UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 20-F

 

 

 

 

 

Commission file number: 0-49984

 

MITEL NETWORKS CORPORATION / CORPORATION MITEL NETWORKS

(Exact name of Registrant as specified in its charter)

 

MITEL NETWORKS CORPORATION

(Translation of Registrant’s name into English)

 

Canada

(Jurisdiction of incorporation or organization)

 

350 Legget Drive

Ottawa, Ontario, Canada K2K 2W7

(Address of principal executive offices)

 

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

None

 

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

Common Shares, Without Par Value

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report: 117,343,736 Common Shares, 20,000,000 Class A Convertible Preferred Shares, Series 1, and 67,789,300 Class B Convertible Preferred Shares, Series 1.

 

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

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  Yes o     No þ

 

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 þ     No o

 

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.

 

Large accelerated filer o     Accelerated filer o     Non-accelerated filer þ

 

Indicate by check mark which financial statement item the registrant has elected to follow.

Item 17  þ Item 18 o

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

 

Basis of Presentation

 

The financial results of Mitel Networks Corporation (“Mitel”, “we,” “us,” “our,” or “the Company”) contained in this Form 20-F are reported in United States dollars and have been prepared in compliance with accounting principles generally accepted in the United States of America for the purposes of this annual report. In this annual report, all dollar amounts are expressed in United States dollars except where otherwise indicated.

 

Forward Looking Information

 

Some of the statements in this annual report are forward-looking statements that reflect our current views with respect to future events and financial performance. Statements that include the words “may,” “should,” “could,” “estimate,” “continue,” “expect,” “intend,” “plan,” “predict,” “potential,” “believe,” “project,” “anticipate” and similar statements of a forward-looking nature, or the negatives of those statements, identify forward-looking statements. Forward-looking statements are subject to a variety of known and unknown risks, uncertainties 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:

 

 

This list is not exhaustive of the factors that may affect any of our forward-looking statements. In evaluating these statements, you should carefully consider the risks outlined under Item 3.D. “Key Information — Risk Factors”. The forward-looking statements contained in this annual report are based on the beliefs, expectations and opinions of management as of the date of this annual report. We do not assume any obligation to update forward-looking statements to reflect actual results or assumptions if circumstances or management’s beliefs, expectations or opinions should change, unless otherwise required by law. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

TABLE OF CONTENTS

 

Note to Shareholders

 

On August 16, 2007, we announced the completion of its acquisition of Inter-Tel (Delaware) Incorporated (“Inter-Tel”), a full-service provider of business communication solutions, for $25.60 per Inter-Tel share in cash representing a total purchase price of approximately $729 million. As a result of the acquisition, Inter-Tel is now a wholly-owned subsidiary of Mitel.

 

Shareholders should note that, except as required by the Form 20-F or otherwise noted herein, the disclosure contained in this annual report describes Mitel’s business operations through fiscal year-end (i.e., April 30, 2007) and does not include or reflect changes resulting from the Inter-Tel acquisition.

 

PART I

 

 

Not applicable.

 

 

Not applicable.

 

 

 

The following sets forth selected financial information derived from our audited consolidated financial statements as of and for the fiscal years ended April 27, 2003 (fiscal “2003”), April 25, 2004 (“fiscal 2004”), April 24, 2005 (“fiscal 2005”); for the six day transition period from April 25, 2005 to April 30, 2005 (the “Transition Period”); and for the fiscal years ended April 30, 2006 (“fiscal 2006”) and April 30, 2007 (“fiscal 2007”). The selected financial information may not be indicative of our future performance and should be read in conjunction with Item 5 “Operating and Financial Review and Prospects” and the consolidated financial statements and the notes attached to the financial statements included elsewhere in this annual report. See Item 8 “Financial Information” and Item 17 “Financial Statements”.

 

STATEMENT OF OPERATIONS DATA

 

BALANCE SHEET DATA

 

 

 

 

 

Not applicable.

 

 

Not applicable.

 

 

An investment in our Common Shares should be regarded as highly speculative and is suitable only for those investors who are able to sustain a total loss of their investment. You should carefully consider the following risks, as

well as the other information contained in this annual report, when evaluating us and our business and prospects. Any of the following risks, as well as risks not currently known to us, could materially and adversely affect our business, results of operations or financial condition, and could result in a complete loss of your investment.

 

Risks Relating to our Business

 

We have incurred net losses since our incorporation in 2001 and we may not be profitable in the future.

 

We incurred a net loss of $35.0 million for fiscal 2007, and net losses of $44.6 million, $49.6 million, $30.6 million and $70.1 million in fiscal 2006, 2005, 2004 and 2003, respectively. We may not be able to achieve profitability or, if achieved, may not be able to sustain profitability. We have incurred restructuring charges in each of the previous six fiscal years, and may incur additional restructuring charges in the future. Our future success in attaining 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 revenue by, among other things, increasing efficiency in design, component sourcing, manufacturing and assembly cost processes.

 

We may fail to realize the anticipated cost savings, revenue enhancements and other benefits expected from our acquisition of Inter-Tel.

 

As part of the integration of Mitel and Inter-Tel following the acquisition, we are executing plans to consolidate sales, operations and support functions, including optimization of our supply chain and procurement structure, and to leverage our research and development and services across a larger base. These actions are expected to result in significant cost savings, opportunities for revenue synergies and other synergistic benefits.

 

Delays we encounter in the execution of our integration plans could have a material adverse effect on our revenues, expenses, operating results and financial condition. Although we expect significant benefits to result from the acquisition, there can be no assurance that we will actually realize these anticipated benefits.

 

Achieving the benefits of the acquisition will depend in part upon meeting the challenges inherent in the successful combination and integration of global business enterprises of the size and scope of Mitel and Inter-Tel and the possible resulting diversion of management attention for an extended period of time. There can be no assurance that we will meet these challenges and that such diversion will not negatively affect our operations.

 

Uncertainties associated with our integration and cost-reduction plans may cause a loss of employees and may otherwise materially adversely affect our future business and operations.

 

Our success is dependent upon the services of a number of key personnel throughout our organization, including members of our senior management and software and engineering staff, as well as the expertise of our directors. Competition for highly skilled directors, management, research and development and other key employees is intense in our industry and we may not be able to attract and retain highly qualified directors, management, research and development personnel and other key employees in the future. Our current and prospective employees may continue to experience uncertainty about their roles with us as we work through our integration associated with the acquisition. Further, management focus may be diverted in favour of integration requirements. This may materially adversely affect our ability to attract and retain key management, sales, marketing, operations, technical support and other personnel. Accordingly, no assurance can be given that we will be able to attract or retain our key employees to the same extent that we have been able to attract or retain our employees in the past.

business in Asia-Pacific from 1987 to 2000. He currently serves on the board of directors of several companies, including Mart Asia Ltd., March Networks Asia Pacific Limited, BreconRidge Manufacturing Solutions Asia Ltd. and Vodatel Networks Holding Ltd. Mr. Fung has a Bachelor of Applied Science in Industrial Engineering Degree from the University of Toronto.

 

Norman Stout was appointed Chief Executive Officer of Inter-Tel and a member of Inter-Tel’s Board of Directors on February 22, 2006. He began his tenure at Inter-Tel in 1994 as a director. Four years later, he joined Inter-Tel as executive vice president, chief administrative officer and president of Inter-Tel Software and Services. Prior to joining Inter-Tel, Mr. Stout was Chief Operating Officer of Oldcastle Architectural Products and since 1996, Mr. Stout also had served as President of Oldcastle Architectural West. Mr. Stout held previous positions as President of Superlite Block; Chief Financial Officer and Chief Executive Officer (successively) of Boorhem-Fields, Inc. of Dallas, Texas; and as a Certified Public Accountant with Coopers & Lybrand. He currently serves on the board of Hypercom Corporation, a public company headquartered in Phoenix, Arizona. Mr. Stout holds a Bachelor of Business Administration degree in Accounting from Texas A&M and an MBA from the University of Texas. He currently holds the position of CEO, US.

 

Craig W. Rauchle was appointed President of Inter-Tel in February 2005. He was appointed Chief Operating Officer of Inter-Tel in August 2001 and served as its Executive Vice President from December 1994 to February 2005. As President and Chief Operating Officer of Inter-Tel, Mr. Rauchle was responsible for Inter-Tel’s sales and support functions, marketing, procurement, distribution and research and development activities. He had been its Senior Vice President and continued as President of Inter-Tel Technologies, Inc., its wholly owned sales subsidiary. Mr. Rauchle joined Inter-Tel in 1979 as Branch General Manager of the Denver Direct Sales Office and in 1983 was appointed the Central Region Vice President and subsequently the Western Regional Vice President. From 1990 to 1992, Mr. Rauchle served as President of Inter-Tel Communications, Inc. In 2006, he was elected to the board of directors of iMergent. Mr. Rauchle holds a Bachelor of Arts degree in Communications from the University of Denver. He currently holds the position of President, US.

 

Douglas W. Michaelides joined us in January 2006 as Vice-President, Marketing. From October 2003 to December 2005, Mr. Michaelides was Senior Vice President, Marketing at MTS Allstream Inc., one of Canada’s largest business telecommunications service providers. Before that he held various positions over a period of 20 years in sales and marketing at Nortel, culminating in the role of Vice President and General Manager of the global professional services business in 2001. Mr. Michaelides has a Bachelor of Science degree in electrical engineering from the University of Toronto and an MBA from York University (Toronto, Ontario, Canada).

 

Ronald G. Wellard joined us in December 2003 as Vice-President, Research and Development and currently holds the position of Vice-President of Product Development. Prior to July 2003, Mr. Wellard was a Vice-President at Nortel and notably held the position of Product Development Director for Meridian Norstar from 1994 to 1999. Mr. Wellard has a Bachelor of Applied Science, Systems Design Engineering degree from the University of Waterloo (Ontario, Canada).

 

 

The addition of manufacturing locations or other contract manufacturers would likely increase the complexity of our supply chain management. 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 addition, alternate sources may not be available to us or may not be in a position to satisfy our production requirements at commercially reasonable prices and quality. Therefore, any significant interruption in manufacturing would 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.

 

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. Software licenses could terminate in the event of a bankruptcy or insolvency of a software supplier or other third party licensor. We have not entered into

source code escrow agreements with every software supplier or third party licensor. 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 the licenses are otherwise terminated, we may be unable to deliver the affected products to meet our customer orders.

 

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

 

Our success depends on the intellectual property in the solutions and services 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 these patents.

 

We make use of some open source software code under various open source licenses available to the general public. A characteristic of an open source license is that it does not provide any indemnification to the licensee against third-party claims of intellectual property infringement. Some open source licenses require the licensee to disclose the licensee’s source code derived from such open source code, and failure to comply with the terms of such licenses can result in the licensee being stopped from distributing products that contain the open source code or being forced to freely disseminate enhancements that were made to the open source code. Further, the use of open source software in our solutions may expose those solutions to security risks.

 

Many foreign jurisdictions offer less protection of intellectual property rights than Canada and the United States, 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.

 

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. Aggressive patent litigation is not uncommon in our industry and can be disruptive. 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 or discontinue the sale of the affected applications and products. We have received notices, and we may receive additional notices, containing allegations that our solutions are subject to patents or other proprietary rights of third parties, including competitors, patent holding companies and consortiums. In addition, in July 2007, one of our competitors filed an answer and counterclaim in the United States District Court for the Eastern District of Texas (and has moved to have the case transferred to the Northern District of California) alleging that we are infringing one of its patents and requesting damages (treble damages in respect of alleged willful infringement of the patent), injunctive relief, attorney’s fees, costs and expenses, and such further relief against us as the court deems just and proper. See Item 8.A. “Financial Information — Consolidated Statements and Other Financial Information — Legal Proceedings” for a more complete description of this proceeding.

 

Our success also depends, in part, upon our customers’ freedom to use our products. For example, certain claims have been asserted against end-users within our industry and demands for the payment of licensing fees have been made of end-users who have implemented our solutions. We generally agree to indemnify and defend our customers to the extent a claim for infringement is brought against our customers with respect to our solutions.

Infringement claims (or claims for indemnification resulting from infringement claims) have been and may in the future be asserted or prosecuted against us or our customers by third parties. Some of these third parties, including 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 these claims have merit, we may be subject to costly and time-consuming legal proceedings, and this could 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 and could be prevented from selling some or all of our solutions. In addition, an infringer of a United States patent may be subject to treble damages and attorney’s fees if the infringement is found to be willful. We may also be obligated to indemnify our business partners or customers in any such litigation. Furthermore, in order to resolve such proceedings, we may need to obtain licenses from third parties or substantially modify or rename our solutions in order to avoid infringement. Moreover, license agreements with third parties may not include all intellectual property rights that may be issued to or owned by the licensors, and future disputes with these parties are possible. In addition, we might not be able to obtain the necessary licenses on acceptable terms, or at all, or be able to modify or rename our solutions successfully. This could prevent us from selling some or all of our solutions. 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 result. Any litigation relating to intellectual property rights, whether or not determined in our favor or settled by us, could at a minimum be costly and would divert the attention and efforts of management and our technical personnel. An adverse determination in any litigation or proceeding could prevent us from making, using or selling some or all of our solutions and subject us to damage assessments.

 

We rely on our channel partners for the majority 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 resellers or potential resellers 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.

 

The most likely potential channel partners for us are those businesses engaged in the voice and data communications business or the provision of communications software applications. 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.

 

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

 

We produce 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, or application or product re-engineering expenses. The sale and support of applications and products 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 contracted suppliers and manufacturers.

 

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 Alcatel-Lucent, Avaya Inc., Cisco Systems, Inc., NEC Corporation , Nortel Networks Corporation, Panasonic Corporation, Shoretel, Inc., Siemens AG, Toshiba Corporation and 3Com Corp. 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 the business communications market, including companies that currently compete in other sectors of the information technology, communications or software industries, mobile communications companies, or communications companies that serve residential rather than business customers.

 

Several of our existing competitors have, and many of our future competitors may have, greater financial, personnel, research 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 geographically balanced 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 cannot match or do not offer. 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. Also, as voice and data communications converge, we may face competition from systems integrators that were traditionally focused on data network integration. 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. Competition from existing and potential market entrants may take many forms, including 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.

 

As voice and data networks converge, we are likely to face increased competition from companies in the information technology, personal and business applications and software industries.

 

The convergence of voice and data networks and their wider deployment by enterprises has led information technology and communication applications deployed on converged networks to become more integrated. This integration has created an opportunity for the leaders in information technology, personal and business applications and the software that connects the network infrastructure to those applications, to enter the telecommunications market and offer products that compete with our systems. Competition from these potential market entrants may take many forms, and they may offer products and applications similar to those we offer. Certain leaders in the information technology, personal and business applications and software industries, have substantial financial and other resources that they could devote to this market.

 

If competitors from the information technology, personal and business applications or software industries enter the telecommunications market, the market for IP telecommunications systems will become increasingly competitive.

If the solutions offered by competitors achieve substantial market penetration, we may not be able to maintain or improve our market position, and our failure to do so could materially and adversely affect our business and results of operations.

 

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

 

We have a number of strategic alliances and continue to pursue strategic alliances with other companies in areas where collaboration can produce industry advancement and acceleration of new markets. 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. In addition, we may face increased competition if a third party acquires one or more of our strategic partners or if our competitors enter into additional successful strategic relationships.

 

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

 

We do business in over 90 countries and are increasing our activities in foreign jurisdictions. Accordingly, our future results could be materially and adversely affected by a variety of uncontrollable and changing factors relating to international business operations, including:

 

 

 

 

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

 

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, we cannot predict the effect of exchange rate fluctuations upon future sales and expenses. 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. 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 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:

 

 

As a result of the above factors, a quarterly or yearly comparison of our results of operations is not necessarily meaningful.

 

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.

 

Our working capital requirements and cash flows have historically been, and our working capital requirements and cash flows 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. Factors which could lead us to suffer cash flow fluctuations include:

 

 

In order to finance our business, we expect to use available cash and to continue to have access to a $30 million revolving credit facility. However, our ability to draw on this facility will be conditioned upon our compliance with covenants contained in the credit agreement. There can be no assurance that we will be in compliance with the covenants required by our lenders in the future.

 

We may need to secure additional sources of funding if our cash, credit facility and borrowings are not available or are insufficient to finance our business. We cannot provide any assurance that such funding will be available on terms satisfactory to us. 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 First and/or Second Lien 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 research and development expenses and capital expenditures. In addition, 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.

 

The exercise of conversion rights by one or more of our preferred shareholders, warrant holders, and option holders, could adversely affect the market value of our Common Shares as well as our ability to complete any future equity financing.

 

As at September 30, 2007, we had outstanding:

 

 

The issuance of Common Shares upon the conversion of our Preferred Shares or the exercise of certain warrants or stock options may occur at a time when the conversion or exercise price is below the market value of our Common Shares. Therefore, the conversion or exercise of these securities will likely have a dilutive effect on the value of our Common Shares. The conversion or exercise of these securities will also result in us having more Common Shares outstanding, which would have a dilutive effect on our earnings per share. Furthermore, the Class 1 Preferred Shares, warrants and stock options, as well as the terms of these securities could materially impair our future ability to raise capital through an offering of equity securities. For additional information on these conversion and exercise rights, see Item 10.B. “Additional Information — Memorandum and Articles of Incorporation — Share Capital”.

 

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

 

On August 16, 2007, in connection with the acquisition of Inter-Tel, we borrowed $300 million under a 7 year term First Lien Credit Agreement and borrowed $130 million under a 8 year Second Lien Credit Agreement. In addition, as part of the transaction, we secured a 5 year, $30 million revolving credit facility, which remained unutilized as at September 30, 2007. All three of these credit agreements have customary default clauses. In the event we were to default on these credit agreements, and were unable to cure the default, the repayment of one or more of 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 existing credit facilities. 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, which may include the sale of part or all of the business, the sale of which may occur at a distressed price.

 

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

 

We currently maintain a defined benefit pension plan, which was closed to new employees in June 2001, for a number of our past and present employees in the United Kingdom. The contributions to fund benefit obligations under this plan are based on actuarial valuations, which themselves are based on certain assumptions 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, 2007, the projected benefit obligation of $173.9 million exceeded the fair value of the plan assets of $123.4 million, resulting in a pension liability of $50.5 million. Changes to pension legislation in the United Kingdom may adversely affect our funding requirements.

 

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, Barbados 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, including Canada, have detailed transfer pricing rules which require that all transactions with non-resident related parties be priced using arm’s length pricing principles, and contemporaneous documentation must exist to support this pricing. The taxation authorities in the jurisdictions where we carry on business, including the Canada Revenue Agency, the United States Internal Revenue Service and HM Revenue & Customs in the United Kingdom, could challenge our arm’s length related party 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.

 

Future changes in financial accounting standards could adversely affect our reported results of operations.

 

A change in accounting policies could have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New pronouncements and varying interpretations of pronouncements have occurred with frequency and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.

 

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 voice-over-Internet-Protocol 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.

 

Specifically, on January 5, 2005, Inter-Tel received court approval of a civil settlement agreement (the “Civil Settlement”) and a criminal plea agreement (the “Plea Agreement”) with the United States of America, each dated as of December 8, 2004 and disclosed on that same date. The court approval of the Civil Settlement and Plea Agreement resolved the investigation of the Department of Justice into the participation of Inter-Tel Technologies, Inc. (“Technologies”), a wholly-owned subsidiary of Inter-Tel, in a federally administered “E-Rate program” to connect schools and libraries to the Internet. In connection with the Civil Settlement, Technologies paid a penalty of $6.7 million and forgave the collection of certain accounts receivable of $0.3 million related to Technologies’ participation in the E-Rate program. In connection with the Plea Agreement, Technologies entered guilty pleas to charges of mail fraud and an antitrust violation. Under the Plea Agreement, Technologies paid a fine of $1.7 million and is observing a three-year probationary period, which has, among other things, required Technologies to implement a comprehensive corporate compliance program. The existence and disclosure of the Civil Settlement and the Plea Agreement may have already caused and may cause future harm to Inter-Tel and, as a result of our acquisition of Inter-Tel, to us.

 

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, research and development and other employees is intense in our industry and we may not be able to attract and retain highly qualified directors, management, and research and development personnel and other key employees in the future. In order to improve productivity, a portion of our compensation to key employees and directors is in the form of stock option grants, and as a consequence, a

depression in our value of our shares could make it difficult for us to motivate and retain employees and recruit additional qualified directors and personnel. The recent decision by the Financial Accounting Standards Board regarding the accounting treatment of stock options as compensation expense could lead to a reduction in our use of stock options as an incentive and retention tool. We currently do not maintain corporate life insurance policies on the lives of our directors or any of our key employees.

 

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

 

As part of our business strategy, we will consider further acquisitions of, or significant investments in, businesses that offer products, services and technologies complementary to ours. These acquisitions could materially adversely affect our operating results and the price of our Common Shares. Acquisitions involve significant risks and uncertainties, including:

 

 

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.

 

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

 

We will be required to document and test our internal controls 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 for the year ended April 30, 2008. As a result, we will be required to assess and/or improve our financial and managerial controls, reporting systems and procedures, and we will incur substantial expenses to test our systems and controls, incur expenses associated with an independent registered accounting firm report on our controls, as well as ongoing compliance costs. If our management is unable to certify the effectiveness of our internal controls or if our independent registered public accounting firm cannot render an opinion on management’s assessment and on the effectiveness of our internal controls over financial reporting, or if significant deficiencies or material weaknesses in our internal controls are identified, we could be subject to regulatory scrutiny and a loss of public confidence.

 

Business interruptions could adversely affect our operations.

 

Our operations are vulnerable to interruption by fire, earthquake or other natural disaster, power loss, computer viruses, security breaches, telecommunications failure, quarantines, national catastrophe, terrorist activities, war and other events beyond our control. We do not have a fully implemented detailed business continuity plan. There can be no assurance that the coverage or limits of our business interruption insurance will be sufficient to compensate for any losses or damages that may occur.

Risks Related to an Investment in our Common Shares

 

There are significant restrictions on the resale of our securities and there can be no assurance as to when such restrictions will cease to apply, if ever.

 

There is presently no public market through which our securities may be sold or resold. Our securities are not listed for trading on any stock exchange, and there is no guarantee that any such listing will be completed in the future. None of our securities have been registered under the United States Securities Act of 1933 , as amended (the “Securities Act”) or the securities laws of any of the states of the United States and are “restricted securities” as defined under the rules of the Securities Act, which may not be transferred to a U.S. person except pursuant to registration under the Securities Act, or pursuant to an available exemption from registration under the Securities Act. Canadian provincial securities laws also restrict the transfer of our securities, unless an exemption from the prospectus requirements is available in respect of such transfer, at least until the time we become a reporting issuer in a province of Canada. In addition, our articles currently contain restrictions on the transfer of our Common Shares. Investors may be unable to liquidate an investment in our securities, whether or not a listing is subsequently affected. An investor should not purchase our securities unless such investor is able to endure a lack of liquidity and/or withstand a total loss of his or her investment.

 

Each of Francisco Partners and Dr. Matthews is a significant shareholder and each has the potential to exercise significant influence over matters requiring approval by our shareholders.

 

Francisco Partners group and Dr. Matthews group beneficially hold 41.5% and 38.7%, respectively, of the voting power of our share capital as of September 30, 2007, as further disclosed in Item 7.A. “Major Shareholders and Related Party Transactions — Major Shareholders” and Item 7.B. “Major Shareholders and Related Party Transactions — Related Party Transactions”. Francisco Partners has the right to nominate four members to our board of directors, Dr. Matthews has the right to nominate three members and Dr. Matthews is also the chairman of our board. Each of Francisco Partners and Dr. Matthews, given the extent of their respective ownership positions, have the potential to control matters requiring approval by shareholders, including the election of directors, any amendments to our articles of incorporation or by-laws, and significant corporate transactions. Each of Francisco Partners and Dr. Matthews may have interests that differ from the interests of our other shareholders.

 

Each of Francisco Partners’ and Dr. Matthews’ ownership of our Common Shares, as well as provisions contained in our articles of incorporation and Canadian law, may reduce the likelihood of a change of control occurring and, as a consequence, may deprive you of the opportunity to sell your Common Shares at a control premium.

 

The voting power of Francisco Partners and Dr. Matthews, 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 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 Competition Act (Canada). This legislation permits the Commissioner of Competition of Canada to review any acquisition of or control over a significant interest in us and grants the Commissioner jurisdiction to challenge such an acquisition before the Canadian Competition Tribunal on the basis that it would, or would be likely to, result in a substantial prevention or lessening of competition in any market in Canada. In addition, the Investment Canada Act subjects an acquisition of control of a Canadian business (as that term is defined therein) by a non-Canadian to government review if the value of assets acquired 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 a net benefit to Canada (see Item 10.B. “Additional Information — Exchange Controls”). 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, certain of our directors and officers, certain of the selling shareholders or our independent public accounting firm 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 directors and officers, certain of our significant shareholders and our independent public accounting firm reside principally in Canada and all or a substantial portion of our assets and 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.

 

U.S. investors will suffer adverse United States federal income tax consequences if we are characterized as a passive foreign investment company.

 

If, for any taxable year, we are treated as a passive foreign investment company, or PFIC, as defined under Section 1297 of the Internal Revenue Code, then U.S. Holders (see Item 10.E. “Additional Information — Taxation — United States Federal Income Tax Considerations”) would be subject to adverse United States federal income tax consequences. Rather than being subject to these adverse tax consequences, U.S. Holders may be able to make a mark-to-market election, which could require the inclusion of amounts in income of a U.S. Holder annually, even in the absence of distributions with respect to, or the disposition of, our Common Shares. We do not believe that we are a PFIC, nor do we anticipate that we will become a PFIC in the foreseeable future. However, we cannot assure you that the Internal Revenue Service will not successfully challenge our position or that we will not become a PFIC in a future taxable year, as PFIC status is re-tested each year and depends on our assets and income in such year. For a more detailed discussion of the PFIC rules, see Item 10.E. “Additional Information — Taxation — United States Federal Income Tax Considerations — Passive Foreign Investment Company Considerations”.

 

 

 

We were incorporated in Canada under the Canadian Business Corporation Act (the “CBCA”) on January 12, 2001 by Zarlink Semiconductor Inc. (“Zarlink”) (formerly Mitel Corporation) in order to reorganize its communications systems division in contemplation of the sale of that business to companies controlled by Dr. Matthews. In a series of related transactions on February 16, 2001 and March 27, 2001, we acquired from Zarlink the “Mitel” name and substantially all of the assets (other than Canadian real estate and most intellectual property assets) and subsidiaries of the Zarlink communications systems business. Our registered office and corporate headquarters are located at 350 Legget Drive, Ottawa, Ontario, Canada, K2K 2W7, Telephone: (613) 592-2122, Facsimile: (613) 592-4784.

 

Significant developments subsequent to fiscal 2006:

 

On May 9, 2006, we filed a registration statement on Form F-1 with the Securities and Exchange Commission (the “SEC”) to sell Common Shares in the United States and a preliminary prospectus with the Canadian securities regulators to sell Common Shares in Canada. We submitted a request to the SEC to withdraw our registration statement on September 26, 2007. We withdrew our prospectus in Canada on April 27, 2007.

 

On June 23, 2006, one of our competitors, Avaya Inc., filed a complaint in the United States District Court for the Eastern District of Virginia alleging that we were infringing on certain of its patents. On September 8, 2006 we filed a defence to Avaya’s complaint and a counterclaim alleging that Avaya was infringing on certain of our patents. Effective February 1, 2007, we entered into a settlement whereby we cross-licensed all of our patents and all of Avaya’s patents filed prior to a specified date, the contents of which are confidential. We agreed to make specified

up-front and past and ongoing royalty payments, based on certain thresholds over a defined period. The legal actions have been withdrawn in conjunction with this cross-licensing settlement.

 

On June 27, 2007 we filed a claim in U.S. District Court for the Eastern District of Texas against ShoreTel Inc. for patent infringement. ShoreTel filed an answer and counterclaimed that we infringed one of its patents and is seeking to have the action transferred to the Northern District of California from the Eastern District of Texas. ShoreTel also filed a defamation suit against us in the Ontario Superior Court of Justice in Toronto, Ontario, Canada alleging inter alia that we committed trade libel by issuing a press release announcing the filing of the infringement case in the Eastern District of Texas. We have answered the claim and are moving the court to move the case to Ottawa, Ontario, Canada obtain a bond to cover costs, and to stay the proceedings until the Texas case is resolved in order to prevent unnecessary costs and duplicative litigation. Decisions on the above motions are pending before the court.

 

Subsequent to April 30, 2006, we implemented additional restructuring actions that resulted in a special charge in the quarter ending October 31, 2006. The restructuring involved the termination of 104 employees around the world and the consolidation of office locations in the United States.

 

On June 26, 2006, the parties to the 2004 Shareholders Agreement executed an amendment under which each of them consented to, and each of Zarlink and Power Technology Investment Corporation (“PTIC”) agreed to defer their respective put rights in connection with 10,000,000 Common Shares and 16,000,000 Series B Preferred Shares, respectively, from September 1, 2006 to May 1, 2007. See Item 10.C. “Additional Information — Material Contracts” for a further description of the 2004 Shareholders Agreement.

 

On September 21, 2006, we closed a common share warrant offering under which we sold 15,000 warrants to Wesley Clover for total consideration of $15 million (the “2006 Warrants”).

 

Pursuant to an Agreement and Plan of Merger (the “Merger Agreement”) dated as of April 26, 2007 among Mitel, Inter-Tel (Delaware), Incorporated (“Inter-Tel”) and Arsenal Acquisition Corporation (“Arsenal”), a wholly-owned subsidiary of Mitel, Mitel agreed to acquire Inter-Tel for $25.60 per share, in cash, representing a total purchase price of approximately $729 million (the “Merger”). Pursuant to the Merger Agreement, Arsenal merged with and into Inter-Tel and Mitel indirectly acquired all of the outstanding stock of Inter-Tel such that Inter-Tel became a wholly-owned subsidiary of Mitel. The Merger was subsequently completed on August 16, 2007.

 

In order to complete the Merger, we obtained both equity and debt financing commitments as described below.

 

First, Mitel received equity financing in the amount of $263,087,000 from Francisco Partners II, L.P. on behalf of Francisco Partners affiliated entities (“Francisco Partners”) and Morgan Stanley Principal Investors Inc. (collectively, the “Investors”). Pursuant to a subscription agreement entered into between Mitel and the Investors on August 16, 2007, the Investors made an aggregate equity investment of $263,087,000 in us in exchange for the issuance to the Investors of the Class 1 Preferred Shares and warrants to acquire Common Shares of Mitel (the “Equity Financing”).

 

Second, Morgan Stanley Senior Funding Inc. and Morgan Stanley Senior Funding (Nova Scotia) Co. (collectively, and together with their respective affiliates, “Morgan Stanley”) arranged a syndicate of lenders to provide a secured first lien term loan and revolving credit facilities and secured second lien loan facility in the aggregate amount of $460 million (collectively, the “Debt Financing”), as follows:

 

 

(i) a $300 million term loan facility;

 

(ii) a $30 million revolving credit facility, consisting of US and Canadian sub-facilities; and

 

 

As a condition to completing each of the Equity Financing and the Debt Financing, we took the following capital and debt restructuring actions, with requisite shareholder approval, to:

 

(i) reduced the stated capital of the Series A Preferred Shares and made a return of capital to the holder of the Series A Preferred Shares;

(ii) amended the conversion rights attaching to the Series A Preferred Shares to provide that such Series A Preferred Shares be convertible, at the option of the holder thereof, into 0.000871 of a Class 1 Preferred Share and 0.2679946 of a Common Share;

 

(iii) converted each existing Series A Preferred Share into 0.000871 of a Class 1 Preferred Share and 0.2679946 of a Common Share;

 

(iv) converted each existing Series B Preferred Share into 1.682 Common Shares;

 

(v) deleted from the articles of the Corporation the Class A Preferred Shares, the Class B Preferred Shares, the Series A Preferred Shares and the Series B Preferred Shares;

 

(vi) repaid all of the $55 million senior secured convertible notes (the “Convertible Notes”) issued by us on April 27, 2005;

 

(vii) purchased for cancellation certain Common Shares upon the exercise of put rights held by Zarlink and PTIC;

 

(viii) terminated the put rights held by EdgeStone;

 

(ix) repurchased the 2006 Warrants issued to Wesley Clover on September 21, 2006;

 

(x) terminated the Series 2 Warrants held by EdgeStone (collectively, the “Re-Organization Transactions”); and

 

(xi) issued Class 1 Shares and warrants to purchase Common Shares to PTIC and Dr. Matthews.

 

International Brotherhood of Electrical Workers

 

As a result of our acquisition of Inter-Tel, certain employees have been transferred from our subsidiary Mitel Networks Inc. (“MNI”) to an Inter-Tel subsidiary, Inter-Tel Technologies, Inc. (“ITT”). Some of these employees, while working for MNI, were represented by the International Brotherhood of Electrical Workers (“IBEW”). Because these MNI employees no longer work for MNI, there is no longer a bargaining unit to be represented by the IBEW. Therefore, in accordance with applicable U.S. federal labor law, MNI has notified the IBEW that it no longer recognizes it as the certified representative of its former employees.

 

Inter-Tel Merger:

 

See Item 10.B. “Additional Information — Memorandum and Articles of Incorporation — Share Capital”. Unless otherwise indicated, disclosure in this Item 4 has not been updated to include the impact of the Inter-Tel acquisition.

 

 

We are a provider of unified communications solutions and services for business customers. Our award winning Internet Protocol, or IP, based communications solutions consist of a combination of telephony hardware products, such as communications platforms and desktop devices, and software applications that integrate voice, video and data communications with business applications and processes. We refer to these hardware products and software applications as communications solutions because they are configured to meet our customers’ specific communications needs. We complement our communications solutions with a range of services, including the design of communications networks, implementation, maintenance, training and support services. We believe that our IP-based communications solutions and services enable our customers to realize significant cost benefits and to conduct their business more effectively.

 

We have been a leading vendor of business communications systems for over 25 years. Over the past six years, we have invested heavily in the research and development of IP-based communications solutions to take advantage of the telephone communications industry shift from legacy PBX systems to IP-based unified communications solutions. As a result of our efforts, we have realigned our business and discontinued certain products and activities relating to our legacy systems. In focusing our investments on our IP-based communications solutions we have incurred losses in each of the past five fiscal years, including net losses of $35 million in fiscal 2007 and

$44.6 million in fiscal 2006. As at April 30, 2007, we had an accumulated deficit of $398.2 million. However, we believe our early and sustained investment in IP-based research and development, and our decision to concentrate our efforts on this technology, has positioned us well to take advantage of the industry shift to IP-based communications solutions. As a result of this strategic focus, we have experienced significant growth in the sales of our IP-based communications solutions as businesses migrate from their legacy systems. Our IP-based product revenues have increased by 60% since fiscal 2005. Substantially all of our system shipments for the fiscal year 2007 were IP-based communications solutions.

 

Our IP-based communications solutions are scalable, flexible, secure, easy to deploy, manage and use, and are currently used by customers with as few as 10 users in a single location to a customer with a seamless multi-site network that supports over 40,000 users today and has the capacity to grow to 65,000 users. Scalability refers to how well a hardware or software system can adapt to increased demands and is a very important feature because it means customers can invest in a network with confidence that they will not outgrow it. Through the use of open and defined standards, our solutions can interoperate with various systems supplied by other vendors, allowing our customers to migrate their legacy systems towards an IP-based system at their own pace, and can also be aligned with our customers’ business systems and processes. We offer packaged software applications that are designed to solve particular business communications challenges, including applications for contact centers, mobility, teleworking, messaging and collaboration. We also develop solutions that focus on specific industries as well as custom software applications that address the needs of specific customers. Our customers include prominent hotel chains, governmental agencies, retail chains, professional services firms, educational establishments and healthcare providers worldwide. We operate from over 40 locations around the world and we sell our communications solutions through a distribution network of over 1,400 channel partners that includes wholesale distributors, solutions providers, authorized resellers, communication services providers, systems integrators, and other distribution channels.

 

Our Solutions

 

We have designed our IP solutions to perform as pure IP-based communications solutions and also as gateways to facilitate interoperability with our customers’ existing voice infrastructure and legacy devices.

 

Our product portfolio consists of communications platforms and gateways (both of which manage call processing), a desktop portfolio (such as phones, desktop PC applications, conference units and operator consoles) and software applications (software which typically enables specialized functionality such as messaging, teleworking and collaboration). We complement these products with a broad range of services.

 

We have won numerous awards for our product innovation, industrial design and performance. Some of these awards include:

 

 

 

 

 

We have made significant investments in the development of new IP-based communications solutions to meet the changing needs of our customers and their migration to IP-based communication systems. Our commitment to the development of our IP solutions has resulted in an IP communications portfolio that we believe is among the broadest and most sophisticated in the industry today.

 

Platforms and Gateways

 

Our IP communications products include the following platforms and gateways:

 

 

 

 

 

Desktop Portfolio:

 

Our desktop portfolio includes a broad range of telephones, consoles, conference units, soft phones (a software-only implementation of an IP telephone that runs on a personal computer) and ancillary devices that support our IP-based communications systems. We have been recognized by a number of third parties as a leader in the design of desktop devices, which have been acknowledged for their ease of use, aesthetics, high quality and functionality.

 

Our IP-based desktop products interoperate with all of our IP-based communications platforms and software applications. These desktop products allow users access to advanced telephony features and services such as integrated web browsing, enhanced directory management, and visual voicemail, regardless of whether they are in the office, at home or travelling.

 

Our latest desktop devices provide the capability to customize the displays for particular industries or for customer specific requirements. Functionality can be easily developed to display web content, information or interactive services linked to internal corporate systems (for example, conference room bookings, emergency broadcasts or information queries). This customization can be undertaken by a customer, a channel partner or can be performed by our professional services organization. In addition, this capability has been leveraged to deliver “out of the box” applications from Mitel’s product development group. The Mitel Intelligent Directory application provides access to the corporate directory with integrated presence capability. We also provide in-building wireless devices which provide access to the majority of the features of the Mitel 3300 ICP.

 

Applications

 

We offer a broad range of IP-based packaged software applications that are used by businesses across a variety of industries. We also offer customized software applications to businesses requiring highly tailored solutions.

 

 

 

 

Our Legacy Telephony Communication Solutions

 

In some developing countries and for specific applications there is still a demand for legacy PBX systems. Our legacy circuit-switched telephony portfolio includes the Mitel SX-2000, a fully featured traditional communications platform that addresses businesses with up to 20,000 users. This system provides extensive features and functionality, allows individual elements of the system to be distributed throughout an organization, can support redundant hardware and software to minimize system downtime and supports networking between systems, based on industry standards, for seamless voice communications between separate sites. The Mitel SX-2000 is complemented by a portfolio of digital telephones and a suite of applications. We offer a simple migration path to IP communications for our extensive base of customers with Mitel SX-2000 and Mitel SX-200 PBX implementations using the Mitel 3300 ICP and Mitel SX-200 ICP.

 

Our Services

 

We complement our product offerings with a broad range of services. Our services are delivered by both our channel partners and us and extend from initial planning and design through to implementation and support. Planning services include needs assessments, site surveys, system configuration, network design and project management. Implementation services include IP-based system and application implementations, advanced messaging implementations and multi-site installations. Additional services include resource coordination, project management, contract administration, performance management, customized applications development, technical support services, long-term systems management service and training. Our support options are flexible to meet the varied needs of our customers, including warranty coverage, software support programs and maintenance agreements. Our service offerings enable us to maintain and grow our relationship with our customers and provide us with recurring revenues.

 

Historically, legacy equipment maintenance was focused on hardware and post implementation services. Dealing with a service concern typically entailed the dispatch of a technician to the customer site for diagnosis and repair or replacement of defective hardware. In recent years, as our product mix has transitioned towards IP-based communications solutions, the nature and delivery of our service offerings has changed. Consultative service, pre-engineering, planning and design have emerged as service opportunities. Post implementation service has become more efficient with the technology evolution, allowing the diagnosis (and in some cases, the resolution) of customer outages or concerns conducted remotely, more quickly and at a lower cost.

Business Segments and Principal Markets

 

The following table sets forth total revenues by geographic regions, both in dollars and as a percentage of total revenues, for the fiscal years indicated:

 

 

For further information regarding our reportable segments please see Item 5 “Operating and Financial Review and Prospects”.

 

Sales, Marketing and Distribution

 

Our sales and marketing strategy leverages our own offices in 18 countries with the local presence and customer relationships of over 1,400 channel partners servicing customers in more than 90 countries. Product fulfillment and order logistics for a portion of our channel partners are generally performed in the United States and Europe by our wholesale distributors. During fiscal 2007, our major distributors included GrayBar Electric Co., Inc., and Tech Data Corporation. Our channel partners are supported by our internal teams of channel managers, systems engineers, technical account managers and sales administrators. To complement our channel partner network, we also provide support to independent consultants who focus on assisting companies with network design, implementation and vendor selection. We believe our extensive channel partner network allows us to effectively sell our solutions globally, without the need to build dedicated in-house sales and service capabilities in every geographic market. We continue to recruit channel partners with a focus on growing market coverage, supporting converged solutions and implementing applications interoperation.

 

We do not employ a traditional direct versus indirect strategy, under which a direct sales team may compete with indirect channel partners for the same end user sales opportunity. Instead, our own sales staff works directly with a prospective customer or in coordination with a channel partner in defining the scope, design and implementation of the solution. These customers can decide to do business directly with us or through a channel partner. Our sales staff is directed to operate a channel-neutral selling approach. On a case-by-case basis we may close a sale on a direct basis, while utilizing one of our channel partners for the purpose of fulfillment and ongoing support. Conversely, channel partners may bring us sales opportunities for which they see a greater likelihood of winning the account if we take a lead role in the selling process.

 

Our marketing organization employs a comprehensive strategy to enhance our brand, 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, product placements, analyst relations and web content delivery. Our channel marketing organization designs and administers the channel program, benefits and incentives targeted at competencies and quality in delivery of our solutions to the market. Our solutions marketing organization develops materials and programs for our portfolio of solutions that provide clear business value to our target customers. Our vertical marketing team understands the unique business needs and challenges of our key vertical markets and tailors our solutions to address those needs. We also operate 16 demonstration 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.

 

As at September 30, 2007, our sales and marketing force, excluding Inter-Tel consisted of 373 employees.

Our Strategy

 

Our strategy is to build from our leading position in the small and medium-sized business market, to attract large enterprise customers, increase our market share and generate attractive returns for our shareholders. To accomplish these objectives, we intend to:

 

 

Our growth strategy may also include the acquisition of additional businesses, technologies, product lines or services in the future and may also include the divestiture or downsizing of product or service groups in order to permit us to focus on what we believe are our core competencies.

 

Manufacturing and Supply Chain Management

 

We outsource all of our manufacturing and certain of our supply chain management and distribution functions. The outsourcing of these functions allows us to:

 

 

We outsource our worldwide manufacturing and repair operations primarily to BreconRidge and Flextronics Telecom Systems, Ltd. (“Flextronics”) . BreconRidge is one of the world’s top 50 electronics manufacturing services companies. BreconRidge specializes in the communications, industrial and consumer market sectors and provides many services including design, process and test engineering services, component sourcing, manufacturing, repair/refurbishment and distribution services. BreconRidge has more than 710,000 square feet of manufacturing capacity in state-of-the-art facilities in Canada, the United States and China. Flextronics has a network of facilities in over 30 countries on four continents. This global presence provides design and engineering solutions that are vertically integrated with manufacturing, logistics, and component technologies to optimize customer operations by lowering costs and reducing time to market.

 

The manufacturing of our products has been allocated among these key suppliers to reduce the risks associated with using a single supply source and to ensure competitive pricing and levels of service. This approach also enables us to respond more rapidly to increases in demand for our products. Our suppliers are responsible for performing periodic market reviews to validate proposed pricing actions.

 

We have an internal operations group which has the responsibility of managing these contract manufacturing relationships. Functions performed by our operations group include:

 

 

In addition, we retain Lytica Inc., an independent contract manufacturing consultancy, to assist us in assessing, on a quarterly basis, if pricing from our manufacturers is at market rates and if the level of service obtained from them is comparable to their competitors.

 

Research and Development

 

Since 2001, we have invested heavily in IP-based product research and development. This strategy has been based on two key planning assumptions. First, we believed that the shift in customer demand towards IP-based solutions would be one of the most significant technology developments in the voice communications industry since digital telephony displaced analog phone systems in the 1980s. Second, we believed that the transition to IP-based solutions, when it did happen, would be rapid. Companies who did not anticipate and proactively plan for this rapid technological change would miss out on a significant market opportunity, suffer significant customer and market share losses and damage their potential for future revenue growth. Our new product development programs are exclusively focused on developing IP-based solutions.

 

Accordingly, we have been executing an aggressive research and development investment strategy, designed to position us with one of the broadest portfolios of IP-based communications solutions in the industry. This strategy has been reflected in our research and development expense levels, which have ranged between 11% and 17% of revenues in the period from fiscal 2001 through fiscal 2007. Our investment strategy has positioned us with a broad range of feature-rich, scalable, standards-based and interoperable IP-based solutions, that allow us to capitalize on our historical strength in the small and medium-sized business market, and expand our addressable market to larger enterprise customers. This strategy has also allowed us to migrate our product revenues over the past four years, from being predominantly based on legacy circuit-switched technology to 93% IP products. Our IP-based product revenues have increased by 60% since fiscal 2005. Additionally, less than 1% of our system shipments for the fiscal year 2007 were legacy PBX systems. As a result, we believe we have minimal exposure to continued erosion of legacy product revenues.

 

Our research and development organization, excluding the acquired Inter-Tel laboratories is based in Ottawa, Canada and comprised of 292 personnel as of September 30, 2007, almost all of whom are engaged in IP product design and verification. Research and development personnel have an average tenure with us of approximately 11 years, and bring competencies in real time software, call control, telephony applications and digital signal processing. Our ratio of software to hardware engineers is approximately 5:1, reflecting our focus on software in our core products and our growing suite of applications. We also leverage external development relationships with a number of third party software development firms, both for specific software applications that we may brand as Mitel products and for non-mission-critical development and support. We target a major release cycle for our key products every six to nine months.

 

The TPC Agreement, as last amended on October 31, 2006 (as described in Item 10.C. “Additional Information — Material Contracts — TPC Agreement” requires us to invest an aggregate of C$366.5 million worth of research and development over a seven year period commencing on March 31, 2005, with a minimum of C$45.8 million to be invested each year. We spent C$52.2 and C$47.7 on research and development for both years ended March 31, 2006 and March 31, 2007 and as such we achieved the minimum requirement for the first and second years of the seven-year period.

 

Intellectual Property

 

We have over 650 patents and pending applications in the United States, Canada and Europe, and in other countries around the world, covering over 250 inventions. Approximately one third of our patents and pending applications relate to IP telephony and collaboration technology, while the balance cover industrial designs (primarily in connection with our desktop devices) and our legacy telephony communications solutions. Within the last five years we have focused our intellectual property efforts on seeking patent protection for our IP-based communications inventions and have a number of patents in the areas of presence, collaboration and mobility.

 

Historically, our strategy has been to rely on our patent portfolio primarily to counter any allegations of infringement on the patents held by our competitors. Given the strength of our IP-based patent portfolio, we are developing a strategy to leverage these assets by asserting our rights in certain patented technologies. Certain

companies have engaged us to pro-actively license or purchase patents within our portfolio and we will continue to encourage others to do the same.

 

Effective February 1, 2007, Mitel and Avaya Inc. entered into a settlement agreement with respect to worldwide mutual cross licensing agreement covering all products and services of each respective portfolios.

 

On June 27, 2007 we filed a lawsuit against ShoreTel Inc. in the U.S. District Court for the Eastern District of Texas, alleging infringement of four of our patents (we subsequently added 2 additional patents to our claim). Given our considerable investment in intellectual property in support of our communications innovations, we intend to assert our rights against those that infringe our intellectual property.

 

Our other intellectual property assets include industrial designs, trademarks, proprietary software, copyrights, operating and instruction manuals, trade secrets and confidential business information.

 

Our solutions may 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 Microsoft collaboration interfaces has been developed internally and is owned by us.

 

In some cases, we have obtained a non-exclusive license 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 application or is sold as a separate self-contained application, such as voicemail or unified messaging applications. 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 these 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 IP-based communications platforms and IP-based desktop portfolio. If any of these third- party licenses were to terminate, we would need to license functionally equivalent technology from another supplier.

 

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.

 

Competition

 

Historically, our competition has come primarily from two groups of vendors. The first group consists of traditional telephony products companies such as Alcatel-Lucent, Avaya Inc., Cisco Systems, Inc., NEC Corporation, Nortel Networks Corporation, Panasonic Corporation, ShoreTel, Inc., Siemens AG, Toshiba Corporation and 3Com Corp. When competing against these companies we generally focus on the following factors:

 

 

The second group of competitors consists of data product companies such as Cisco, who, in recent years, have expanded their offerings to include IP-based voice communications products. When competing against these companies, we focus on our ability to migrate to IP-based solutions at a pace that makes sense for the customer and the richness of our software applications, in addition to the other factors listed above.

 

We also compete with a number of new startup companies who are focused on the IP-based communications market. We compete against these new entrants by leveraging our size, our extensive channel network, our large installed based, our global presence and our deep knowledge of telephony built on over 25 years of developing telephony solutions.

 

 

See Item 7.A. “Major Shareholders and Related Party Transactions — Major Shareholders” and Item 7.B. “Major Shareholders and Related Party Transactions — Related Party Transactions” for a discussion of our major shareholders and their related ownership interest in Mitel.

 

We carry on our worldwide business directly and through our subsidiaries. Our material subsidiaries as of October 23, 2007 are shown on the chart below, with the jurisdiction of incorporation in parentheses:

 

 

 

Leased Facilities:

 

As of April 30, 2007, we did not own any real property but leased the following:

 

 

 

 

 

The Ottawa facilities are leased from Brookstreet Research Park Corporation, 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. See Item 7.B. “Major Shareholders and Related Party Transactions — Related Party Transactions — Brookstreet Research Park Corporation”.

 

In addition to these significant properties as of April 30, 2007, we also operated a number of regional sales offices throughout the world from leased facilities totaling, in the aggregate, approximately 750,000 square feet, including offices:

 

 

 

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

 

The following discussion should be read in conjunction with our consolidated financial statements and the notes to those statements, as well as the other financial information appearing elsewhere in this annual report. This annual report contains forward-looking statements that involve risks and uncertainties and that reflect estimates and assumptions. Our actual results may differ materially from those indicated in forward-looking statements. Factors that could cause our actual results to differ materially from our forward-looking statements are described in Item 3.D. “Key Information — Risk Factors” and elsewhere in this annual report.

 

Inter-Tel Merger

 

On August 16, 2007, the Company announced the completion of its acquisition of merger with Inter-Tel, a full-service provider of business communications solutions, for $25.60 per Inter-Tel share in cash representing a total purchase price of approximately $729. As a result of the acquisition, Inter-Tel is now a wholly-owned subsidiary of Mitel. The transaction was funded by a combination of equity and debt financing and resulted in significant changes to our debt and equity structure.

 

The transaction will be accounted for in our second quarter of fiscal 2008 using the purchase method of accounting under accounting principles generally accepted in the United States. The deemed purchase price will be allocated to the underlying tangible and identifiable assets and liabilities acquired based on their respective fair values and any excess purchase price allocated to goodwill.

 

With the exception of Item 5.B. “Operating and Financial Review and Prospects — Liquidity and Capital Resources” and Item 5.D. “Operating and Financial Review and Prospects — Trend Information”, the following discussion has not been updated to include the impact of the acquisition on forward-looking information.

Overview

 

We are a provider of unified communications solutions and services for business customers. Our Internet Protocol, or IP, based communications solutions consist of a combination of telephony hardware products, such as communications platforms and desktop devices, and software applications that integrate voice, video and data communications with business applications and processes. We refer to these hardware products and software applications as communications solutions because they are configured to meet our customers’ specific communications needs. We complement our communications solutions with a range of services, including the design of communications networks, implementation, maintenance, training and support services. We believe that our IP-based communications solutions and services enable our customers to realize significant cost benefits and to conduct their business more effectively.

 

We were incorporated in Canada on January 12, 2001 by Zarlink in order to reorganize its communications systems division in contemplation of the sale of that business to companies controlled by Dr. Matthews. In a series of related transactions on February 16, 2001 and March 27, 2001, we acquired from Zarlink the “Mitel” name and substantially all of the assets (other than Canadian real estate and most intellectual property assets) and subsidiaries of the Zarlink communications systems business.

 

Over the past six years, we have invested heavily in the research and development of IP-based communications solutions to take advantage of the telephone communications industry shift from legacy PBX systems to IP-based unified communications solutions. As a result of our efforts, we have realigned our business and discontinued certain products and activities relating to our legacy systems. In focusing our investments on our IP-based communications solutions we have incurred losses in each of the past five fiscal years, including net losses of $35.0 million in fiscal 2007 and $44.6 million in fiscal 2006. As at April 30, 2007, we had an accumulated deficit of $398.2 million. However, we believe our early and sustained investment in IP-based research and development, and our decision to concentrate our efforts on this other technology, has positioned us well to take advantage of the industry shift to IP-based communications solutions. As a result of this strategic focus, we have experienced significant growth in the sales of our IP-based communications solutions as businesses migrate from their legacy systems. Our IP-based product revenues increased by 60% of total product revenues over the past two years. Substantially all of our system shipments for the quarter ended April 30, 2007 were IP-based communications solutions.

 

Comparability of Periods

 

On April 24, 2005, we changed our fiscal year end from the last Sunday in April to April 30 in each year. The selection of the last Sunday in April as our fiscal year end typically resulted in a fifty-two week year with four thirteen week quarters. The change in the fiscal year end allows us to better align our reporting results with those of our industry peers. Results for the six-day transition period from April 25, 2005 to April 30, 2005 have not been included in this discussion and analysis as it would not be meaningful to extrapolate this six-day period to forecast quarterly or annual operating results. In light of our realignment of our business over the past six years to focus on IP-based communications solutions, we believe that period-over-period comparisons of our operating results are not necessarily meaningful and should not be relied upon as being a good indicator of our future performance.

 

Effective fiscal 2006, we changed our structure of reporting so that the reportable segments are now represented by the following four geographic areas: the United States; Canada and Caribbean & Latin America (CALA); Europe, Middle East & Africa (EMEA); and Asia-Pacific. These reportable segments were determined in accordance with how management views and evaluates our business. In previous years, we reported our operations in two segments: the Communications Solutions segment (“Solutions”) and the Customer Services segment (“Services”). The results of operations for fiscal 2005 have been restated to conform with the new presentation.

 

Prior to May 1, 2006, our financial statements and those of our subsidiaries were measured using their local currency as the functional currency. Effective May 1, 2006, we changed the Canadian parent company’s functional currency from the Canadian dollar to the US dollar as a result of a change in our primary economic environment, where the majority of sales and expenses now occur in US dollars. Our consolidated financial statements continue to be prepared with US dollar reporting currency using the current rate method. Assets and liabilities of foreign operations are translated from foreign currencies into US dollars at the exchange rates in effect at the balance sheet

date while revenue and expense items are translated at the weighted-average exchange rates for the 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.

 

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 and cash flows.

 

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

 

Gross margins and operating costs are evaluated in similar manners as actual performance is measured 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 ability to collect accounts receivable by measuring our days sales outstanding.

 

In addition to the above indicators, from time to time, we also monitor performance in the following areas: status with our key customers on a global basis; 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 our customers and maintaining strong relationships with those customers, we monitor the status of key customer contracts and conduct regular customer satisfaction surveys 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 and services to business customers with these revenues being classified as product or service revenues. Product revenues are comprised of revenues generated from the sales of platforms and desktop devices, software applications and other product-related revenues, while service revenues are primarily comprised of revenues from maintenance and support, managed services, installation and other professional services.

 

We sell our communications solutions and services through a distribution network of channel partners that includes wholesale distributors, solutions providers, authorized resellers, communications service providers, systems integrators, and other technology providers. 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.

 

Software revenues are 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, revenues are allocated to each element based on the relative fair value or the residual method, as applicable, and using vendor specific objective evidence of fair values, which is based on prices charged when the element is sold separately. Revenues related to post-contract support, including technical support and unspecified when-and-if available software upgrades, is recognized ratably over the post-contract support term for contracts that are greater than one year. For contracts where the post-contract support period is one year or less, the costs are deemed insignificant, and the unspecified software upgrades are expected to be and historically have been infrequent, revenues are recognized together with the initial licensing fee and the estimated costs are accrued.

 

We make sales to distributors and resellers based on contracts with terms typically ranging from one to three years. For products sold through these distribution channels, revenues are recognized at the time the risk of loss is

transferred to distributors and resellers according to contractual terms and if all contractual obligations have been satisfied. These arrangements usually involve multiple elements, including post-contract technical support and training. Costs related to insignificant technical support obligations, including second-line telephone support for certain products, are accrued. For other technical support and training obligations, revenues from product sales are allocated to each element based on vendor specific objective evidence 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 fifteen 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 resellers do not provide for return or price protection rights while sales to distributors provide for these rights. Product return rights 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 distributors, we estimate the product return provision using past return experience with similar distribution partners operating in the same regions. We offer various cooperative marketing programs to assist our distribution 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 products, including installation and related maintenance and support services, directly to end-user customers. For products 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 for free customer support and maintenance services extending twelve months from the date of installation. Customer support and maintenance contracts are also sold separately. When customer support or maintenance services are provided free of 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 system management services of communication systems (“Managed Services”). Under these arrangements, Managed Services and communication equipment are provided to end-user customers for terms that typically range from one to ten years. 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.

 

Cost of Revenues

 

Cost of revenues is comprised of product costs and service costs. Product cost of revenues consists of cost of goods purchased from third-party electronics manufacturing services, or EMS suppliers, inventory provisions, engineering costs, warranty costs and other supply chain management costs.

 

We outsource most of our worldwide manufacturing and repair operations to BreconRidge. In addition to BreconRidge, we outsource the manufacturing of a number of our IP-based platforms to Flextronics International in China and Plexus Corp. of the United States, and also outsource certain desktop sets to WKK Technology Ltd. in China. The manufacturing of our products has been allocated among these key suppliers to reduce the risks associated with using a single supply source. (See Item 3.D. “Key Information — Risk Factors — Because we depend primarily upon one outside contract manufacturer to manufacture our products, our operations could be

delayed or interrupted if we encounter problems with this contractor.”) We retain Lytica Inc., an independent contract manufacturing consultancy, to assist us in attempting to confirm, on a quarterly basis, that pricing from BreconRidge, Flextronics and WKK Technology Ltd. is at market rates and the level of service obtained from them is comparable to their competitors.

 

Service cost of sales is primarily comprised of labor costs associated with maintenance and support, Managed Services, installation and other professional services.

 

Research and Development Expenses

 

Our product development programs are focused on developing IP-based communications solutions. Our research and development organization is based in Ottawa, Canada and comprises over 300 personnel, almost all of whom are engaged in IP product design and verification. We also leverage outsourced development relationships with a number of third party software development firms, for non-mission-critical development and support.

 

Research and development expenses consist primarily of salaries and related expenses for engineering personnel, materials and consumables and subcontract service costs.

 

Sales, General and Administrative Expenses

 

Sales, general and administrative (“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 financing functions, legal and professional fees, insurance and other corporate and overhead expenses.

 

Special Charges

 

Special charges relate to restructuring activities, product line exit and other loss accruals undertaken to improve our operational efficiency and to realign our business to focus on IP-based communications solutions. Special charges consist primarily of workforce reduction costs, lease termination obligations, assets write-offs and legal costs. 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.

 

Other Operating Expenses

 

Other expenses included as deductions against operating income include gains or losses on sale of assets or operations.

 

 

The following table sets forth our audited consolidated statement of operations data for the fiscal periods indicated:

 

STATEMENT OF OPERATIONS DATA

 

Fiscal 2007 as compared to Fiscal 2006

 

The following table sets forth our comparative results of operations, both in dollars and as a percentage of total revenues, for fiscal 2007 and 2006:

 

 

 

 

Revenues:

 

Geographic Segment Revenues:

 

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

 

 

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, for the fiscal years indicated:

 

 

During fiscal 2007 revenues declined by $2.2 million, or 0.6%, compared to fiscal 2006.

 

Revenue in the United States declined by $16.9M, or 9.5%, as compared to fiscal 2006. The decline in revenue is primarily attributable to decreased product sales through both the region’s channel partners and direct sales offices. In addition, the region experienced a decline in its service revenue primarily due to decreased installation services that are directly associated with the decline in product sales through our direct sales offices.

 

Despite the revenue decrease in the United States, we experienced revenue growth of $14.7 million for the fiscal year ended April 30, 2007 across all of the other geographical segments, with the most significant growth, in absolute dollars, coming from EMEA and Canada and CALA.

 

Revenue growth of $6.1 million in EMEA is primarily attributable to increased product sales through the region’s channel partners, specifically in the United Kingdom and Continental Europe. However, revenue growth in the region has been partially mitigated by a year-over-year decline in the region’s service business resulting primarily from a decline in both maintenance and support and managed service revenues.

 

Revenue growth of $5.8 million in the Canada and CALA segment is primarily attributable to increased product sales through channel partners and our direct sales offices in Canada.

 

The overall growth in global product sales as well as the decline in global service revenues is addressed in greater detail below.

 

The following table sets forth total revenues for groups of similar products and services, both in dollars and as a percentage of total revenues, for the fiscal years indicated:

 

 

 

Product Revenues:

 

Revenues from product sales were $263.6 million in the fiscal year ended April 30, 2007 compared to $260.5 million in fiscal 2006, representing an increase of 1.2%.

 

Revenues generated by sales of our communications platforms and desktop devices decreased by $2.9 million or 1.4% on a year-over-year basis. Despite the overall decline, sales of IP-based communication platforms and desktop devices increased by 4.5%, or approximately $8 million, compared to fiscal 2006. Consistent with recent periods, we continued to experience a decrease in sales of our legacy communication platforms and desktop devices with revenue from these products declining by approximately $11 million on a year-over-year basis. Revenues from the sale of legacy communication platforms and desktop devices were less than 10% of total platform and desktop appliances revenue in Fiscal 2007. The growth in IP-based communications platforms and desktop devices revenues has been driven primarily by increased shipments of platforms and desktop devices during Fiscal 2007. While we have experienced some pricing adjustments on IP-based communication platforms and desktop devices compared to fiscal 2006, pricing changes have not had a significant impact on the revenue growth for the year.

 

In addition to the growth in IP communication platforms and desktop devices, we also experienced significant year-over-year growth in software applications revenues, with software applications revenues growing by $4.2 million or 12.3% in fiscal 2007 compared to fiscal 2006. IP-based software applications represented over 95% of total software applications revenues for fiscal 2007, an increase from approximately 83% in fiscal 2006, and revenues from IP-based software applications increased in excess of 14% in comparison to fiscal 2006. The growth in IP-based software applications revenues reflects (i) a year-over-year increase in the rate of attachment of software applications to the underlying platforms and desktop devices (ii) approximately $0.6 million of revenue resulting from the sale of IP applications introduced during fiscal 2007 and (iii) approximately $0.6 million of revenue resulting from price increases on specific applications.

 

Other product revenues, which include mainly original equipment manufacturer products that we re-sell, remained relatively consistent as a percentage of sales in fiscal 2007 compared to fiscal 2006.

 

Overall IP-based product revenues represented 93% of total product revenue for fiscal 2007, an increase from 86% in fiscal 2006.

 

Service Revenues:

 

Revenue from services sales was 31.5% of total revenues during fiscal 2007, representing a decrease from 32.7% of total revenues for fiscal 2006. This decrease is primarily attributable to a decline in maintenance and support revenues of $3.7 million, a decline in installation services revenues of $3.4 million and a decline in revenues from Managed Services contracts of $1.5 million.

 

The decline in maintenance and support revenues and revenues from Managed Services contracts is due primarily to the decline in revenue from the EMEA region due to increased market competition. In fiscal 2007, maintenance and support revenues and revenues from Managed Service contracts declined by approximately $5.0 million over fiscal 2006 levels in the EMEA region. We estimate that 85% of this decline was due to contracts that were not renewed due to market competition, while the rest of the decline is attributable to lower pricing on services due to competitive market pressures.

 

The decline in installation services revenue was primarily attributable to the decline in product sales via our direct sales offices in the United States.

 

The overall decline in service revenues was partially mitigated by an increase in professional and other service revenues of $3.3 million which is primarily attributable to increased training and professional services revenue in the United States and United Kingdom.

We continue to generate more than 60% of our total service revenues from the provision of fixed maintenance contracts.

 

Gross Margin:

 

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

 

 

Gross margin declined to 41.5% of revenues for fiscal 2007 compared to 41.7% for fiscal 2006.

 

Products gross margin as a percentage of revenues decreased from 42.8% in fiscal 2006 to 42.4% in fiscal 2007. The decrease in margin is primarily due to:

 

 

Service margins improved marginally to 39.6% in fiscal 2007 from 39.5% in fiscal 2006. The slight improvement in service margins was due primarily to the change in mix of service revenues, as total service revenues contained a lower proportion of relatively lower margin installation services revenue in fiscal 2007 compared to fiscal 2006.

 

Operating Expenses

 

Research and Development:

 

Research and development expenses decreased from 11.4% of total revenues in fiscal 2006 to 10.8% in fiscal 2007, with spending in absolute dollars declining by $2.4 million year-over-year. The reduction in both absolute dollars and as a percentage of revenue is attributed to restructuring actions taken during fiscal 2007 to align our operating expense model with current revenue levels.

 

Historically, we have invested between 11% and 17% of revenues on research and development from fiscal 2002 through fiscal 2007, consistent with an aggressive research and development investment strategy that has positioned us with a broad range of feature- rich, scalable, standards-based and interoperable IP-based communication solutions.

The TPC Agreement, as last amended on October 31, 2006 (as described under Item 10.C. “Additional Information — Material Contracts — TPC Agreement”) required us to invest an aggregate of C$366.5 million worth of research and development over a seven year period commencing on March 31, 2005, with a minimum of C$45.8 million to be invested each year. We spent C$52.2 and C$47.7 on research and development for both years ended March 31, 2006 and March 31, 2007 and as such we achieved the minimum requirement for the first and second years of the seven-year period.

 

Selling, General and Administrative:

 

SG&A expenses increased from 31.1% of total revenues in fiscal 2006 to 32.0% in fiscal 2007, with spending in absolute dollars growing by $2.8 million year-over-year. The increase in both absolute dollars and as a percentage of revenues is due primarily to strategic investments in various sales initiatives in regions outside of the United States. In addition, in fiscal 2007 we incurred $0.3 million in incremental compensation expense associated with employee stock option grants.

 

Special Charges:

 

During the year ended April 30, 2007, we recorded net special restructuring charges of $9.3 million related to further cost reduction measures taken to align our operating expense model with current revenue levels net of reversals of prior year’s charges of $0.2 million resulting from adjustments to original estimated severance costs. The net restructuring charges included workforce reduction costs of $8.9 million for employee severance and benefits and associated legal costs incurred in the termination of 129 employees throughout the world. In addition, special charges included $0.4 million of accreted interest costs associated with excess facilities obligations and $0.2 million in non-cancelable lease costs relating to various sales office closures in the United States.

 

During fiscal 2006, we recorded special restructuring charges of $5.7 million related to further cost reduction measures taken to align our operating expense model with current revenue levels, net of reversals of prior year’s charges of $0.8 million resulting primarily from adjustments to original lease termination obligations for excess space in Canada and the United Kingdom. The net restructuring charges included workforce reduction costs of $5.7 million relating to employee severance and benefits and associated legal costs incurred in the termination of 84 employees throughout the world. In addition, special charges included $0.8 million of accreted interest costs associated with excess facilities obligations.

 

Litigation Settlement:

 

On June 23, 2006, one of our competitors filed a complaint in the United States District Court for the Eastern District of Virginia alleging that we infringed on certain of its patents and requested damages. On September 8, 2006 we filed a defense to the competitor’s complaint and a counterclaim alleging that the competitor is infringing upon certain of our patents and also requested damages.

 

On March 19, 2007 an agreement was reached to settle all litigation claims outside of court. Under the terms of the settlement agreement, the competitor agreed to release us from all past infringements and the parties have also entered into a covenant to not sue each other for a period of 5 years from the effective date. In accordance with SFAS No. 5, Accounting for Contingencies, a one-time litigation settlement charge of $16.3 million was recorded during fiscal 2007. The litigation settlement amount is comprised of $14.8 million, representing the present value of $19.7 million payable over a five-year period and discounted using an interest rate of 12%, plus $1.5 million in legal costs.

 

Initial Public Offering Costs:

 

On May 9, 2006, we initiated an initial public offering by filing a registration statement on Form F-1 under the United States Securities Act of 1933 to sell Common Shares in the United States and a preliminary prospectus with the Canadian securities regulators to sell Common Shares in Canada. In fiscal 2006 and fiscal 2007, we incurred $3.3 million in costs associated with the initial public offering.

On April 26, 2007, we signed a definitive merger agreement whereby we agreed to acquire Inter-Tel for $25.60 per Inter-Tel share. It was our intention, upon the completion of the proposed acquisition of Inter-Tel, to withdraw from the initial public offering process. As a result, we expensed all costs incurred associated with the initial pubic offering in fiscal 2007.

 

Costs incurred in fiscal 2006, totaling $1.6 million, associated with the initial public offering were deferred on our balance sheet as at April 30, 2006. There are no costs associated with the initial public offering deferred on the balance sheet as at April 30, 2007.

 

Gain on Sale of Manufacturing Operations:

 

On August 31, 2001, we outsourced our manufacturing operations, including the sale of related net assets and the transfer of employees and certain liabilities to BreconRidge, for total net consideration of $5.0 million in the form of long-term promissory notes receivable of $5.4 million and promissory notes payable of $0.4 million. The transaction resulted in a loss on disposal of $1.5 million recorded in fiscal 2002 operating expenses. The loss represented the excess of the carrying value of the plant, equipment and manufacturing workforce over the total net consideration.

 

The original loss on disposal recorded during fiscal 2002 contained estimates and assumptions regarding expected subleasing income arising from premises that had been subleased to BreconRidge pursuant to the disposal of the manufacturing operations.

 

In fiscal 2006 and fiscal 2007, the future estimated operating cost estimates for the premises were re-evaluated with the result being a reversal of $0.9 million and $1.0 million, respectively, of the loss on disposal previously recognized. This reversal is shown as a gain on sale of manufacturing operations in both fiscal 2006 and fiscal 2007.

 

Gain on Sale of Assets:

 

On August 31, 2005, we sold land, building and fixed assets in Caldicot, United Kingdom relating to our United Kingdom subsidiary for net proceeds of $12.4 million, resulting in a pre-tax gain of $7.3 million. The transaction included a commitment for us to lease-back a portion of the property, which requires us to defer a portion of the gain on sale equivalent to the present value of the lease payments. As a result we entered into a 6-month interim lease and a 10-year long-term lease for a portion of the property sold. Accordingly, $5.8 million of the gain was deferred and is being amortized over the combined 101/2-year term of the leases. The remaining gain of $1.5 million was recognized in the results of operations in fiscal 2006.

 

Interest Expense:

 

Interest expense was $9.1 million in fiscal 2007 compared to $7.6 million in fiscal 2006. The primary reason for the increased interest expense was an incremental $0.8 million in interest expense associated with the $55 million in convertible notes due to a year over year increase in interest rates and $0.5 million in interest expense associated with the litigation settlement.

 

Other (Income) Expense, Net:

 

Other (income) expense, on a net basis, consists primarily of foreign exchange rate gains and losses, interest income and amortization of the deferred gain on sale of the United Kingdom assets. Other income, on a net basis, amounted to $0.6 million in fiscal 2007 compared to $0.4 million during fiscal 2006. The income recorded in fiscal 2007 is primarily attributable to transactional foreign currency losses of $0.3 million, interest income of $0.3 million and $0.6 million of amortization associated with the deferred gain on sale of assets. In comparison, other income in Fiscal 2006 was comprised of interest income of $0.7 million, $0.3 million of amortization of the deferred gain on sale of assets and transactional foreign currency losses of $0.6 million. We use foreign currency forward contracts and foreign currency swaps to minimize the short-term impact of currency fluctuations on foreign currency receivables, payables and inter-company balances.

Mark-to-Market Adjustment on Derivatives:

 

In April 2004, we issued preferred shares. At any date after five years from the original issuance date, or any date prior to a partial sale event (as defined in the terms of the preferred shares) other than a public offering, the holders of preferred shares have a right to require us to redeem the preferred shares for cash. The redemption amount is equal to the original issue price of C$1.00 per preferred share multiplied by the number of preferred shares outstanding, plus any declared but unpaid dividends, plus the then current fair market value of the Common Shares into which the preferred shares are convertible. As a portion of the redemption price of the preferred shares is indexed to our common share price, an embedded derivative exists which must be accounted for separately under generally accepted accounting principles.

 

In fiscal 2007, we recorded a non-cash gain of $8.6 million, representing the mark-to-market adjustment on the derivative instrument associated with our preferred shares. During fiscal 2006, we recorded a non-cash expense of $32.6 million.

 

The difference between the initial carrying amount of the derivative and the redemption amount is being accreted over the five-year period to redemption, with the accretion of the derivative being recorded as a non-cash expense in our consolidated statement of operations. In fiscal 2007, a fair value gain of $8.6 million was recorded as a result of a decrease in the fair value estimate of our Common Shares from $1.38 at April 30, 2006 to $1.05 at April 30, 2007. The decrease in the Common Shares resulted in a $21.2 million gain which was partially offset by $12.6 million of regular accretion expense.

 

Provision for Income Taxes:

 

We recorded net income tax expense of $1.8 million for fiscal 2007 compared to income tax recoveries of $1.9 million for fiscal 2006. The net income tax expense for fiscal 2007 reflects a current tax recovery of $0.2 million offset by a deferred tax expense of $2.0 million resulting from the reversal of deferred tax recoveries relating to our United States operations that were originally recorded in fiscal 2006. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. During fiscal 2006, we determined that certain deferred tax assets relating to our operations were more likely than not to be realized and as a result recorded a deferred tax asset of $2.8 million. In fiscal 2007, this assessment could no longer be supported as there was uncertainty surrounding the Company’s future profitability. Accordingly, the $2.0 million balance that remained unrealized was written off.

Fiscal 2006 as compared to Fiscal 2005

 

The following table sets forth our comparative results of operations, both in dollars and as a percentage of total revenues, for fiscal 2006 and 2005: