      $ 662.0   

Network services

     78.9        75.5        73.1   
                        
     649.7        647.9        735.1   
                        

Cost of revenues:

      

Telecommunications

     294.8        291.1        348.9   

Network services

     43.4        42.9        41.7   
                        
     338.2        334.0        390.6   
                        

Gross margin

     311.5        313.9        344.5   
                        

Expenses:

      

Selling, general and administrative

     221.5        211.3        248.5   

Research and development

     54.1        51.7        60.1   

Special charges and restructuring costs (note 18)

     15.5        5.2        23.3   

Loss (gain) on litigation settlement

     1.0        (5.5     —     

Impairment of goodwill (note 8)

     —          —          284.5   
                        
     292.1        262.7        616.4   
                        

Operating income (loss)

     19.4        51.2        (271.9

Interest expense

     (20.0     (29.8     (40.1

Debt retirement costs, including write-off of related deferred financing costs

     (0.6     (1.0     —     

Fair value adjustment on derivative instruments (note 19)

     1.0        7.4        100.2   

Other income (expense), net

     0.8        0.9        (0.8
                        

Income (loss) before income taxes

     0.6        28.7        (212.6

Current income tax recovery (expense) (note 22)

     (8.9     (4.1     0.7   

Deferred income tax recovery (expense) (note 22)

     96.4        12.6        18.4   
                        

Net income (loss)

   $ 88.1      $ 37.2      $ (193.5
                        

Net income (loss) attributable per common share (note 17):

      

Basic

   $ 1.66      $ (7.30   $ (16.38

Diluted

   $ 1.57      $ (7.30   $ (16.38

Weighted-average number of common shares outstanding:

      

Basic

     52.9        14.7        14.3   

Diluted

     56.0        14.7        14.3   

(The accompanying notes are an integral part of these Consolidated Financial Statements)

 

59


Table of Contents

MITEL NETWORKS CORPORATION

(incorporated under the laws of Canada)

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIENCY)

AND COMPREHENSIVE INCOME (LOSS)

(in U.S. dollars, millions)

 

     Common Shares           Additional
Paid-in
Capital
    Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Total
Shareholders’
Equity
(Deficiency)
 
     Shares     Amount     Warrants          

Balance at April 30, 2008

     14.3      $ 277.1      $ 56.7      $ 1.9      $ (495.4   $ (85.0   $ (244.7

Expired warrants

     —          —          (0.1     0.1        —          —          —     

Share purchase loan repayments

     —   (1)     0.7        —          —          —          —          0.7   

Stock-based compensation

     —          —          —          2.4        —          —          2.4   

Accretion of interest on redeemable preferred shares

     —          —          —          —          (41.0     —          (41.0
                                                        
     14.3      $ 277.8      $ 56.6      $ 4.4      $ (536.4   $ (85.0   $ (282.6
                                                        

Net loss

     —          —          —          —          (193.5     —          (193.5

Other comprehensive income (loss):

              

Unrealized derivative gain on cash flow hedges

     —          —          —          —          1.9        —          1.9   

Foreign currency translation adjustments

     —          —          —          —          —          (12.3     (12.3

Pension liability adjustments

     —          —          —          —          —          56.4        56.4   
                                                        

Comprehensive income (loss)

     —          —          —          —          (191.6     44.1        (147.5
                                                        

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

Exercise of stock options

     0.1        0.1        —          —          —          —          0.1   

Share purchase loan repayments

     —          0.2        —          —          —          —          0.2   

Stock-based compensation

     —          —          —          3.3        —          —          3.3   

Issuance of common shares through public offering

     10.5        137.0        —          —          —          —          137.0   

Costs associated with public offering

     —          (6.3     —          —          —          —          (6.3

Accretion of interest on redeemable preferred shares

     —          —          —          —          (48.3     —          (48.3

Amended conversion of redeemable preferred shares

     —          96.2        —          —          (96.2     —          —     

Conversion of redeemable preferred shares

     27.9        297.8        —          —          —          —          297.8   
                                                        
     52.8      $ 802.8      $ 55.6      $ 7.7      $ (871.5   $ (40.9   $ (46.3
                                                        

Net income

     —          —          —          —          37.2        —          37.2   

Other comprehensive income (loss):

              

Unrealized derivative gain on cash flow hedges

     —          —          —          —          4.4        —          4.4   

Foreign currency translation adjustments

     —          —          —          —          —          (2.2     (2.2

Pension liability adjustments

     —          —          —          —          —          (48.0     (48.0
                                                        

Comprehensive income (loss)

     —          —          —          —          41.6        (50.2     (8.6
                                                        

Balance at April 30, 2010

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

Exercise of stock options

     0.3        2.7        —          (1.4     —          —          1.3   

Stock-based compensation

     —          —          —          4.5        —          —          4.5   
                                                        
     53.1      $ 805.5      $ 55.6      $ 10.8      $ (829.9   $ (91.1   $ (49.1
                                                        

Net income

     —          —          —          —          88.1        —