News Column

MITEL NETWORKS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 7, 2014

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the unaudited interim consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q ("Report") and our audited annual financial statements included in our Transition Report on Form 10-K for the eight months ended December 31, 2013 ("Annual Report"). All amounts are expressed in U.S. dollars unless otherwise noted. Certain information contained in this Report, including information regarding future financial results, performance and plans, expectations, and objectives of management, constitute forward-looking information within the meaning of Canadian securities laws and forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We refer to all of these as forward-looking statements. Statements that include the words "may," "will," "should," "could," "target," "outlook," "estimate," "continue," "expect," "intend," "plan," "predict," "potential," "believe," "project," "anticipate" and similar statements of a forward-looking nature, or the negatives of those statements, identify forward-looking statements. In particular, this Report contains forward-looking statements pertaining to, among other matters: the Company's ability to achieve or sustain profitability in the future; fluctuations in quarterly and annual revenues and operating results; fluctuations in foreign exchange rates; general global economic conditions; our business strategy; our plans and objectives for future operations; our industry; our future economic performance, profitability and financial condition; the costs of operating as a public company; our R&D expenditures; our ability to successfully implement our restructuring plans; our ability to successfully integrate the acquisition of Aastra Technologies Limited ("Aastra") and realize certain synergies; our ability to successfully implement and achieve our business strategies; intense competition; our reliance on channel partners for a significant component of our sales; and our dependence upon a small number of outside contract manufacturers to manufacture our products. Forward-looking statements are subject to a variety of known and unknown risks, uncertainties, assumptions and other factors that could cause actual events or results to differ from those expressed or implied by the forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. We operate in a very competitive and rapidly changing environment. New risks emerge from time to time. In making these statements we have made certain assumptions. While we believe our plans, intentions, expectations, assumptions and strategies reflected in these forward-looking statements are reasonable, we cannot assure you that these plans, intentions, expectations assumptions and strategies will be achieved. Our actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained in this Report as a result of various factors, including the risks and uncertainties discussed elsewhere in this Report and in our Annual Report. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth in this Report. Except as required by law, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Please refer to the section entitled "Risk Factors" included in our Annual Report for a further discussion of risk and uncertainties affecting our business and financial results.



Overview

Mitel is a global provider of business communications and collaboration software and services. Our communication solutions meet the needs of customers in over 100 countries. On January 31, 2014, Mitel completed the acquisition of Aastra, as described below. In conjunction with the transaction, the Company reorganized its business into two new business units: Premise and Cloud.



Premise

The Premise segment sells and supports products and services for premise-based customers. This includes the Company's premise-based IP and TDM telephony platforms, desktop devices and unified communications and collaboration ("UCC") and contact centre applications that are deployed on the customer's premises. Premise-based sales are typically sold as an initial sale of hardware and software, with ongoing recurring revenue from hardware and software maintenance and other managed services that we also offer.



Cloud

The Cloud segment sells and supports products that are deployed in a cloud environment. The Cloud segment is comprised of a retail offering and a wholesale offering. The retail cloud offering, branded MiCloud, provides hosted cloud and related services directly to the end user. The Company is typically paid a monthly recurring fee for these services, which include UCC applications, voice and data telecommunications and desktop devices. The wholesale offering, branded Powered by Mitel, enables service providers to provide a range of hosted communications offerings to their end customers. The hosted offering includes hosted PBX, voice and video calling, SIP Trunking, voicemail, call center, audio conferencing and video and web collaboration services. The wholesale cloud offering is also sold to large enterprise customers who run their own data centers in private cloud or hybrid cloud networks with management provided by Mitel, or one of Mitel's channel partners. Revenue in the wholesale cloud offering is billed either as monthly recurring fees or as an upfront sale of hardware and software. 22



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Significant Events and Recent Developments:

Secondary offering - May 2014

In the second quarter of 2014, a CAD $94.3 million secondary offering of common shares was completed. The Company did not issue or sell any common shares and did not receive any proceeds from the offering.



Voluntary prepayment of term loan - May 2014

In May 2014, we made a voluntary prepayment of $25.0 million on our term loan.

Acquisition of Oaisys - March 2014

On March 4, 2014, Mitel completed the acquisition of Oaisys, a leading developer of integrated call recording and quality management solutions. We believe the acquisition of Oaisys further strengthens Mitel's position in the growing contact center market. The cost of the acquisition was $7.9 million.



Acquisition of Aastra - January 2014

On January 31, 2014, Mitel completed the acquisition of Aastra. Aastra was a global provider of unified communications and collaboration software, solutions and services with annual revenues of approximately CAD $600 million for the year ended December 31, 2013, of which approximately 75% were generated in Europe. Mitel acquired all of the outstanding Aastra common shares in exchange for $80.0 million cash as well as the issuance of 44.2 million Mitel common shares. In conjunction with the acquisition, Mitel refinanced its then-existing credit facilities with a $355.0 million term loan and an undrawn revolving facility of $50.0 million.



Acquisition of prairieFyre - June 2013

On June 17, 2013, we completed the acquisition of prairieFyre Software Inc. ("prairieFyre"), a global provider of contact center, business analytics, and workforce optimization software and services. The acquisition provides us with a cornerstone development platform to address increasing demand for cloud-based contact center solutions. Our net cash cost for the acquisition was $20.0 million for a 100% equity ownership interest in prairieFyre. As a highly integrated original equipment manufacturer ("OEM"), substantially all of prairieFyre's revenues were derived from Mitel and our channel partners. As a result, upon acquisition, substantially all of prairieFyre's revenues are eliminated against Mitel's cost of revenues, resulting in an increase in our consolidated gross margin and gross margin percentage. prairieFyre's operations have been included in the consolidated results of operations since the date of acquisition. Sale of DataNet - March 2013



On March 1, 2013, we completed the sale of our DataNet business, which distributed a wide variety of third-party telephony and data products and related services. As a result, the operating results of DataNet have been reported as discontinued operations on the consolidated statement of operations up to the time of sale.

Refinancing of Credit Agreement - February 2013

In February 2013, we completed a refinancing of our senior long-term debt by entering into new credit agreements, consisting of an undrawn $40.0 million first lien revolving credit facility, a $200.0 million first lien term loan and an $80.0 million second lien term loan (the "February 2013 Credit Facilities"). Proceeds of $276.4 million from the February 2013 Credit Facilities (net of original issue discount of $3.6 million), along with $36.4 million of cash on hand, were used to repay the remaining $174.0 million outstanding first lien term loan and $130.0 million outstanding second lien term loan, as well as fees and expenses related to the transaction. In January 2014 we refinanced our credit facilities in connection with the acquisition of Aastra, as described above. Operating Results Total revenues for the three months ended June 30, 2014 were $288.7 million compared to $146.6 million for the three months ended June 30, 2013. The revenue increase was primarily due to the acquisition of Aastra on January 31, 2014, which contributed $144.8 million of revenues. Excluding the acquisition of Aastra, revenue decreased by $2.7 million primarily due to lower product and 23

-------------------------------------------------------------------------------- service revenues largely due to the comparative three month period ending June 30, 2013 including a portion of the historically stronger fourth quarter ending April 30, 2013. This was partially offset by continued growth in the cloud segment. Our operating income for the three months ended June 30, 2014 was $3.2 million compared to $8.2 million for the three months ended June 30, 2013. The decrease in operating income was largely driven by higher amortization of acquisition-related intangible assets primarily due to the Aastra acquisition as well as higher special charges and restructuring costs incurred as a result of restructuring and integration costs related to the Aastra acquisition, which offset increased operating income from the operations of the Aastra business.



Comparability of Periods

Our functional currency is the U.S. dollar and our consolidated financial statements are prepared with U.S. dollar reporting currency using the current rate method. With the acquisition of Aastra, a significant portion of our revenues are now earned in Euros. Changes in foreign-exchange rates from period to period can have a significant impact on our results of operations and financial position, which may also make the comparability of periods complex. The results of operations from acquisitions are included in our results from operations from the date of acquisition. In addition, we have incurred various costs related to acquisitions and the integration of those acquisitions, which have been recorded in special charges and restructuring costs, as described below.



Selected Consolidated Financial Data

The following tables set forth our comparative results of operations, both in dollars and as a percentage of total revenues:

Three months ended June 30, 2014 2013 Change* % of % of Amounts Revenue Amounts Revenue Amount (in millions, except percentages and per share amounts) Revenues $ 288.7$ 146.6$ 142.1 Cost of revenues 136.9 47.4 % 66.0 45.0 % 70.9 Gross margin 151.8 52.6 % 80.6 55.0 % 71.2 Expenses: Selling, general and administrative 91.8 31.8 % 50.7 34.6 % 41.1 Research and development 31.9 11.0 % 13.5 9.2 % 18.4 Special charges and restructuring costs 10.9 3.8 % 2.6 1.8 % 8.3 Amortization of acquisition-related intangible assets 14.0 4.8 % 5.6 3.8 % 8.4 148.6 51.5 % 72.4 49.4 % 76.2 Operating income 3.2 1.1 % 8.2 5.6 % (5.0 ) Interest expense (5.5 ) (1.9 )% (6.3 ) (4.3 )% 0.8 Debt retirement costs (0.8 ) (0.3 )% - - (0.8 ) Other income (loss) 1.7 0.6 % (0.3 ) (0.2 )% 2.0 Income (loss) from operations, before taxes (1.4 ) (0.5 )% 1.6 1.1 % (3.0 ) Income tax recovery 2.2 0.8 % 1.1 0.8 % 1.1 Net income $ 0.8 0.3 % $ 2.7 1.8 % $ (1.9 ) Adjusted EBITDA, a non-GAAP measure(1) $ 38.8 13.4 % $ 21.4 14.6 % $ 17.4



* The percentage change has not been presented as the comparison is not meaningful, largely as a result of the acquisition of Aastra.

Net income per common share Net income per common share-Basic $ 0.01$ 0.05 Net income per common share-Diluted $ 0.01$ 0.05 Weighted-average number of common shares outstanding Basic 99.1 53.7 Diluted 103.7 56.3 24

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Six months ended June 30, 2014 2013 Change* % of % of Amounts Revenue Amounts Revenue Amount (in millions, except percentages and per share amounts) Revenues $ 530.2$ 289.7$ 240.5 Cost of revenues 249.0 47.0 % 128.3 44.3 % 120.7 Gross margin 281.2 53.0 % 161.4 55.7 % 119.8 Expenses: Selling, general and administrative 168.7 31.8 % 99.6 34.4 % 69.1 Research and development 58.2 11.0 % 27.3 9.4 % 30.9 Special charges and restructuring costs 24.1 4.5 % 4.1 1.4 % 20.0 Amortization of acquisition-related intangible assets 25.3 4.8 % 11.2 3.9 % 14.1 276.3 52.1 % 142.2 49.1 % 134.1 Operating income from continuing operations 4.9 0.9 % 19.2 6.6 % (14.3 ) Interest expense (11.4 ) (2.2 )% (11.7 ) (4.0 )% 0.3 Debt retirement costs (15.5 ) (2.9 )% (2.6 ) (0.9 )% (12.9 ) Other income (loss) 1.8 0.3 % (0.2 ) (0.1 )% 2.0 Income (loss) from operations, before taxes (20.2 ) (3.8 )% 4.7 1.6 % (24.9 ) Income tax recovery (expense) 7.4



1.4 % (0.7 ) (0.2 )% 8.1

Net income (loss) from continuing operations (12.8 ) (2.4 )% 4.0 1.4 % (16.8 ) Net loss from discontinued operations - - (3.0 ) (1.0 )% 3.0 Net income (loss) $ (12.8 ) (2.4 )% $ 1.0 0.3 % $ (13.8 ) Adjusted EBITDA, a non-GAAP measure(1) $ 74.4 14.0 % $ 44.4 15.3 % $ 30.0



* The percentage change has not been presented as the comparison is not meaningful, largely as a result of the acquisition of Aastra.

Net income (loss) per common share-Basic Net income (loss) per common share from continuing operations $ (0.14 )$ 0.07 Net loss per common share from discontinued operations $ - $ (0.05 ) Net loss per common share $ (0.14 )$ 0.02 Net income (loss) per common share-Diluted Net income (loss) per common share from continuing operations $ (0.14 )$ 0.07 Net loss per common share from discontinued operations $ - $ (0.05 ) Net loss per common share $ (0.14 )$ 0.02 Weighted-average number of common shares outstanding Basic 91.4 53.7 Diluted 91.4 56.3 25



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(1) Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA")

The following table presents a reconciliation of Adjusted EBITDA to net income, the most directly comparable U.S. GAAP measure:

Three months ended June 30 Six months ended June 30 2014 2013 2014 2013 (in millions) Net income (loss) $ 0.8$ 2.7$ (12.8 )$ 1.0 Net loss from discontinued operations - - - 3.0 Net income (loss) from continuing operations 0.8 2.7 (12.8 ) 4.0 Adjustments: Interest expense 5.5 6.3 11.4 11.7 Income tax expense (recovery) (2.2 ) (1.1 ) (7.4 ) 0.7 Amortization and depreciation 19.6 9.0 35.8 17.9 Debt retirement costs 0.8 - 15.5 2.6 Foreign exchange loss (gain) (1.3 ) 0.5 (1.0 ) 1.0 Special charges and restructuring costs 10.9 2.6 24.1 4.1 Stock-based compensation 1.7 1.0 3.0 2.1 Acquisition accounting for deferred revenue(1) 3.0 - 5.8 - Other - 0.4 - 0.4 Adjusted EBITDA from continuing operations 38.8 21.4 74.4 44.5 Adjusted EBITDA from discontinued operations(2) - - - (0.1 ) Adjusted EBITDA $ 38.8$ 21.4$ 74.4$ 44.4



(1) In accordance with the fair value provisions applicable to the accounting for

business combinations, acquired deferred revenue relating to the Aastra

acquisition was recorded on the opening balance sheet at an amount that was

lower than the historical carrying value. Although this purchase accounting

requirement has no impact on the Company's business or cash flow, it

adversely impacts the Company's reported GAAP revenue in the reporting

periods following the acquisition. In order to provide investors with

financial information that facilitates comparison of results, the Company

provides non-GAAP financial measures which exclude the impact of the

acquisition accounting adjustments. The Company believes that this non-GAAP

financial adjustment is useful to investors because it allows investors to

compare reports of financial results of the Company as the revenue reduction

related to acquired deferred revenue will not recur when similar software

maintenance and service contracts are recorded in future periods.

(2) The reconciliation from net loss from discontinued operations to Adjusted

EBITDA from discontinued operations for the six months ended June 30, 2013

consists of special charges and restructuring costs of $1.6 million, non-cash

impairment of goodwill of $1.9 million and an income tax recovery of $0.6

million.

We define Adjusted EBITDA as net income (loss), adjusted for the items as noted in the above tables. Adjusted EBITDA is not a measure calculated in accordance with U.S. GAAP. Adjusted EBITDA should not be considered as an alternative to net income, income from operations or any other measure of financial performance calculated and presented in accordance with U.S. GAAP. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. We encourage you to evaluate these adjustments and the reasons we consider them appropriate, as well as the material limitations of non-GAAP measures and the manner in which we compensate for those limitations. We use Adjusted EBITDA: • as a measure of operating performance;



• for planning purposes, including the preparation of our annual operating

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



• in communications with our board of directors concerning our financial

performance.

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

26 -------------------------------------------------------------------------------- We believe Adjusted EBITDA may also be useful to investors in evaluating our operating performance because securities analysts use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of companies. Our investor and analyst presentations also include Adjusted EBITDA. However, we also caution you that other companies in our industry may calculate Adjusted EBITDA or similarly titled measures differently than we do, which limits the usefulness of Adjusted EBITDA as a comparative measure. Moreover, although Adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, Adjusted EBITDA and similar non-GAAP measures have limitations as analytical tools, and you should not consider them in isolation or as a substitute for an analysis of our results of operations as reported under U.S. GAAP.



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

• interest income or interest expense; • cash requirements for income taxes; • foreign exchange gains or losses;



• significant cash payments made in connection with special charges and

restructuring costs; • employee stock-based compensation; and



• cash requirements for the replacement of assets that have been depreciated

or amortized.

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



Results of Operations

Revenues

The following tables set forth revenues by business segment in dollars and as a percentage of total revenues:

Three months ended June 30, 2014 2013 Change % of % of Revenues Revenues Revenues Revenues Amount % (in millions, except percentages) Premise segment - product $ 194.7 67.5 % $ 90.0 61.4 % $ 104.7 116.3 Premise segment - service 66.5 23.0 % 40.0 27.3 % 26.5 66.3 Cloud segment - product 6.2 2.2 % 3.1 2.1 % 3.1 100.0 Cloud segment - non-recurring service 0.4 0.1 % - - 0.4 * Cloud segment - recurring service 20.9 7.2 % 13.5 9.2 % 7.4 54.8 $ 288.7 100.0 % $ 146.6 100.0 % $ 142.1 96.9



* The comparison is not meaningful.

Six months ended June 30, 2014 2013 Change % of % of Revenues Revenues Revenues Revenues Amount % (in millions, except percentages) Premise segment - product $ 354.5 66.9 % $ 177.1 61.1 % $ 177.4 100.2 Premise segment - service 122.4 23.1 % 82.7 28.5 % 39.7 48.0 Cloud segment - product 12.9 2.4 % 4.3 1.5 % 8.6 200.0 Cloud segment - non-recurring service 0.4 0.1 % - - 0.4 * Cloud segment - recurring service 40.0 7.5 % 25.6 8.9 % 14.4 56.3 $ 530.2 100.0 % $ 289.7 100.0 % $ 240.5 83.0



* The comparison is not meaningful.

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-------------------------------------------------------------------------------- Revenues increased across all segments as a result of the acquisitions made in the last twelve months and, in particular, the acquisition of Aastra in January 2014. In addition, our revenues were favorably impacted by a general strengthening of foreign currencies when compared against the U.S. dollar. In particular, the British pound sterling and Euro were stronger against the U.S. dollar by an average of 9.3% and 5.7%, respectively, in the second quarter of 2014 when compared to the second quarter of 2013 and 7.2% and 4.4%, respectively, in the first six months of 2014 when compared to the first six months of 2013. Revenue for the three and six months ended June 30, 2014 includes a reduction in revenue of $3.0 million and $5.8 million, respectively (three and six months ended June 30, 2013-nil and nil), relating to purchase accounting. In accordance with the fair value provisions applicable to the accounting for business combinations, acquired deferred revenue relating to the Aastra acquisition was recorded on the opening balance sheet at an amount that was lower than the historical carrying value. Although this purchase accounting adjustment has no impact on the Company's business or cash flow, it adversely impacts the Company's reported GAAP revenue in the reporting periods following the acquisition. Based on the fair value of deferred revenue recorded in the initial purchase price allocation, we expect that revenue will be adversely affected by a total of $11.3 million over the two years ending December 31, 2015. Excluding the results of operations from the acquisition of Aastra, Premise segment product revenues decreased by $2.5 million, or 2.8%, to $87.5 million for the three months ended June 30, 2014 compared to the three months ended June 30, 2013 and increased by $1.6 million, or 0.9%, to $178.7 million for the six months ended June 30, 2014 compared to the six months ended June 30, 2013. The decrease in revenue for the three month period ending June 30, 2014 was largely due to the comparative three month period ending June 30, 2013 including a portion of the historically stronger fourth quarter ending April 30, 2013, which was partially offset by the favorable impact of changes in foreign exchange rates. For the six month period, stronger revenues were primarily due to the favorable impact of changes in foreign exchange rates. Excluding the results of operations from the acquisition of Aastra, Cloud segment product revenues increased by $0.1 million to $3.2 million for the three months ended June 30, 2014 compared to the three months ended June 30, 2013 and by $4.6 million to $8.9 million for the six months ended June 30, 2014 compared to the six months ended June 30, 2013 primarily due to sales to cloud service providers. Excluding the results of operations from the acquisition of Aastra, for the three months ended June 30, 2014 compared to the three months ended June 30, 2013, Premise segment service revenues decreased by $4.7 million, or 11.8%, to $35.3 million while Cloud segment recurring service revenues increased by $4.5 million, or 33.3%, to $18.0 million. For the six months ended June 30, 2014 compared to the six months ended June 30, 2013 Premise segment service revenues decreased by $9.7 million, or 11.7%, to $73.0 million while Cloud segment recurring service revenues increased by $9.8 million, or 38.3%, to $35.4 million. The decrease in Premise segment service revenues is primarily due to lower legacy services such as hardware maintenance as well as customers transitioning from a premise solution to a cloud solution. The increase in Cloud segment recurring revenues reflects new and existing customer migrating to our cloud solutions. Gross Margin The following table sets forth gross margin, both in dollars and as a percentage of revenues: Three months ended June 30, 2014 2013 Change Gross % of Gross % of Absolute Margin Revenues Margin Revenues Amount % (in millions, except percentages) Premise segment - product $ 112.0 57.5 % $ 58.5 65.0 % $ 53.5 (7.5 ) Premise segment - service 25.8 38.8 % 14.2 35.5 % 11.6 3.3 Cloud segment - product 3.7 59.7 % 1.8 58.1 % 1.9 1.6 Cloud segment - non-recurring service 0.2 50.0 % - - 0.2 * Cloud segment - recurring service 10.1 48.3 % 6.1 45.2 % 4.0 3.1 $ 151.8 52.6 % $ 80.6 55.0 % $ 71.2 2.4



* The comparison is not meaningful.

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Six months ended June 30, 2014 2013 Change Gross % of Gross % of Absolute Margin Revenues Margin Revenues Amount % (in millions, except percentages) Premise segment - product $ 207.3 58.5 % $ 116.5 65.8 % $ 90.8 (7.3 ) Premise segment - service 47.4 38.7 % 30.6 37.0 % 16.8 1.7 Cloud segment - product 6.9 53.5 % 2.6 60.5 % 4.3 (7.0 ) Cloud segment - non-recurring service 0.2 50.0 % - - 0.2 * Cloud segment - recurring service 19.4 48.5 % 11.7 45.7 % 7.7 2.8 $ 281.2 53.0 % $ 161.4 55.7 % $ 119.8 (2.7 )



* The comparison is not meaningful.

In the second quarter of 2014, overall gross margin percentage decreased by an absolute 2.4% to 52.6% compared to 55.0% for the second quarter of 2013 primarily as a result of the acquisition of Aastra, which contributed $66.4 million of gross margin, a gross margin percentage of 45.9%, to the second quarter of 2014. Excluding the effect of the Aastra acquisition, Mitel gross margin percentage increased by an absolute 4.3% to 59.3%, primarily due to the acquisitions of prairieFyre in June 2013 and Oaisys in March 2014. For the six months ended June 30, 2014, overall gross margin percentage decreased by an absolute 2.7% to 53.0% compared to 55.7% for the second quarter of 2013 primarily as a result of the acquisition of Aastra, which contributed $106.0 million of gross margin, a gross margin percentage of 45.3%, to the six months ended June 30, 2014. Excluding the effect of the Aastra acquisition, Mitel gross margin percentage increased by an absolute 3.4% to 59.1%, primarily due to the acquisitions of prairieFyre in June 2013 and Oaisys in March 2014. Excluding the effect of the acquisition of Aastra, Premise segment product gross margin percentage increased by an absolute 5.3% to 70.3% for the second quarter of 2014 and increased by an absolute 3.6% to 69.4% for the six months ended June 30, 2014 when compared to the 2013 periods while Premise segment service gross margin percentage increased by an absolute 3.4% to 38.9% in the second quarter of 2014 and by an absolute 4.1% to 41.1% in the six months ended June 30, 2014 when compared to the 2013 periods. The increases in Premise segment product gross margin percentage were primarily as a result of the acquisitions of prairieFyre in June 2013 and Oaisys in March 2014. The increases in Premise segment service gross margin percentage were primarily as a result of the acquisitions of prairieFyre in June 2013 and Oaisys in March 2014 as well as cost reductions from restructuring actions taken during the year. Excluding the effect of the acquisition of Aastra, Cloud segment product gross margin percentage decreased to 50.1% for the second quarter and decreased to 46.7% for the six months ended June 30, 2014 as the Cloud segment was in its early stages in the first six months of 2013. Cloud segment recurring service gross margin percentage increased by an absolute 2.6% to 47.8% in the second quarter of 2014 and increased by an absolute 2.0% to 47.7% in the first six months of 2014 when compared to the 2013 periods due primarily to increases in revenues as certain costs of revenues remain fixed.



Operating Expenses

Selling, General and Administrative ("SG&A")

SG&A expenses decreased to 31.8% of revenues in the second quarter of 2014 from 34.6% in the second quarter of 2013, an increase of $41.1 million in absolute dollars. SG&A expenses decreased to 31.8% of revenues for the six months ended June 30, 2014 from 34.4% for the six months ended June 30, 2013, an increase of $69.1 million in absolute dollars. The increase in absolute dollars is primarily due to acquisitions made in the last 12 months. Our SG&A expenses for the three and six months ended June 30, 2014 included $1.7 million and $3.0 million, respectively (three and six months ended June 30, 2013-$1.0 million and $2.1 million, respectively), of stock-based compensation expenses associated with employee stock options. Excluding acquisitions made in the last 12 months, SG&A expenses increased to 38.1% of revenues for the second quarter of 2014 compared to 34.6% in the second quarter of 2013 and increased to 36.2% of revenues for the six months ended June 30, 2014 compared to 34.3% the six months ended June 30, 2013, largely due to increased spending on sales growth initiatives, in particular Mitel cloud offerings. 29



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Research and Development ("R&D")

R&D expenses in the second quarter of 2014 increased to 11.0% of revenues compared to 9.2% of revenues for the second quarter of 2013, an increase of $18.4 million in absolute dollars. R&D expenses for the six months ended June 30, 2014 increased to 11.0% of revenues compared to 9.4% for the six months ended June 30, 2013, an increase of $30.9 million in absolute dollars. The increase was largely driven by acquisitions made in the last twelve months. Excluding acquisitions made in the last 12 months, R&D expenses increased to 10.2% of revenues in the second quarter of 2014 compared to 9.2% of revenues in the second quarter of 2013 and 9.9% of revenues in the six months ended June 30, 2014 compared to 9.4% of revenues in the six months ended June 30, 2013. The increases were primarily due to increased spending on contact center initiatives.



Our R&D expenses in absolute dollars can fluctuate depending on the timing and number of development initiatives in any given quarter. R&D expenses as a percentage of revenues is highly dependent on revenue levels and could vary significantly depending on actual revenues achieved.

Special Charges and Restructuring Costs

Special charges and restructuring costs of $10.9 million were recorded in the three months ended June 30, 2014. The costs consisted of $3.9 million of employee-related charges, $2.8 million of facility-related charges and $4.2 million of integration-related charges. The employee-related charges consisted of headcount reductions of approximately 50 people and related costs, primarily in North America and Europe. Facility-related charges consisted primarily of lease termination obligations for facilities, primarily in North America. Integration-related charges include professional fees and incidental costs relating to the integration of the Aastra business. We recorded special charges and restructuring costs of $13.2 million in the first quarter of 2014, primarily relating to the acquisition and integration of the Aastra business. The costs consisted of $2.2 million of employee-related charges, $1.1 million of facility-related charges, $4.9 million of integration-related charges as well as $5.0 million of acquisition-related charges. The employee-related charges consisted of termination and related costs related to headcount reductions of approximately 50 people, primarily in North America. Facility-related charges consisted primarily of lease termination obligations for facilities, primarily in North America. Integration-related charges include professional fees and incidental costs relating to the integration of the Aastra business. Acquisition-related charges consisted primarily of legal and advisory fees incurred to close the Aastra acquisition in January 2014.



We recorded special charges and restructuring costs of $1.5 million in the first quarter of 2013 and $2.6 million in the second quarter of 2013. The charges primarily relate to headcount reductions and additional lease termination obligations as we reduced our cost structure.

We expect to take additional restructuring actions in the future to reduce our operating expenses and gain operating efficiencies. The timing and potential amount of such actions will depend on several factors, including future revenue levels and opportunities for operating efficiencies identified by management. We expect to incur approximately $83.0 million of costs relating to the integration of the Aastra business, which we expect to create approximately $75.0 million of annualized synergies. We expect to complete these initiatives in approximately three years from the acquisition of Aastra in January 2014.



Amortization of acquisition-related intangible assets

In the three and six months ended June 30, 2014 amortization of acquisition-related intangible assets increased to $14.0 million and $25.3 million, respectively, compared to $5.6 million and $11.2 million, respectively, for the three and six months ended June 30, 2013. The increase is due primarily to the acquisition of Aastra in January 2014.



Operating Income from Continuing Operations

We reported operating income from continuing operations of $3.2 million in the second quarter of 2014 compared to $8.2 million in the second quarter of 2013 and operating income from continuing operations of $4.9 million in the six months ended June 30, 2014 compared to $19.2 million in the six months ended June 30, 2013.The decrease in operating income was driven by higher special charges and restructuring costs, which was partially offset by higher gross margin in the legacy Mitel business. Operating income from acquisitions was not significant in the three and six months ended June 30, 2014 as adverse effects from purchase price allocation adjustments to revenue of $3.0 million and $5.8 million, respectively, and amortization of acquired intangible assets of $7.4 million and $12.3 million, respectively, largely offset income from operations. 30



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Non-Operating Expenses

Interest Expense

Interest expense was $5.5 million in the second quarter of 2014 compared to $6.3 million in the second quarter 2013 and $11.4 million in the six months ended June 30, 2014 compared to $11.7 million in the six months ended June 30, 2013. The decrease in interest expense was due to the refinancing of our credit facilities in conjunction with the acquisition of Aastra in January 2014 as a lower interest rate margin and a lower LIBOR floor on the refinanced debt (4.25% and 1.00%, respectively, at June 30, 2014 compared to 5.75% and 1.25% at June 30, 2013) was partially offset by higher debt levels.



Debt retirement costs

In the second quarter of 2014, we recorded debt retirement costs of $0.8 million relating to a write-off of the pro-rata share of unamortized debt issue costs and original issue discount as a result of the $25.0 million voluntary prepayment of our term loan in May 2014. In the first quarter of 2014, we recorded debt retirement costs of $14.7 million relating to the refinancing of our debt in January 2014. These costs consisted of $10.0 million of unamortized debt issue costs and unamortized original issue discount, $4.2 million of prepayment fees relating to repaying our prior credit facilities and $0.5 million of other costs relating to the refinancing. For the first quarter of 2013, we recorded debt retirement costs of $2.6 million relating to the refinancing our debt in February 2013. These costs consisted of $2.6 million of unamortized debt issue costs and unamortized original issue discount relating to repaying our prior credit facilities.



Income tax expense

For the second quarter of 2014, we recorded a net income tax recovery of $2.2 million compared to a recovery of $1.1 million for the second quarter of 2013. For the six months ended June 30, 2014, we recorded a net income tax recovery of $7.4 million compared to an expense of $0.7 million for the six months ended June 30, 2013. The income tax recovery in the second quarter of 2014 was primarily due to a tax recovery on certain non-recurring items primarily related to the Aastra acquisition. The tax recovery in the second quarter of 2013 was primarily driven by the expected effective tax rate for the year.



Net Income (Loss) from Continuing Operations

Our net income from continuing operations for the second quarter of 2014 was $0.8 million compared to net income from continuing operations of $2.7 million in the second quarter of 2013. The lower net income from continuing operations was primarily due to lower operating income, as described above. Our net loss from continuing operations for the six months ended June 30, 2014 was $12.8 million compared to net income from continuing operations of $4.0 million for the six months ended June 30, 2013. The net loss from continuing operations was primarily due to higher debt retirement costs and lower operating income, as described above.



Net Loss from Discontinued Operations

Net loss from discontinued operations for the six months ended June 30, 2013 consists of the operations of DataNet, which was sold in March 2013. Further information on the sale of DataNet can be found under Item 7 of our Annual Report.



Net Income (Loss)

Our net income for the second quarter of 2014 was $0.8 million compared to a net income of $2.7 million in the second quarter of 2013. The lower net income was primarily due to lower operating income, as described above. Our net loss for the six months ended June 30, 2014 was $12.8 million compared to a net income of $1.0 million for the six months ended June 30, 2013. The net loss was primarily due to higher debt retirement costs and lower operating income, as described above.



Other Comprehensive Income (Loss)

Other comprehensive loss of $12.0 million for the three months ended June 30, 2014 and $17.6 million for six months ended June 30, 2014 is primarily due to pension liability adjustments for the U.K. pension plan. The U.K. pension plan was updated at March 31, 2014 and June 30, 2014 for actual investment performance and certain changes in assumptions. The increase in pension liability and corresponding other comprehensive loss in the first quarter and second quarter was primarily due to an increase in the 31



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accrued benefit obligation from a decrease in the discount rate from 4.7% at December 31, 2013 to 4.6% at March 31, 2014 to 4.4% at June 30, 2014. The discount rate assumption was determined on a consistent basis and reflects prevailing rates available on high-quality, fixed income debt instruments.

Other comprehensive loss for the six months ended June 30, 2013 includes a loss of $19.5 million recorded in the first quarter of 2013 related to pension liability adjustments as the U.K. pension plan's valuation was updated for actual investment performance and certain changes in assumptions.

Adjusted EBITDA

Adjusted EBITDA, a non-GAAP measure, was $38.8 million in the second quarter of 2014 compared to $21.4 million in the second quarter of 2013, an increase of $17.4 million. Adjusted EBITDA was $74.4 million for the six months ended June 30, 2014 compared to $44.4 million for the six months ended June 30, 2013, an increase of $30.0 million. This increase was driven primarily by higher gross margin from the legacy Mitel business as well contributions from acquisitions made in the last 12 months. For a definition and explanation of Adjusted EBITDA and why we believe it is useful in evaluating our financial condition, as well as a reconciliation of Adjusted EBITDA to the most directly comparable GAAP measure, net income (loss), see "Selected Consolidated Financial Data-Adjusted EBITDA" elsewhere in this Report. Cash Flows



Below is a summary of comparative results of cash flows and a discussion of the results for the three and six months ended June 30, 2014 and June 30, 2013.

Three months ended Six months ended June 30, June 30, 2014 2013 Change 2014 2013 Change (in millions) Net cash provided by (used in) Operating activities $ 25.8$ 25.3$ 0.5$ 52.6$ 35.0$ 17.6 Investing activities (4.3 ) (25.5 ) 21.2 (13.7 ) (27.1 ) 13.4 Financing activities (23.9 ) (1.5 ) (22.4 ) 53.5 (38.7 ) 92.2 Effect of exchange rate changes on cash and cash equivalents 0.6 (0.1 ) 0.7 1.6 (1.8 ) 3.4 Increase (decrease) in cash and cash equivalents $ (1.8 )$ (1.8 ) $ - $ 94.0$ (32.6 )$ 126.6



Cash Provided by Operating Activities

Net cash generated from operating activities in the second quarter of 2014 was $25.8 million compared to $25.3 million in the second quarter of 2013. The increase was due operating cash flow from the acquisition of Aastra, which was partially offset by increased special charges and restructuring costs. Net cash generated from operating activities for the six months ended June 30, 2014 was $52.6 million compared to $35.0 million for the six months ended June 30, 2013. The increase was due to favorable changes in non-cash operating assets of $21.2 million for the six months ended June 30, 2014 compared to $3.8 million for the six months ended June 30, 2013.



Cash Used in Investing Activities

Net cash used for investing activities was $4.3 million in the second quarter of 2014 compared to $25.5 million in the second quarter of 2013. The decrease is due to the $23.1 millionJune 2013 acquisition of prairieFyre. Net cash used for investing activities was $13.7 million for the six months ended June 30, 2014 compared to $27.1 million for the six months ended June 30, 2013. The cash used in investing activities for the six months ended June 30, 2014 includes $6.2 million for acquisitions consisting of $0.6 million for the January 2014 acquisition of Aastra (cash paid of $80.0 million, net of cash acquired of $79.4 million) and $5.6 million for the March 2014 acquisition of Oaisys (cash paid of $5.9 million net of cash acquired of $0.3 million). Net cash used in investing for the six months ended June 30, 2013 includes $23.1 million for the June 2013 acquisition of prairieFyre (cash paid of $27.3 million net of cash acquired of $4.2 million).



Cash used in investing activities also includes acquisitions of property, plant and equipment.

32



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Cash Used in Financing Activities

Net cash used in financing activities in the second quarter of 2014 was $23.9 million compared to $1.5 million during the second quarter of 2013. Cash used in financing in the second quarter of 2014 included the $25.0 million voluntary repayment of our term loan made in May 2014. Net cash provided by financing activities for the six months ended June 30, 2014 was $53.5 million compared to cash used in financing activities of $38.7 million for the six months ended June 30, 2013. Cash provided by financing for the six months ended June 30, 2014 consists primarily of net proceeds from the January 2014 refinancing, partially offset by the $25.0 million voluntary repayment of our term loan made in May 2014. The proceeds from the new credit facility of $353.2 million were partially offset by repayments of the prior credit facilities of $258.5 million as well as fees and costs related to the refinancing of $15.2 million. The use of cash for the six months ended June 30, 2013 consisted primarily of a net repayment of long-term debt as a result of the February 2013 refinancing.



Liquidity and Capital Resources

As of June 30, 2014, our liquidity consisted primarily of cash and cash equivalents of $134.2 million and an undrawn $50.0 million revolving facility. At June 30, 2014, we had $329.1 million outstanding under our secured credit facilities, consisting of a term loan due 2020. At December 31, 2013 we had $258.5 million outstanding under our then-existing credit facilities consisting of a first lien term loan due 2019 and second lien term loan due 2020. On January 31, 2014, in conjunction with the acquisition of Aastra, we refinanced our credit facilities. The new credit facilities consist of a $355.0 million term loan and a $50.0 million revolving facility (the "January 2014 Credit Facilities"). Proceeds of $353.2 million (net of original discount of $1.8 million), along with cash on hand, were used to repay the remaining $258.5 million outstanding on the prior credit facilities, the $80.0 million of cash consideration paid for the acquisition of Aastra, as well as fees and expenses in connection with the refinancing and the acquisition of Aastra. In May 2014, we made a $25.0 million voluntary repayment of our term loan. The undrawn $50.0 million revolving credit facility bears interest at LIBOR plus 4.25%, or, at the option of the Company, a base rate plus an applicable margin, and matures in January 2019. The Company may borrow Canadian dollars under the revolving credit facility. Such borrowings bear interest at the Canadian prime rate plus an applicable margin. The $355.0 million term loan bears interest at LIBOR (subject to a 1.00% floor) plus 4.25%, or, at the option of the Company, a base rate plus an applicable margin, and matures in January 2020. The term loan requires quarterly principal repayments of 0.25% of the original outstanding principal. As a result of our operating performance since the acquisition of Aastra, which generated sufficient cash to make two voluntary prepayments of our term loan facility of $25.0 million each on August 7, 2014 and in May 2014, as well as current debt market conditions, we may seek to amend our existing credit facility to reduce the variable interest rates on our term loan facility. Any amendment to the term loan facility would be subject to the approval of the holders of our term loan and other conditions. As such, there is no guarantee that we would be able to obtain such an amendment. We are also required to make annual principal repayments on the term loan based on a percentage of excess cash flow (as defined in the January 2014 Credit Facilities). The annual excess cash flow repayments are required to be paid within 100 days following the end of the fiscal year. The first annual excess cash flow payment is required be paid within 100 days of December 31, 2014. Voluntary prepayments are applied against mandatory principal repayments. As a result of the $25.0 million voluntary prepayment in May 2014, we estimate that our annual principal repayments due in the next twelve months, including the 2014 annual excess cash flow payment, will be nil. The annual excess cash flow payment may vary significantly from the estimate based on our operating results and changes in working capital during the remainder of 2014. The term loan can be repaid without premium or penalty. The January 2014 Credit Facilities have customary default clauses, wherein repayment of the credit facilities may be accelerated in the event of an uncured default. The proceeds from the issuance of debt, and proceeds from the sale of Company assets, may also be required to be used, in whole or in part, to make mandatory prepayments under the credit facilities. The January 2014 Credit Facilities contain affirmative and negative covenants, including: (a) periodic financial reporting requirements, (b) a maximum ratio of Consolidated Total Debt (net of up to $50.0 million of unrestricted cash) to the trailing twelve months Earnings before Interest, Taxes, Depreciation and Amortization ("Leverage Ratio"), as specified in the credit facilities, (c) limitations on the incurrence of subsidiary indebtedness and also the borrowers themselves, (d) limitations on liens, (e) limitations on investments and (f) limitations on the payment of dividends. The maximum Leverage Ratio applies to the Company for the period ending June 30, 2014 and for all fiscal quarters thereafter until maturity in January 2020, and is as follows: Maximum Consolidated Fiscal Quarters Ending Leverage Ratio June 30, 2014 through March 31, 2015 3.00:1.00 June 30, 2015 through March 31, 2016 2.50:1.00 June 30, 2016 through March 31, 2017 2.25:1.00 June 30, 2017 and thereafter 2.00:1.00 33



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The following table presents our maximum Leverage Ratio and our actual Leverage Ratio: Maximum Actual Period Ending Leverage Ratio Leverage Ratio June 30, 2014 3.0 1.9 At June 30, 2014 and December 31, 2013, our cash equivalents consist of short-term, investment-grade commercial paper and government debt. We classify our cash equivalents as current based on their nature and their availability for use in current operations. We believe the overall credit quality of our portfolio is strong, with a majority of our cash equivalents invested in federal government treasury bills of Canada, the U.S. and the U.K. We follow an investment policy where our excess cash is invested in investment-grade commercial paper and government debt, generally with a maturity of less than three months. There is no limit on the investments in the federal governments of Canada, the U.S. or the U.K. We diversify our portfolio by limiting the amount invested in any other single institution.



We have defined benefit plans, primarily in the U.K., France and Germany. In addition, we have a multi-employer defined benefit pension plan in Switzerland.

Our defined benefit pension plan in the U.K. is in place for a number of our past and present employees in the U.K. The plan has been closed to new members since 2001 and closed to new service since 2012. The plan is partially funded. At June 30, 2014, the plan had an unfunded pension liability of $75.0 million (December 31, 2013-$57.3 million). Contributions to fund the benefit obligations under this plan are based on actuarial valuations, which themselves are based on certain assumptions about the long-term operations of the plan, including the life expectancy of members, the performance of the financial markets and interest rates. The amount of annual employer contributions required to fund the pension deficit annually is determined every three years, in accordance with U.K. regulations and is based on a calendar year. In June 2013, the Company's annual funding requirement to fund the pension deficit for the 2014 calendar year was determined to be $5.4 million (£3.2 million), and will increase at an annual rate of 3% for the calendar years 2015 and 2016. As part of the acquisition of Aastra, we assumed certain unfunded pension obligations related to entities in France and Germany. In France, retirees generally benefit from a lump sum payment upon retirement or departure. In Germany, retirees generally benefit from the receipt of a perpetual annuity at retirement, based on their years of service and ending salary. At June 30, 2014, we had unfunded pension liabilities in France and Germany of $7.8 million and $17.0 million, respectively. In addition, as part of the acquisition of Aastra, we assumed a partially funded multi-employer pension plan in Switzerland. In Switzerland, retirees generally benefit from the receipt of a perpetual annuity at retirement based on an accrued value at the date of retirement. The accrued value is related to the actual returns on contributions during the working period. As the plan is a multi-employer plan, no liability is recorded on the consolidated balance sheet for Mitel's pro-rata share of the net benefit obligation. Mitel's pro-rata share of the plan's assets and projected benefit obligation at the date of acquisition was $98.4 million and $104.1 million, respectively. We believe we will have sufficient liquidity to support our business operations for the next 12 months. However, we may elect to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending on restructuring and integration actions, the timing and extent of spending to support product development efforts and expansion of sales and marketing, the timing of introductions of new products and enhancements to existing products, market acceptance of our products and the cost and timing of acquisitions, if any,. Additional equity or debt financing may not be available on acceptable terms or at all. In addition, any proceeds from the issuance of debt may be required to be used, in whole or in part, to make mandatory payments under our credit agreements. 34



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Contractual Obligations

The following table sets forth our contractual obligations as of June 30, 2014: Payments Due by Fiscal Year Last six 2019 months and Contractual Obligations of 2014 2015 2016



2017 2018 beyond Total

(in millions) Long-term debt obligations(1) $ 8.6$ 17.3$ 20.9$ 20.7$ 20.5$ 336.4$ 424.4 Capital lease obligations(2) 3.0 5.2 4.1 2.0 0.3 - 14.6 Operating lease obligations(3) 16.0 23.6 20.2 15.7 13.8 28.5 117.8 Defined benefit pension plan contributions(4) 2.8 5.7 5.9 - - - 14.4 Other(5) 3.2 3.4 - - - - 6.6 Total $ 33.6$ 55.2$ 51.1$ 38.4$ 34.6$ 364.9$ 577.8



(1) Represents the principal and interest payments on our term loan. Interest on

our term loan is based on LIBOR plus 4.25% with LIBOR subject to a 1.00%

floor. For the purposes of estimating the variable interest, the greater of

the average 3-month LIBOR from the last three years (0.3%) and the LIBOR

floor (1.00%) has been used. No amounts have been included for potential

repayments relating to the annual repayment of excess cash flows as an

estimate is not practicable.

(2) Represents the principal and interest payments for capital lease obligations.

Interest rates on these obligations range from 5.4% to 9.0%.

(3) Operating lease obligations exclude payments to be received by us under

sublease arrangements.

(4) Represents the expected contribution to our defined benefit pension plan in

the U.K. The amount of annual employer contributions required to fund the

U.K. plan's deficit is determined every three years in accordance with U.K.

regulations. Future funding requirements after calendar year 2016 are

dependent on the unfunded pension liability and the time period over which

the deficit is amortized and have been excluded from the table. In addition,

no amounts have been included for unfunded pension liabilities in France or

Germany. Total cash payments under the pension plans in France and Germany

for the year-ended December 31, 2014 are expected to be approximately $1.0

million.

(5) Primarily represents payments under an information technology outsourcing

agreement.

Total contractual obligations listed do not include contractual obligations recorded on the balance sheet as current liabilities, except for those associated with a long-term liability. Contractual obligations also exclude $14.4 million of liabilities relating to uncertain tax positions due to the uncertainty of the timing of any potential payments.

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



Off-Balance Sheet Arrangements

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

Sales-type leases

We offer our customers lease financing and other services under our managed services offering. We fund this offering, which we have branded as the TotalSolution® program, in part through the sale to financial institutions of rental payment streams under the leases. Such financial institutions have the option to require us to repurchase such income streams, subject to limitations, in the event of defaults by lease customers and, accordingly, we maintain reserves based on loss experience and past due accounts. In addition, such financial institutions have the option to require us to repurchase such income streams upon any uncured breach by us under the terms of the underlying sale agreements. At June 30, 2014, sold payments remaining unbilled net of lease recourse reserves, which represents the total balance of leases that are not included in our balance sheet, were $74.0 million (December 31, 2013-$87.8 million). 35



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Critical Accounting Policies

The preparation of our consolidated financial statements and related disclosures in conformity with GAAP requires us to make estimates and assumptions about future events that can have a material impact on the amounts reported in our consolidated financial statements and accompanying notes. The determination of estimates requires the use of assumptions and the exercise of judgment and, as such, actual results could differ from those estimated. Our significant accounting policies are described in note 2 to our audited annual consolidated financial statements included in our Annual Report. The following critical accounting policies have been updated to reflect results to June 30, 2014:



Sales-Type Leases, reserves

Our total reserve for losses related to the entire lease portfolio, including amounts classified as accounts receivable on our balance sheet, was 3.6% of the ending aggregate lease portfolio as of June 30, 2014 compared to 4.0% at December 31, 2013. The reserve is based on a review of our past write-off experience and a review of the accounts receivable aging as of June 30, 2014. We believe our reserves are adequate to cover future potential write-offs. Should, however, the financial condition of our customers deteriorate in the future, additional reserves in amounts that could be material to the financial statements could be required.



Allowance for Doubtful Accounts

Our allowance for doubtful accounts is based on our assessment of the collectability of customer accounts. A considerable amount of judgment is required in order to make this assessment, including a detailed analysis of the aging of our accounts receivable, the current creditworthiness of our customers and an analysis of historical bad debts and other adjustments. If there is a deterioration of a major customer's creditworthiness or actual defaults are higher than our historical experience, our estimate of the recoverability of amounts due could be adversely affected. We review in detail our allowance for doubtful accounts on a quarterly basis and adjust the allowance amount estimate to reflect actual portfolio performance and change in future portfolio performance expectations. As of June 30, 2014 and December 31, 2013, the provision represented 5.1% and 4.8% of gross receivables, respectively.



Stock-Based Compensation

The fair value of the stock options granted is estimated on the grant date using the Black-Scholes option-pricing model for each award, net of estimated forfeitures, and is recognized over the employee's requisite service period, which is generally the vesting period. The assumptions used in the Black-Scholes option-pricing model for the options granted in the first six months of 2014 are included in note 14 to the unaudited interim consolidated financial statements. For the three and six months ended June 30, 2014, stock-based compensation expense was $1.7 million and $3.0 million, respectively (three and six months ended June 30, 2013-$1.0 million and $2.1 million, respectively). As of June 30, 2014, there was $10.9 million of unrecognized stock-based compensation expense (December 31, 2013-$6.0 million). We expect this cost to be recognized over a weighted average period of 3.2 years (December 31, 2013-2.3 years).



Recent Accounting Pronouncements

Classification of unrecognized tax benefits

In July 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-11 to include explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss carryforward or a tax credit carryforward exists. The ASU provides amendments to the Income Taxes subtopic of the FASB Accounting Standards Codification ("ASC"), such that generally, unrecognized tax benefits should be presented as a reduction of deferred tax assets created by net operating losses or tax credit carryforwards in the same jurisdiction. We adopted this ASU prospectively in the first quarter of 2014. The adoption did not have a material effect to our consolidated financial statements.



Discontinued operations

In April 2014, the FASB issued ASU 2014-08 to change the criteria for reporting discontinued operations such that disposals of small groups of assets will no longer qualify for discontinued operations presentation. The ASU provides amendments to the Presentation of Financial Statements and Property, Plant and Equipment subtopics of the FASB ASC. As a result of the ASU, only those disposals of components that represent a strategic shift that has or will have a major effect on the entity's operations will be reported as discontinued operations. We will adopt this ASU prospectively, no later than the first quarter of 2015. 36



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Revenue recognition

In May 2014, the FASB issued ASU 2014-09 to provide a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The ASU adds a Revenue from Contracts with Customers subtopic to the FASB ASC and supersedes most current revenue recognition guidance, including industry-specific guidance. The amendment becomes effective for us in the first quarter of 2017 and early adoption is not permitted. We are currently evaluating the effect that the adoption of this ASU will have on our consolidated financial statements.


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