**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM10–K**

 
| **ý****ANNUAL REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|-----------------------------------------------------------------------------------------------------------|
| ** **                                                                                                |
| **FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005**                                                      |
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| **OR**                                                                                                    |
| ** **                                                                                                |
| **o****TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**  |
| ** **                                                                                                |
| **COMMISSION FILE NUMBER: 000–27707**                                                                |
| ** **                                                                                                |
| **AETHER  HOLDINGS, INC.**                                                                                |
| (EXACT NAME OF REGISTRANT AS SPECIFIED IN  ITS CHARTER)                                                   |
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| **DELAWARE**                                                                                              | ** ** | **52-2186634** |
| (State or other jurisdiction of  incorporation or organization)                                           |   | (IRS Employer  Identification Number) |
|                                                                                                      |   |   |
| **621 E. Pratt St., Suite 601, Baltimore, MD**                                                            | ** ** | **21202** |
| (Address of principal executive offices)                                                                  |   | (Zip Code) |
|                                                                                                      |   |   |
| (Registrant’s telephone number, including  area code): **(443) 573–9400**                       |
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| SECURITIES REGISTERED PURSUANT TO  SECTION 12(b) OF THE ACT:**NONE.**                                |
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| SECURITIES REGISTERED PURSUANT TO  SECTION 12(g) OF THE ACT:                                         |
| ** **                                                                                                |
| **COMMON STOCK, PAR VALUE $.01**                                                                          |

 

Indicate by check mark if the registrant is a well-known****seasonedissuer, as defined in Rule 405 of the Securities Act.

Yes o No ý

 

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Act.

Yes o No ý

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of regulation S–K is not contained herein, and will not be contained,to the best of the registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of the Form 10–K or anyamendment of this Form 10–K. o

 

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

 
| Large accelerated filer | o | Accelerated filer | ý | Non-accelerated filer | o |
|-------------------------|---|-------------------|--------|-----------------------|---|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theAct).    Yes o No ý

 

The aggregate market value of the voting stock held by nonaffiliates ofthe registrant was $128,669,166 ($3.29 per share) as of June 30, 2005.

 

As of March 10, 2006, 44,018,946 shares of the registrant’s commonstock, $.01 par value per share, were outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

None.

 

 

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**AETHER HOLDINGS, INC.**

**ANNUAL REPORT ON FORM 10-K**

**FOR THE YEAR ENDED DECEMBER 31, 2005**

 

**INDEX**

 
| PART I    |                                                                                                                 |
|-----------|----------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                 |   |
| Item 1    | Business                                                                                                             |   |
| Item 1A   | Risk Factors                                                                                                         |   |
| Item 1B   | Unresolved Staff Comments                                                                                            |   |
| Item 2    | Properties                                                                                                           |   |
| Item 3    | Legal Proceedings                                                                                                    |   |
| Item 4    | Submission of Matters to a  Vote of Security Holders                                                                 |   |
|      |                                                                                                                 |   |
| PART II   |                                                                                                                 |
|      |                                                                                                                 |   |
| Item 5    | Market for the Company’s  Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  Securities |   |
| Item 6    | Selected Financial Data                                                                                              |   |
| Item 7    | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                          |   |
| Item 7A   | Quantitative  and Qualitative Disclosures About Market Risk                                                          |   |
| Item 8    | Financial  Statements and Supplementary Data                                                                         |   |
| Item 9    | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure                                |   |
| Item 9A   | Controls and  Procedures                                                                                             |   |
| Item 9B   | Other Information                                                                                                    |   |
| PART  III |                                                                                                                 |
|      |                                                                                                                 |   |
| Item 10   | Directors  and Executive Officers of the Registrant                                                                  |   |
| Item 11   | Executive Compensation                                                                                               |   |
| Item 12   | Security Ownership of Certain  Beneficial Owners and Management and Related Stockholder Matters.                     |   |
| Item 13   | Certain  Relationships and Related Transactions                                                                      |   |
| Item 14   | Principal  Accounting Fees and Services                                                                              |   |
|      |                                                                                                                 |   |
| PART IV   |                                                                                                                 |
|      |                                                                                                                 |   |
| Item 15   | Exhibits,  Financial Statement Schedules                                                                             |   |

 

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**FORWARD-LOOKINGSTATEMENTS**

 

This Annual Report on Form10-K contains forward-looking statements that involve risks and uncertainties. Whenused in this Report, the words “anticipate,” “believe,” “estimate,” “intend,” “may,”“will,” “expect” and similar expressions as they relate to our company or ourmanagement are intended to identify a statement as a “forward-lookingstatement.”  Our actual results,performance or achievements could differ materially from the results expressedin, or implied by, these forward-looking statements. Factors that could causeor contribute to such differences include those discussed in Item 1A of thisReport under the heading “Risk Factors.” Forward-looking statements reflect ourreasonable beliefs and expectations as of the time we make them, and we have noobligation to update or revise any forward-looking statements, whether as aresult of new information, future events or otherwise. In this Report on Form10-K, we refer to Aether Holdings, Inc. as “Aether,” “the Company,” “we” or “us.”

 

**PART I**

 

**ITEM 1. BUSINESS**

** **

*Introduction*

 

Ouroverall business objective is to become profitable and produce taxable earningsthat will enable us to realize value, in the form of tax savings, from oursignificant accumulated tax loss carryforwards. In pursuit of this objective,we own and manage a portfolio of mortgage-backed securities (“MBS”). We ownhybrid adjustable-rate mortgage-backed securities issued by the FederalNational Mortgage Association (“FNMA”) and the Federal Home Loan MortgageCorporation (“FHLMC”). Hybrid adjustable-rate MBS are characterized by periodiccaps on the interest rates on the underlying mortgages (generally, rateadjustments are limited to 2% every twelve months following the initial rateadjustment) as well as lifetime caps. The initial interest rate adjustment, onthe securities we own occurs 36-60 months following the date of origination.

 

Ingeneral, earnings from our MBS business activities represent the interestincome we earn on the MBS we own, less the interest expense we incur onborrowings used to finance the purchase of such securities (to the extent weuse borrowed funds), plus or minus any gains or losses we recognize on the saleof securities, minus any “other than temporary” declines in the value of ourMBS, minus the amortization of any premiums, plus the accretion of anydiscounts and minus the other expenses of managing our business. The expensesof managing our business include the fees we have agreed to pay our outsideinvestment manager, FBR Investment Management, Inc. (“FBR”), and our outsideadvisor, FinPro, Inc. (“FinPro”).

 

Ouroutside professional financial and investment advisors have substantialexperience in the MBS market and in managing a leveraged portfolio of MBSinvestments. In June 2004, we engaged FBR as our outside investmentadvisor to carry out the day-to-day management of our MBS portfolio, subject tooversight by our management and our Board of Directors and to investmentpolicies adopted by our Board. FBR currently manages a multi-billion dollar leveragedportfolio of MBS for one of its affiliates, but that affiliate announced inDecember 2005 that as a result of continued unfavorable market conditions forMBS it planned to reposition a portion of its MBS portfolio. As of July 1,2005, the initial one-year term of our agreement with FBR expired, and thisagreement is now continuing without a fixed term, subject to the right ofeither party to terminate the agreement with ninety days’ prior notice. Inaddition, we have contracted with FinPro to provide us with independentoversight of FBR and to assist us in developing, evaluating and managing ourMBS strategy. FinPro is an investment advisory and management-consulting firmthat specializes in providing financial advisory services to financial institutions.FinPro has substantial experience in the MBS market and related markets.

 

Theleverage we have employed consists of borrowings under repurchase agreements,which are short-term borrowings that we renew on a monthly basis. We renew ourshort-term borrowings at the interest rates offered on the renewal date. As aresult, during a period of rising short-term interest rates, as was the caseduring 2005, the cost of our borrowings increases more rapidly than the yieldon our MBS, which adjust much less frequently. This reduces the spread that werealize between the cost of our borrowings and the yield on our MBS, whichresults in a reduction in overall net interest income. As of the end of 2005,the interest rate spread on our leveraged MBS portfolio was negative.

 

During2005, the fair market value of our MBS portfolio declined. Continued increasesin short-term interest rates, partially offset by the benefit associated withthe seasoning of our MBS (as the securities’ individual coupon rates movecloser to an interest rate reset date), caused this decline in market value. Inaddition, the net interest income we earned on our portfolio declined as ourborrowing costs associated with the leveraged portion of the portfolioincreased. As a result of unfavorable market conditions for MBS, we have notpurchased any MBS since May 2005. In the second half of 2005, we soldapproximately $106.7 million of MBS. In addition, on March 8, 2006, we enteredinto a commitment to sell an additional $140 million of MBS, which will settleon March 27, 2006. At settlement, we plan to use approximately $120 million ofthe sale proceeds to repay all of our then-outstanding borrowings underrepurchase agreements. Becausethe weighted average cost of our short-term borrowings has begun to exceed theweighted average yield on our MBS, de-leveraging our MBS portfolio will have afavorable effect on our net interest income from MBS.

 

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Althoughwe have experienced a decline in our net interest income due to current marketconditions, as of December 31, 2005, we have realized $3.7 million in netearnings from our MBS portfolio since the inception of our MBS strategy in June2004. This amount represents the net of $5.6 million in net interest income,$2.1 million of net gains on sales of MBS, and a $4.0 million write down ofthe book value of our MBS, which we discuss below under “Recent Developments.”

 

Wehave decided not to purchase any additional MBS in the near term, pending theresults of our strategic activities, which we discuss below under “RecentDevelopments,” and a further assessment of the outlook for our MBS business inlight of market conditions later in 2006. Although we expect to maintain ourunleveraged MBS portfolio (following the March 2006 sales) during this period,we may sell additional MBS based upon our continued evaluation of marketconditions and the advice of our outside professional investment advisors.

 

AtDecember 31, 2005, we had approximately $9.7 million of cash (including$8.6 million in restricted cash) and cash equivalents, and we ownedapproximately $253.9 million of MBS at fair value. Our total assets wereapproximately $266.0 million, and our total liabilities were approximately$139.6 million, of which $133.4 million reflected borrowings under repurchaseagreements. We had accumulated federal net operating losses of approximately$777.8 million that we can “carry forward” and use to offset future taxableincome until they expire between 2011 and 2025. We also had accumulated federalcapital losses of approximately $287.8 million that we can “carry forward” anduse to offset future capital gains until they expire between 2006 and 2010.

 

Inthis Report, discussions of our Company’s current operations will reflect ourMBS business. Our historical financial results reflect the operations of ourcurrent business as “continuing operations.” The financial results of our mobile and wireless data businesses, whichwe sold during 2004, are reported as “discontinued operations.”

 

*Recent Developments*

 

Inlight of ongoing market conditions that have continued to negatively affect thevalue of our MBS, as well as reduce the amount of net interest income we earnfrom our leveraged MBS portfolio, we have been evaluating additional andalternative business strategies that have the potential to help us achieve ourbusiness objectives more quickly. On February 17, 2006 we retained Jefferies& Company, Inc. (“Jefferies”) to assist us in this process and to help usidentify additional potential strategic opportunities. As of the date of thisReport, we have not decided to pursue any new strategic alternatives. In thefuture, if we decide to pursue one or more new business opportunities, we mayneed to sell some or all of our MBS investments. Such sales of MBS may need tobe made under adverse market conditions, or for prices and on terms that areless favorable than those we might otherwise be able to secure. In suchsituations, we may realize a loss on our investments. See Item 1A “RiskFactors- Other Risks of Our Business” for a further discussion of the risksassociated with our exploration of potential new business strategies.

 

As of December 31, 2004and 2005, our investments consisted primarily of MBS and cash equivalents. Asa result of the decline in the profitability of our leveraged MBS portfolio,our recent decision to repay the leveraged portion of our MBS portfolio, andour decision to evaluate additional and alternative business opportunities thatmay require the sale of some or all of our remaining MBS, management does notcontinue to have the firm intention to hold existing MBS investments untilmaturity or until such time as the market value of those securities hasrecovered. Accordingly, we determined that unrealized losses in the MBSportfolio at December 31, 2005 should be considered “other than temporary”impairments under Statement of Accounting Standards 115 and should be chargedagainst operating results as of that date. This decision reflects a change inour intention to hold all MBS until a recovery of fair value occurs. During thefourth quarter of 2005, the Company recognized the unrealized loss ofapproximately $2.1 million and wrote-off the unamortized premium of $1.9million for a total other than temporary impairment charge of approximately $4.0million.

 

We willcontinue to account for our MBS portfolio as “available for sale.”  Accordingly, in accordance with US generallyaccepted accounting principles (“GAAP”), we will continue to evaluate the fairvalue of our MBS portfolio on a quarterly basis. Any further decreases inmarket values that we concluded are “other than temporary” impairments will beincluded in results from continuing operations.

 

OnMarch 8, 2006, based on the advice of our outside professional financial andinvestment advisors, we entered into a commitment with Jefferies to sellapproximately $140 million of our MBS (with settlement on March 27,2006). The terms we received from Jefferies were as good as or better than theterms offered by other investment banks. We will use approximately $120 millionof the sale proceeds to repay all of our then-outstanding short-term borrowingsunder repurchase agreements. Asa result, we expect that our MBS portfolio will not be leveraged by the end of thefirst quarter of 2006. The impairment charge of $4.0 million that is includedin loss from continuing operations in the fourth quarter of 2005 includes $2.5million of losses associated with thespecific MBS that we committed to sell on March 8, 2006. As a result of theMarch 8 sale, we will record an additional loss on the sale of MBS ofapproximately $490,000 in the first quarter of 2006. We intend to continue toclosely monitor market conditions and their effect on our MBS portfolio valueand yield.

 

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MORTGAGE-BACKED SECURITIES 

 

*MBS Approach and Policies*

 

Underthe investment policy and guidelines that we adopted for our MBS business, wemay invest up to $100 million of our cash in MBS and may leverage our MBSportfolio up to eight times. Although we incurred a moderate level ofborrowings earlier in 2005, to allow us to expand our MBS portfolio, asdiscussed above, we have de-leveraged the portfolio gradually during the secondhalf of 2005, as changing market conditions made the use of leveragesignificantly less attractive financially.

 

Inthe fourth quarter of 2005 because the interest we were earning on ourshort-term investments was less than the interest rates we were paying on our MBS,we used approximately $20 million of available cash to reduce the borrowings wehad outstanding under our master repurchase agreements.  These repaymentsand the corresponding reduction in leverage on our portfolio increased our netequity in MBS to approximately $120 million.  After the completion of thesales of MBS in March 2006 and the repayment of approximately $120 million ofour outstanding borrowings under our repurchase agreements and taking intoaccount the repayments on our MBS received during the first quarter of 2006 andthe $4.0 million unrealized loss associated with the portfolio,  our netinvestment in MBS will be approximately $95 million as of the end of the firstquarter of 2006, which is within the range of investments authorized by the Boardof Directors.

 

Asdiscussed above, we will have completely de-levered our MBS portfolio by theend of the first quarter of 2006 and will have a significantly smaller MBSportfolio than we had in 2005. We do not expect to re-leverage our MBSportfolio or purchase additional MBS absent a significant improvement in marketconditions, and then only based on the advice of our outside financial andinvestment advisors, after consultation with our Board of Directors. At therecommendation of our management, after consultation with FBR, FinPro and otheroutside advisors, our Board of Directors has adopted a set of investmentguidelines and policies that govern our MBS business. These guidelines andpolicies remain subject to ongoing review, as well as amendment or waiver atthe discretion of the Board. Under the terms of our management agreement withFBR, we must approve in advance any actions by FBR that are not within thescope of our guidelines and policies. As a matter of corporate policy, we willnot approve any action that deviates from our guidelines and policies unlesssuch deviation has been reviewed with FinPro and, with the advice of managementand FinPro, approved by our Board of Directors.

 

Ourcurrent MBS guidelines and policies include the following:

 

•      FBRmust obtain our permission before purchasing MBS individually in an amountexceeding $50 million or purchasing hybrid adjustable rate MBS greater than 5years to reset, fixed-rate MBS, or MBS derivatives.

•      FBRmust obtain our permission before taking any actions that would cause theportfolio’s asset-to-equity ratio to exceed 9:1.

•      FBRmay not enter into repurchase agreements on our behalf with any counter-partyin an amount that would exceed 35% of the aggregate amount of our thenoutstanding repurchase agreements.

•      FBRmay not enter into interest rate swap agreements or futures contracts withoutour prior approval.

•      Riskmanagement systems will be used to actively monitor and manage our exposure tointerest and mortgage prepayment rates, the shape of the yield curve, creditrisk, risk of capital loss, the availability and cost of financing, andchanging yield spreads relating to MBS.

 

During the second half of 2005, in light of changed market conditions,we directed FBR not to take any action with regard to our MBS portfolio withoutour express prior approval.

 

Wehave the right to modify or waive these policies and strategies without theconsent of our stockholders to the extent that the Board of Directorsdetermines, based upon the recommendations of management and with the advice ofour outside investment and financial advisors, that a modification or waiver isin the best interests of our stockholders. Among other factors, developments inthe market that affect our policies and strategies or that change ourassessment of the market may cause us to revise our policies and strategies.

 

*MBS Investments*

 

The MBS in which we investare agency mortgage-backed securities which, although not rated, carry animplied “AAA” rating. Agency mortgage-backed securities are MBS where agovernment agency or federally chartered corporation, such as FHLMC, FNMA orGovernment National Mortgage Association (“GNMA”), guarantees payments ofprincipal and/or interest on the securities.

 

MBS provide funds formortgage loans made primarily to residential homeowners. These securitiesgenerally represent interests in pools of mortgage loans made by savings andloan institutions, mortgage bankers, commercial banks and other mortgagelenders. 

 

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These pools of mortgageloans are assembled for sale to investors, like us, by various governments,government-related and private organizations. MBS differ from other forms oftraditional debt securities, which normally provide for periodic payments ofinterests and principal payments in scheduled amounts or at maturity or onspecified call dates. Instead, MBS provide for monthly payment, which consistsof both interest and principal. In effect, these payments are a “pass-through”of the monthly interest and principal payments made by the individual borroweron the mortgage loans, net of any fees paid to the issuer or guarantor of thesecurities. Additional payments result from prepayments of principal upon thesale, refinancing or foreclosure of the underlying residential property. SomeMBS, such as securities issued by GNMA, are described as “modified pass-through”securities. These securities entitle the holder to receive all interest andprincipal payments owed on the mortgage pool, net of certain fees, regardlessof whether the mortgagors actually make mortgage payments when due. To date, wehave not invested in any securities issued by GNMA.

 

The investmentcharacteristics of pass-through MBS differ from those of traditionalfixed-income securities. The major differences include the payment of interestand principal on the MBS on a more frequent schedule, as described above, andthe possibility that principal may be prepaid at any time due to prepayments onthe underlying mortgage loans or other assets. These differences can result insignificantly greater price and yield volatility than is the case withfixed-income securities.

 

Various factors affect therate at which mortgage prepayments occur, including changes in interest rates,general economic conditions, the age of the mortgage loan, the location of theproperty and other social and demographic conditions. Generally prepayments onMBS increase during periods of falling mortgage interest rates and decreaseduring periods of rising mortgage interest rates. We may reinvest prepaymentsat a yield that is higher or lower than the yield on the initial underlying MBSsecurity purchased, thus affecting the weighted average yield of ourinvestments.

 

To the extent MBS arepurchased at a premium, faster than expected prepayments result in acceleratedamortization of the premium paid, which can have a negative effect on the yieldfrom our MBS portfolio. Conversely, if these securities were purchased at adiscount, faster than expected prepayments accelerate our recognition of thediscount and can have a positive effect on the yield from our MBS portfolio.

 

*FHLMC Certificates*

 

FHLMC is a privately-owned,government-sponsored enterprise created pursuant to an act of Congress onJuly 24, 1970. The principal activity of FHLMC currently consists of thepurchase of mortgage loans or participation interests in mortgage loans and theresale of the loans and participations in the form of guaranteed MBS. FHLMCguarantees to each holder of FHLMC certificates the timely payment of interestat the applicable pass-through rate and ultimate collection of all principal onthe holder’s pro rata share of the unpaid principal balance of the relatedmortgage loans, but does not guarantee the timely payment of scheduled principalof the underlying mortgage loans. The obligations of FHLMC under its guaranteesare solely those of FHLMC and are not backed by the full faith and credit ofthe United States. If FHLMC were unable to satisfy these obligations,distributions to holders of FHLMC certificates would consist solely of paymentsand other recoveries on the underlying mortgage loans and, accordingly,defaults and delinquencies on the underlying mortgage loans would adverselyaffect monthly distributions to holders of FHLMC certificates.

 

FHLMC certificates may bebacked by pools of single-family mortgage loans or multi-family mortgage loans.These underlying mortgage loans may have original terms to maturity of up to 40years. FHLMC certificates may be issued under cash programs (composed ofmortgage loans purchased from a number of sellers) or guarantor programs(composed of mortgage loans acquired from one seller in exchange forcertificates representing interests in the mortgage loans purchased).

 

FHLMC certificates may payinterest at a fixed rate or an adjustable rate. The interest rate paid onadjustable-rate FHLMC certificates (“FHLMC ARMs”) adjusts periodically within60 days prior to the month in which the interest rates on the underlyingmortgage loans adjust. The interest rates paid on certificates issued underFHLMC ARMs’ standard programs adjust in relation to the Treasury index. Otherspecified indices used in FHLMC ARM programs include the 11th District Cost ofFunds Index published by the Federal Home Loan Bank of San Francisco, LIBOR andother indices. Interest rates paid on fully-indexed FHLMC ARM certificatesequal the applicable index rate plus a specified number of basis points. Themajority of series of FHLMC ARM certificates issued to date have

pools of mortgage loans withmonthly, semi-annual or annual interest adjustments. Adjustments in theinterest rates paid are generally limited to an annual increase or decrease ofeither 100 or 200 basis points and to a lifetime cap of 500 or 600 basis pointsover the initial interest rate. Certain FHLMC programs include mortgage loanswhich allow the borrower to convert the adjustable mortgage interest rate to afixed rate. Adjustable-rate mortgages which are converted into fixed-ratemortgage loans are repurchased by FHLMC or by the seller of the loan to FHLMCat the unpaid principal balance of the loan plus accrued interest to the duedate of the last adjustable rate interest payment.

 

*FNMA Certificates*

 

FNMA is a privately-owned,federally-chartered corporation organized and existing under the FederalNational Mortgage Association 

 

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Charter Act. FNMA providesfunds to the mortgage market primarily by purchasing home mortgage loans fromlocal lenders, thereby replenishing their funds for additional lending. FNMAguarantees to the registered holder of a FNMA certificate that it willdistribute amounts representing scheduled principal and interest on themortgage loans in the pool underlying the FNMA certificate, whether or notreceived, and the full principal amount of any such mortgage loan foreclosed orotherwise finally liquidated, whether or not the principal amount is actuallyreceived. The obligations of FNMA under its guarantees are solely those of FNMAand are not backed by the full faith and credit of the United States. If FNMAwere unable to satisfy its obligations, distributions to holders of FNMAcertificates would consist solely of payments and other recoveries on theunderlying mortgage loans and, accordingly, defaults and delinquencies on theunderlying mortgage loans would adversely affect monthly distributions toholders of FNMA.

 

FNMA certificates may bebacked by pools of single-family or multi-family mortgage loans. The originalterm to maturity of any such mortgage loan generally does not exceed 40 years. FNMAcertificates may pay interest at a fixed rate or an adjustable rate. Eachseries of FNMA ARM certificates bears an initial interest rate and margin tiedto an index based on all loans in the related pool, less a fixed percentagerepresenting servicing compensation and FNMA’s guarantee fee. The specifiedindex used in different series has included the Treasury Index, the 11thDistrict Cost of Funds Index published by the Federal Home Loan Bank of SanFrancisco, LIBOR and other indices. Interest rates paid on fully-indexed FNMAARM certificates equal the applicable index rate plus a specified number ofbasis points. The majority of series of FNMA ARM certificates issued to datehave evidenced pools of mortgage loans with monthly, semi-annual or annualinterest rate adjustments. Adjustments in the interest rates paid are generallylimited to an annual increase or decrease of either 100 or 200 basis points andto a lifetime cap of 500 or 600 basis points over the initial interest rate.Certain FNMA programs include mortgage loans which allow the borrower toconvert the adjustable mortgage interest rate of the adjustable-rate mortgageto a fixed rate. Adjustable-rate mortgages which are converted into fixed-ratemortgage loans are repurchased by FNMA or by the seller of the loans to FNMA atthe unpaid principal of the loan plus accrued interest to the due date of thelast adjustable rate interest payment. Adjustments to the interest rates onFNMA ARM certificates are typically subject to lifetime caps and periodic rateor payment caps.

 

*GNMA Certificates*

 

GNMA certificates are thoseissued by the Government National Mortgage Association. GNMA is a wholly ownedcorporate instrumentality of the United States within the Department of Housingand Urban Development. The National Housing Act of 1934 (the “Housing Act”)authorizes GNMA to guarantee the timely payment of the principal of andinterest on certificates which represent an interest in a pool of mortgagesinsured by the Federal Housing Administration or partially guaranteed by theDepartment of Veterans Affairs and other loans eligible for inclusion inmortgage pools underlying GNMA certificates.  Section 306(g) of theHousing Act provides that the full faith and credit of the United States ispledged to the payment of all amounts which may be required to be paid underany guaranty by GNMA.

 

At present, most GNMAcertificates are backed by single-family mortgage loans. The interest rate paidon GNMA certificates may be a fixed rate or an adjustable rate. The interestrate on GNMA certificates issued under GNMA’s standard ARM program adjustsannually in relation to the Treasury index. Adjustments in the interest rateare generally limited to an annual increase or decrease of 100 basis points andto a lifetime cap of 500 basis points over the initial coupon rate.

 

LEVERAGE AND BORROWINGS

 

During2005, we used short-term repurchase agreements as our sole source of financingin connection with the leveraging of our MBS portfolio. Amounts due at maturityunder our repurchase agreements are funded primarily throughrollover/reissuance of new repurchase agreements along with principal andinterest payments received from MBS we own. As of December 31, 2005, our debt toequity ratio was 1.1 to 1. We will have no debt associated with our MBSportfolio as of the end of the first quarter of 2006.

 

Wehave established master repurchase arrangements with five financialinstitutions. These master repurchase arrangements do not constitutecommitments by us or by the counterparties. A repurchase agreement, althoughstructured as a sale and repurchase obligation, acts as a financing under whichwe effectively pledge our MBS as collateral to secure a short-term loan andalthough the MBS is used as collateral, we continue to receive principal andinterest payments in respect of the MBS. Generally, the other party to theagreement makes the loan in an amount equal to a percentage of the market valueof the pledged collateral. At the maturity of the repurchase agreement, we arerequired to repay the loan and correspondingly receive back our collateral. Thesetypes of leveraging arrangements for MBS purchases typically permit more than90% of the purchase price of the underlying MBS to be financed through therepurchase agreement.

 

Repurchaseagreements may require us to pledge additional assets to the lender in theevent the estimated fair value of existing pledged collateral declines below aspecified percentage. The pledged collateral fluctuates in value during thelife of the repurchase agreement due to, among other things, principalrepayments, market changes in interest rates and credit quality. When thefluctuation negatively impacts the collateral, a lender may require us to postadditional collateral, or we may choose to sell the pledged security 

 

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andrepay the “loan.”  This type of activitycould adversely affect the performance of our portfolio of MBS. During 2005, wetypically used repurchase agreements that had original maturities ofapproximately 30-31 days. In the event a lender under a repurchase agreementdecides not to renew a repurchase agreement at its maturity, we would berequired to use our own cash or obtain other financing to close out therepurchase agreement and pay off the loan. In addition, differences in timingof interest rate adjustments on our acquired securities and our borrowings mayadversely affect our MBS strategy and the returns on the portion of our cash weinvest in MBS,” because the interest rates paid by our MBS investmentstypically do not adjust more than once per year and in the current environmentof increasing short-term interest rates, our borrowing costs increased morequickly than the interest rates paid by our MBS portfolio. As a result, risinginterest rates have had a negative effect on our financial performance and havesignificantly reduced the yield we realize from our MBS portfolio.

 

Inthe event of our insolvency or bankruptcy, certain repurchase agreements mayqualify for special treatment under the Bankruptcy Code, the effect of which,among other things, would be to allow the creditor under the agreement to avoidthe automatic stay provisions of the Bankruptcy Code and to foreclose on thecollateral agreement without delay. In the event of the insolvency orbankruptcy of a lender during the term of a repurchase agreement, the lendermay be permitted, under applicable insolvency laws, to repudiate the contract,and our claim against the lender for damages may be treated simply as anunsecured claim. In addition, if the lender is a broker or dealer subject tothe Securities Investor Protection Act of 1970, or an insured depositoryinstitution subject to the Federal Deposit Insurance Act, our ability toexercise our rights to recover our securities under a repurchase agreement orto be compensated for any damages resulting from the lender’s insolvency may befurther limited by those statutes. These claims would be subject to significantdelay and, if and when received, may be substantially less than the damages weactually incur.

 

Wehave repurchase arrangements in place with five financial institutions thathave each received the highest available long-term debt rating from anationally recognized rating agency. In the event one of our lenders isdowngraded, the approval of our Board of Directors will have to be obtainedbefore entering into additional repurchase agreements with that lender. We seekto diversify our exposure by entering into repurchase agreements with separatelenders so that no one lender constitutes more than 35% of all of ouroutstanding repurchase agreements. If, during the term of a repurchaseagreement, a lender were to file for bankruptcy, we might experience difficultyrecovering the pledged security and might have only an unsecured claim againstthe lender’s assets for the difference between the amount we borrowed and theestimated fair value of the collateral we pledged to such lender (if any).

 

Wemay also use derivative transactions and other hedging strategies, such asinterest rate swaps and caps, options to purchase swaps and caps, financialfutures contracts and options on futures, to help mitigate prepayment andinterest rate risks if we determine that the cost of these transactions isjustified by their potential benefit. We would use hedging to mitigate declinesin the market value of our MBS during periods of increasing or decreasinginterest rates or to limit or cap the interest rates on our borrowings. Weexpect that the extent and type of our hedging activity will vary based on thelevel and volatility of interest rates and mortgage principal prepayments, thetype of MBS we acquire and other changing market conditions. We will not enterinto hedging transactions for speculative purposes.

 

DISPOSITION OF WIRELESS AND MOBILE DATABUSINESSES

 

In2004, we sold our mobile and wireless data businesses, which were organizedinto three operating segments. In January 2004, we sold our EnterpriseMobility Solutions (“EMS”) segment for $18.0 million in cash and a $1.0 millionnote (which was paid in full in August 2004). In September 2004 wesold our Transportation and Mobile Government businesses for $25.0 million incash and $10.0 million in cash, respectively. For detailed information on thesedispositions and certain contingent obligations associated with thetransactions, see Notes 14, 15 and 17 of the notes to our ConsolidatedFinancial Statements included in Item 8 of this Report.

 

TAX CONSIDERATIONS

 

Animportant aspect of our business strategy is to realize value, in the form oftax savings, from our accumulated tax loss carryforwards. We have workextensively with outside legal and accounting professionals to validate theunderlying assumptions relating to our tax carryforwards. Under federal andstate tax laws, we may use these carryforwards to substantially reduce theincome taxes we otherwise would have to pay on future taxable income. As aresult, we could have little or no income tax liability for a period of time. Ourability to realize value from these tax loss carryforwards is subject tovarious risks and uncertainties, including regulations that, under certaincircumstances, may limit our ability to use these carryforwards to reducefuture taxes that we might otherwise owe.

 

TheInternal Revenue Code and applicable Internal Revenue Service (“IRS”)regulations, contain limitations on certain changes in ownership of our stockby certain stockholders (generally persons who hold, or who acquire, at least5% of our outstanding shares, calculated in accordance with IRS regulations)which, if exceeded, could reduce or eliminate our ability to use ouraccumulated tax loss carryforwards in the future (if those changes resulted ina “change of ownership” as that term is defined in Section 382 of theInternal Revenue Code and applicable IRS regulations). These same tax rules andthe need to avoid an ownership change also limit 

 

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theamount of additional shares we can issue to raise new capital for investment inour business. In an effort to mitigate these risks, we proposed, and ourstockholders approved on July 12, 2005, a holding company reorganization inwhich Aether Systems, Inc. became a wholly owned subsidiary of the Company. Inthe reorganization, each share of Aether Systems common stock was exchanged forone share of common stock of the Company. The stock of the Company is nowtraded on the Nasdaq National Market under the symbol “AETH,” and the stock issubject to transfer restrictions that generally restrict any direct or indirecttransfer (such as transfers of stock of the Company that result from thetransfer of interests in other entities that own stock of the Company) if theeffect would be to:  (i) increase thedirect or indirect ownership of Company stock by any person (or public group)from less than 5% to 5% or more; (ii) increase the percentage of Company stockowned directly or indirectly by a person (or public group) owning or deemed toown 5% or more of the stock of the Company; or (iii) create a new public group.These transfer restrictions are intended to guard against the possibility thatpublic trading of our stock would result in a “change of ownership” under theInternal Revenue Code and applicable IRS regulations and to protect thelong-term value of our substantial net operating loss and capital losscarryforwards.

 

Inan effort to seek to accelerate the realization of the value from ouraccumulated net operating loss and capital loss carryforwards, we may seekadditional capital, from time to time, through periodic offerings of shares ofour stock as market conditions allow. Such additional capital would then beused to expand our business in pursuit of additional taxable income. Ingeneral, we would expect to seek to sell shares only when such sales would notbe dilutive to the value of our outstanding shares at the time of any suchoffering. This means we generally would not expect to sell shares at any timewhen the offering price is below the per share book value of our assets. Becausewe cannot predict the future trading price of our stock, we cannot predict whenor whether we would be able to sell shares of stock to raise additional capitalunder the desired conditions. In addition, as noted above, provisions of theInternal Revenue Code and certain applicable IRS regulations will limit thenumber of additional shares of stock we can sell from time to time withoutcausing a limitation on our ability to use our accumulated tax loss carryforwardsto reduce our future tax obligations.

 

Althoughwe may choose to pay dividends in the future, we do not currently anticipatepaying dividends to our stockholders in the near term as we seek to realizevalue from our loss carryforwards by increasing our earnings as quickly aspossible. Instead, we expect to re-invest earnings in our business to promoteits expansion. We expect that our tax loss carryforwards will allow us toreinvest earnings without reduction for income tax payments for as long as thosecarryforwards remain available to us.

 

Ifwe were to pay dividends to stockholders from current earnings, these dividendswould, generally speaking, be eligible to be treated as “qualified dividends”for federal income tax purposes, currently taxed at a maximum federal rate of15%, assuming that the recipient stockholder meets the various requirementsunder the Internal Revenue Code for such treatment. The maximum rate forqualified dividends is currently projected to increase to the maximum federalincome tax rate applicable to ordinary income (currently 35%) for tax yearsbeginning after December 31, 2008 in accordance with the Jobs and GrowthTax Relief Reconciliation Act of 2003.

 

REGULATION

 

We operate under anexception from the definition of an “investment company” set forth inSection 3(c)(5) of the Investment Company Act for companies that areprimarily engaged in the business of purchasing or otherwise acquiringmortgages and other liens on and interests in real estate. Absent suchexception or another applicable exception, we would be required to register asan investment company under the Investment Company Act and would be required tocomply with the various regulations adopted by the SEC for application toregistered investment companies. The staff of the Securities and ExchangeCommission (the “SEC”) has expressed the view that, in order to be consideredto be “primarily engaged” in the real estate business, a company must have atleast 55% of its assets in qualifying real estate interests, which the SECstaff has said, through “no-action” positions, include whole pool mortgageinterests issued by FHLMC, FNMA or GNMA, and at least 25% of its assets inother real estate related assets. This 25% minimum is reduced to the extent acompany invests more than 55% of its assets in qualifying real estate interests.Neither the SEC nor its staff has defined the term “real estate related assets”for purposes of the 25% requirement set forth above. The staff has indicated,however, that a loan will qualify as a real estate related asset if at least55% of the fair market value of the loan is secured by real estate at the timethe company acquires the loan. The staff has also indicated that agency partialpool certificates and certain interests in companies that invest in mortgagesor other interests in real estate are real estate related assets. We conductour business in such a manner as to be exempted from the definition of aninvestment company under Section 3(c) (5) of the Investment Company Act. TheMBS investments we have purchased qualify as qualifying real estate assets,based on the current views of the SEC staff. If we failed to remain exempt fromthe regulations applicable to “investment companies,” our business could beadversely affected, as discussed in Item 1A under the heading “Risk Factors –Loss of Investment Company Act exemption would adversely affect us.”

 

To the extent we explorealternative or additional business strategies we may be limited by the rulesand regulations of the Investment Company Act. We will not pursue any strategywhich would interfere with our exemption from registration under the InvestmentCompany Act.

 

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COMPETITION

 

Our ability to generateincome from our MBS business depends, in large part, on our ability to acquireand sell MBS in the marketplace on favorable terms. In acquiring MBS, wecompete with real estate investment trusts (REITs), financial institutions,such as banks, life insurance companies, savings and loan associations, andinstitutional investors, such as mutual funds and pension funds, other lendersand other entities that purchase MBS, many of which have greater financialresources than we do. We and other companies that invest in MBS may look tosell such investments at the most favorable prices when market conditionsdictate in order to reduce our leverage or reduce the overall amount we haveinvested in MBS. In addition, our outside investment advisor also acquires andsells MBS for an $11 billion portfolio that it manages for an affiliate. As wesell a portion of our MBS portfolio in order to repay all of our outstandingshort-term borrowings, we likely will be competing with other sellers to obtainthe best available sale prices for our MBS. Such other sellers may include FBR,as it repositions its affiliate’s portfolio. FBR’s obligations to its affiliatemay conflict with its obligations to us.

 

GENERAL CORPORATE MATTERS

 

Aetherwas originally formed as Aeros, L.L.C. in January 1996. We changed our nameto Aether Technologies International, L.L.C. in August 1996 and to AetherSystems L.L.C. in September 1999. Immediately prior to completing ourinitial public offering of common stock on October 20, 1999, we convertedfrom a limited liability company to a Delaware corporation and changed our nameto Aether Systems, Inc. On July 12, 2005, the stockholders of Aether Systemsapproved a holding company reorganization of Aether Systems in which each shareof Aether Systems common stock was exchanged for one share of common stock ofthe Company and Aether Systems became a wholly-owned subsidiary of the Company.The sole activity of the Company is to hold 100% of the stock of Aether Systems.Immediately after the reorganization, the consolidated assets, liabilities andstockholders’ equity of the Company were the same as the consolidated assets,liabilities and stockholders’ equity of Aether Systems immediately prior to thereorganization. On July 13, 2005, the stock of Aether Systems ceased to tradeon the Nasdaq National Market, and the stock of the Company began trading underthe symbol “AETH.”  The reorganizationwas designed to help to protect the long-term value to the Company of itssubstantial net operating loss and capital loss carryforwards.

 

Ourexecutive offices are located at 621 E. Pratt St., Suite 601, Baltimore, MD21202. Our telephone number is (443) 573-9400 and our fax number is (443)573-0383.

 

OurInternet address is www.aetherholdings.com. We make available free of charge,on or through our website, our annual report on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K, and amendments to those reports filedor furnished to the SEC pursuant to Section 13(a) or Section 15(d) ofthe Securities Exchange Act of 1934, as amended (the “Exchange Act”) as soon asreasonably practicable after we electronically file such material with, orfurnish it to, the SEC. We are providing the address of our internet websitesolely for the information of investors. We do not intend the internet addressto be an active link, and the contents of the website are not a part of thisReport.

 

We have adopted a generalcode of ethics for our business. We have also adopted a code of ethical conductthat applies solely to our principal executive officer, principal financialofficer, principal accounting officer, controller and persons performingsimilar functions. The Board of Directors is responsible for reviewing andauthorizing any waivers from both the code of ethics and code of ethicalconduct for senior financial officers and we will file any waivers from, oramendments to, these codes on our website www.aetherholdings.com. Both thegeneral code of ethics and the code of ethical conduct for senior financialofficers, as well as the charters for our audit committee, nominatingcommittee, corporate governance committee and compensation committee, areavailable on Aether’s website, www.aetherholdings.com. This information is alsoavailable in print upon written request to our secretary at the address setforth above.

 

We have also adoptedprocedures for our stockholders to communicate with our Board of Directors. Stockholderswho wish to contact the Board of Directors, or an individual director, shouldcontact the Board of Directors or individual director atinvestor_relations@aetherholdings.com or in writing at 621 E. Pratt St., Suite601, Baltimore, MD 21202. The Secretary will compile all communications andsubmit them to the Board of Directors, or individual directors, on a periodicbasis.

 

EMPLOYEES

 

As of December 31,2005, we employed a total of 7 persons. None of our employees is covered by acollective bargaining agreement. We believe that our relations with ouremployees are good.

 

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**ITEM 1A.RISK FACTORS**

 

Ourbusiness activities are subject to various important risks and uncertainties,including the following:

 

Risksof our Current Business 

 

*1. Increases in prepayment rate adversely affect us.*

 

The MBS we acquire arebacked by pools of underlying mortgage loans. The payments we receive from ourMBS are generally,  payments by themortgagors on the underlying mortgage loans. When borrowers prepay theirmortgage loans at rates that are faster than expected, the result is that ourMBS are prepaid faster than expected. These accelerated prepayments mayadversely affect the performance of our business.

 

Prepayment ratesgenerally increase when interest rates fall and decrease when interest ratesrise, but changes in prepayment rates are difficult to predict. Prepaymentrates also may be affected by conditions in the housing and financial markets,general economic conditions and the relative interest rates on fixed-rate andadjustable-rate mortgage loans.

 

When they were purchased,our MBS had a higher interest rate than the market interest rate at the time.In exchange for this higher interest rate, we paid a premium over the marketvalue to acquire the security. In accordance with accounting rules, we amortizethis premium on a level yield over the term of the MBS. If the MBS is prepaidin whole or in part prior to its maturity date, however, we would be requiredto amortize all (or a corresponding portion, in the case of a partialprepayment) of the remaining unamortized premium. This accelerated amortizationnegatively impacts the yield on our MBS.

 

We could, however, reducethe potential negative impact of increased prepayments by acquiring MBS at adiscount. In accordance with GAAP, we would recognize this discount on a levelyield over the term of the MBS. If a discounted security is prepaid in whole orin part prior to its maturity date, we will recognize income equal to theamount of the discount not previously recognized (or a portion of suchremaining discount, in the case of a partial prepayment). Consequently, thereported performance of our business would be enhanced if discounted securitiesare prepaid faster than expected.

 

While we seek to minimizeprepayment risk to the extent practical, in selecting investments we manage theprepayment risk against other risks and the potential returns of eachinvestment. No strategy, however, can completely insulate us from prepaymentrisk.

 

*2. An increase in interest rates adversely affects the bookvalue of our MBS.*

 

Increases in the generallevel of interest rates may cause the fair market value of our assets todecline. Generally, hybrid adjustable-rate MBS (during the fixed-rate componentof the mortgages underlying such securities), which comprised 100% of our MBSat December 31, 2005, will be more negatively affected by such increases thantraditional one-year adjustable-rate mortgage securities. In accordance withGAAP, we are required to reduce the carrying value of our MBS by the amount ofany decrease in the fair value of our MBS compared to their respectiveamortized costs. If decreases in fair value occur, we are required by GAAP toeither reduce current earnings or reduce stockholders’ equity withoutimmediately affecting current earnings, depending on the accountingclassification of the MBS and whether or not we believe the losses aretemporary. In either case, our net book value decreases to the extent of anydecreases in fair value.

 

*3. If we are unable to renew orobtain additional sufficient funding on favorable terms or at all, we couldincur losses.*

 

We depend on borrowings,which to date have been short-term borrowings under repurchase agreements, tofund purchases of MBS in excess of our available cash. Our ability to satisfycommitments to purchase additional MBS depends on our ability to enter intorepurchase agreements in sufficient amounts and on favorable terms. Inaddition, because repurchase agreements are short-term arrangements and MBS arelong-term securities, we must be able to continually renew or replaceoutstanding repurchase agreements as they mature. We currently have repurchasearrangements with five lendersto provide financing for our purchases of MBS. These arrangements are notcommitments to lend money to us. If we are unable to obtain funds to satisfyour MBS purchase commitments, or if we are unable to renew or replace maturingborrowings on favorable terms or at all, our financial condition and resultscould be materially and adversely affected. We could be required to sell ourMBS (or to sell forward purchase commitments prior to their settlement, or sellthe underlying MBS at the time of settlement) under adverse market conditions,or for prices and on terms that are less favorable than those we mightotherwise be able to secure. In such situations, we would be forced to sellinvestments at a loss.

 

*4. Our cash balances and cash flows may become limitedrelative to our cash needs and our borrowings could force us to sell assetsunder adverse market conditions.*

 

Our primary liquidity riskarises from financing long-maturity MBS with short-term borrowings. Because wehave purchased certain of our MBS with borrowed funds, a decline in the marketvalue of our investment securities, caused by rising interest rates or 

 

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prepayments, may result inour lenders initiating margin calls. A margin call means that the lenderrequires us to pledge additional collateral to re-establish the ratio of themarket value of the collateral to the amount of the borrowing. If we are unableto satisfy margin calls, our lenders may foreclose on our collateral. Thiscould force sales of our MBS under adverse market conditions where the value ofthe collateral securing our borrowing is less than the amount owed to ourlenders. In this case, we would be responsible for any deficiency between thevalue of the collateral and the amounts we borrowed. This would increaseour liquidity needs.

 

Additionally, repurchaseagreements may qualify for special treatment under the Bankruptcy Code. Thisspecial treatment would allow the lenders under these agreements to avoid theautomatic stay provisions of the Bankruptcy Code and to liquidate thecollateral under these agreements without delay.

 

*5. Limitations on our ability toraise additional capital through sales of shares of our capital stock mayrestrict our ability to address liquidity needs through stock issuances and maylimit our ability to expand our MBS portfolio by raising additional capitalthrough such stock offerings.*

 

Because of limitationsimposed by sections 382 and 383 of the Internal Revenue Code, which regulateour ability to use our accumulated net operating loss carryforwards and capitalloss carryforwards in the future (as discussed below), there are limits on thenumber of additional shares of stock we can sell to raise additional capital. Accordingly,assuming market conditions would otherwise permit us to sell additional sharesof our stock, this legal limit may prevent us from raising as much additionalcapital through sales of our stock as we might want or need at any particulartime. As a result, we may be unable to address a specific liquidity needsthrough a sale of our stock. We also may not be able to increase the size ofour MBS portfolio as much or as rapidly as we would otherwise like, because oflimits on our ability to raise additional cash through stock offerings.

 

*6. We may change our investment policies and guidelineswithout stockholder approval**.*

 

Our Board of Directors,with the advice of our management and FinPro, determine all of our investmentpolicies and guidelines. The Board of Directors may amend or revise theseinvestment policies and guidelines at any time without notice to stockholders. Changesto the leverage ratio, types of securities included in our portfolio and changesto our risk management policies could adversely affect our financial condition,results of operations, or the market price of our common stock.

 

*7. Competition may increase and negatively impact ourbusiness**.*

 

The success of ourbusiness depends, in large part, on our ability to acquire MBS at favorablespreads over borrowing costs, as well as our ability to sell MBS at favorableprices when necessary in response to changing market conditions. In acquiringand selling MBS, we compete against REITs, financial institutions, such asbanks, savings and loans, life insurance companies and institutional investorssuch as mutual funds and pension funds. Many of these entities have greaterfinancial resources than us and as a result, we may not be able to acquiresufficient MBS at favorable spreads over our borrowing costs. In addition, wemay face competition for a limited number of buyers at a time when we areseeking to sell MBS, which could result in us receiving less favorable pricesfor MBS that we sell. Our investment advisor (FBR) may be one of thesecompetitors, to the extent it seeks to sell MBS for its affiliate, which has avery large MBS portfolio and has committed to repositioning a portion of thatportfolio. See the discussion below under “The manager of our MBS portfolio, FBR, may have a conflict of interest.”  Existingcompetitors may grow, and new competition may enter the market over time, allof which can increase competition and could result in less favorable pricingand lower yields on assets.

 

*8. Defaults on the mortgage loansunderlying our MBS may reduce the value of our investment portfolio and harmour results of operations**.*

 

We bear the risk of anylosses resulting from any defaults on the mortgage loans underlying the MBS inour investment portfolio. The MBS that we purchased are subject to guaranteesof the payment of principal and interest on mortgage loans underlying such MBS,either by federal government agencies, including Ginnie Mae, or byfederally-chartered corporations, including Fannie Mae and Freddie Mac. WhileGinnie Mae’s obligations are backed by the full faith and credit of the UnitedStates, the obligations of Fannie Mae and Freddie Mac are solely their own. Asa result, a substantial deterioration in the financial strength of Fannie Mae,Freddie Mac could increase our exposure to future delinquencies, defaults orcredit losses on our holdings of Fannie Mae or Freddie Mac-backed MBS, andcould harm our results of operations. In addition, while Freddie Mac guaranteesthe eventual payment of principal, it does not guarantee the timely paymentthereof, and our results of operations may be harmed if borrowers are late ordelinquent in their payments on mortgages underlying Freddie Mac-backed MBS. Moreover,Fannie Mae, Freddie Mac, Ginnie Mae guarantees relate only to payments on themortgages underlying such agency-backed or corporate-backed securities, and donot guarantee the market value of such MBS or the yields on such MBS. As aresult, we remain subject to interest rate risks; prepayment risks, extensionrisks and other risks associated with our investment in such MBS and mayexperience losses in our investment portfolio.

 

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*9. A prolonged economic slow-down, a lengthy or severerecession or declining real estate values could harm our operations**.*

 

The residential mortgagemarket has experienced considerable growth during the past ten years, withtotal outstanding U.S. mortgage debt growing from approximately $4.4 trillionat the end of 1993 to approximately $8.2trillion as of December 2005, according to the Bond MarketAssociation and the Federal Reserve. If this growth cannot be sustained or wesuffer an economic recession, the market for MBS may be adversely affected.

 

*10. Differences in timing ofinterest rate adjustments on our acquired securities and on our borrowingsadversely affect our MBS business and the returns on the portion of our cash weinvest in MBS.*

 

We have relied primarilyon short-term borrowings under repurchase agreements to acquire MBS withlonger-term maturities. The interest rates on our short-term borrowingsfluctuate monthly and carry interest rates that are based on prevailingshort-term interest rates. Conversely, all of the MBS we have acquired arehybrid, adjustable-rate securities. This means that the interest rates on ourMBS are initially fixed for a period of time, generally three years, subsequentto which they vary over time based upon changes in an objective index such asone year LIBOR or the one year Constant Maturity Treasury Rate, which generallyreflect longer term interest rates. Accordingly, as short-term interest ratesincrease, it adversely affects our investment strategy and the returns on ourcapital.

 

As interest ratesincreased during 2005, we experienced a negative interest spread whichadversely affected our net interest income because the interest rates on ourborrowings adjusted upward faster than the interest rates on ouradjustable-rate securities.

 

*11. Interest rate caps could reduce the returns from ourbusiness**.*

 

Adjustable-rate andhybrid adjustable-rate MBS are typically subject to periodic and lifetimeinterest rate caps. Periodic interest rate caps limit the amount an interestrate can increase during any given adjustment period. Lifetime interest ratecaps limit the amount an interest rate can increase over the life of thesecurity. Our borrowings are not subject to similar restrictions. Accordingly,in a period of rapidly increasing interest rates (such as over the last threequarters), we would experience a decrease in net income or experience a netloss from our MBS portfolio because increases in the interest rates on ourborrowings will not be limited, while increases in the interest rates on ouradjustable-rate securities would be capped.

 

*12. Hedging against interest rate exposure could adverselyaffect performance of our portfolio of MBS**.*

 

We may enter intoderivative transactions and other hedging strategies, such as interest rateswaps and caps, options to purchase swaps and caps, financial futures contractsand options on futures that are intended to hedge our exposure to rising rateson funds borrowed to finance our investment securities. Interest rate hedgingmay fail to reduce exposure to interest rate and prepayment risks discussed inthis “Risk Factors” section because, among other things:

 

•      interestrate hedging can be expensive, particularly during periods of rising andvolatile interest rates, and the cost of implementing the hedge may offset itspotential benefit;

•      availableinterest rate hedging may not correspond directly with the interest rate riskfor which protection is sought;

•      theduration of the hedge may not match the duration of the related liability; and

•      thecredit quality of the party owing money on the hedge may be downgraded to suchan extent that it impairs its ability to sell or assign its side of the hedgingtransaction.

 

*13. We are dependent on FBR to assist us in managing theportfolio of MBS**.*

 

Because we do not haveexperience in managing a leveraged portfolio of MBS, we are heavily dependenton the efforts and expertise of FBR. If we were to lose FBR’s services, ourability to fulfill our objectives and continue our MBS business could beadversely affected. As of July 1, 2005, the initial one-year term of ouragreement with FBR expired, and this agreement is now continuing on amonth-to-month basis without a fixed term, subject to the right of either partyto terminate the agreement with ninety days prior notice. During the term ofthe agreement, unanticipated changes in circumstances to us or FBR could resultin FBR ceasing to provide services to us. Accordingly, we cannot assure youthat FBR will continue to work with us. FBR has not indicated that it plans toterminate its contract with us or that the repositioning of FBR’s portfoliowill have any impact on its ability to continue to manage our portfolio. If FBRwere to terminate its agreement with us, however, it may be difficult for us,within a reasonable period of time, to replace FBR with another firm havingcomparable expertise and offering comparable financial terms.

 

*14. The manager of our MBS portfolio, FBR, may have aconflict of interest**.*

 

FBR manages amulti-billion dollar portfolio of MBS for an affiliate using a strategy verysimilar ours. On December 21, 2005, an affiliate of FBR announced that it willreposition its MBS portfolio and sell some portion of its existing portfoliobeginning in the first 

 

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quarter of 2006. FBR mayface potential conflicts of interest, including the allocation of opportunitiesto sell MBS at favorable prices. We may seek to sell MBS in response tounfavorable market conditions at a time when many other MBS investors(including FBR) are seeking to sell. FBR has no obligation to resolve in ourfavor conflicts of interest that may arise in connection with competingportfolios. Employees of FBR will only devote the time and attention to our MBSthat they deem necessary in their discretion, and there may be conflicts inallocating time, services and functions between our portfolio and otherportfolios that FBR manages. The failure of employees of FBR to devote adequatetime and attention to our MBS strategy could adversely affect the performance ofour business.

 

*15. FBR’s past performance or theperformance of other companies that invest in MBS may not be indicative of howour MBS portfolio will perform**.*

 

The operations andresults of any business with which FBR or its related companies have been orare associated or of any other company that follows a strategy similar to theone we are involved in are not intended to be, and should not be considered as,any indication of the likely future performance of our leveraged portfolio ofMBS. The performance of our MBS portfolio may be affected by changes in marketconditions, prepayment rates, availability of financing and interest rates,which are outside of our control or the control of FBR. In addition, othercompanies employing a strategy similar to the one we are pursuing may havedifferent investment policies or greater financial resources than we have.Therefore, the past performance of FBR or other companies that use a strategysimilar to ours is no guarantee, and may not be indicative, of the futureperformance of our portfolio of MBS.

 

*16. Changes in our businessstrategy may adversely affect out MBS portfolio and near term earnings.*

 

We have used borrowedfunds to purchase a portion of the securities in our MBS portfolio. If wechange our overall business strategy at a time when we have outstandingborrowings, our current lenders may cease to renew such borrowings at maturity.This could force us to sell our MBS under adverse market conditions, whichcould result in additional losses.

 

A new business strategywould be subject to new and additional risks. We also may experience transitionexpenses and the increase in operating costs as we implement a new strategy.

 

Regulatoryand Tax Risks of Our MBS Business

 

*1. Loss of Investment Company Act exemption would adverselyaffect us**.*

 

In managing a leveragedportfolio of MBS, we rely on an exemption from the Investment Company Act of1940 for companies that are engaged primarily in the business of purchasing orotherwise acquiring mortgages and other liens on and interests in real estate. Underthe SEC staff’s current interpretation of that exemption, in order to meet thecriteria for such exemption, we have to maintain at least 55% of our assets inqualifying real estate interests, such as whole pool mortgage interests issuedby FHLMC, FNMA or GNMA, and at least 25% of our assets in other real estaterelated assets, such as non-whole pool MBS. This 25% minimum is reduced to theextent we invest more than 55% of our assets in qualifying real estate interests.These requirements could limit our ability to purchase certain types of MBSthat might otherwise be attractive, and these restrictions could result in alower level of income from our portfolio.

 

Changes in the InvestmentCompany Act of 1940 or the rules there under, or in the SEC staff’sinterpretation of the statute and rules, could force us to sell a substantialportion of our portfolio under potentially adverse market conditions. Inaddition, the use of leverage is a fundamental part of our MBS business. In theevent we were required to register as an investment company under theInvestment Company Act of 1940, our ability to use leverage and the returns onour equity capital would be substantially reduced, we would suffer additionalregulatory costs and expenses and we would not be able to pursue our MBSbusiness as described in this Report.

 

*2. We may not be able to realize value from our tax losscarryforwards**.*

 

As of December 31,2005**,**we had federal net operatingloss carryforwards of approximately $777.8 million that expire between 2016 and2025. In addition, we had capital loss carryforwards of approximately $272.2million that expire between 2006 and 2010. In the event were to undergo anownership change as defined in section 382 of the Internal Revenue Code,our net operating loss carryforwards and capital loss carryforwards generatedprior to the ownership change would be subject to annual limitations, whichcould reduce, eliminate, or defer the utilization of these losses. Based upon areview of past changes in our ownership, as of December 31, 2005, we donot believe that we have experienced an ownership change (as defined undersection 382) that would result in any limitation on our future ability touse these net operating loss and capital loss carryforwards. However, we cannot assure you that the IRS or some other taxing authority may not disagreewith our position and contend that we have already experienced such anownership change, which would severely limit our ability to use our net operatingloss carryforwards and capital loss carryforwards to 

 

14

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offset future taxableincome.

 

Generally, an ownershipchange occurs if one or more stockholders, each of whom owns 5% or more invalue of a corporation’s stock, increase their aggregate percentage ownershipby more than 50% over the lowest percentage of stock owned by such stockholdersat any time during the preceding three-year period. For example, if a singlestockholder owning 10% of our stock acquired an additional 50.1% of our stockin a three-year period, a change of ownership would occur. Similarly, if tenpersons, none of whom owned our stock, each acquired slightly over 5% of ourstock within a three-year period (so that such persons own, in the aggregatemore than 50%) an ownership change would occur. Ownership of stock isdetermined by certain constructive ownership rules which can attributeownership of stock owned by entities (such as estates, trusts, corporations,and partnerships) to the ultimate indirect owner.

 

For purposes of thisrule, all holders who each own less than 5% of a corporation’s stock aregenerally treated together as one (or, in certain cases, more than one) 5%stockholder. Transactions in the public markets among stockholders owning lessthan 5% of the equity securities generally are not included in the calculation.Special rules can result in the treatment of options (including warrants) orother similar interests as having been exercised if such treatment would resultin an ownership change.

 

Due to the importance ofavoiding a future ownership change under the tax laws, we will be limited inour ability to issue additional stock in the future to provide capital for ourbusiness. We would only be able to issue such additional stock in a manner thatwould not cause an ownership change, for purposes of these rules, and thus, asdiscussed above, our ability to access the equity markets could be restricted,to some extent.

 

*3. We may not be able to use our tax loss carryforwardsbecause we may not generate taxable income**.*

 

The use of our netoperating loss carryforwards is subject to uncertainty because it is dependentupon the amount of taxable income we generate. Similarly, the extent of ouractual use of our capital loss carryforwards is also subject to uncertaintybecause their use depends on the amount of capital gains we generate. There canbe no assurance that we will have sufficient taxable income (or capital gains)in future years to use the net operating loss carryforwards or capital losscarryfowards before they expire. This is especially true for our capital losscarryfowards, because they expire over a shorter period of time than our netoperating loss carryforwards.

 

*4. The IRS could challenge the amount of our tax losscarryforwards**.*

 

The amount of our netoperating loss carryforwards and capital loss carryforwards has not beenaudited or otherwise validated by the IRS. The IRS could challenge the amountof our net operating loss carryforwards and capital loss carryforwards, whichcould result in an increase in our liability for income taxes. In addition,calculating whether an ownership change has occurred is subject to uncertainty,both because of the complexity and ambiguity of section 382 and because oflimitations on a publicly traded company’s knowledge as to the ownership of,and transactions in, its securities. Therefore, we cannot assure you that thecalculation of the amount of our net loss carryforwards may not be changed as aresult of a challenge by a governmental authority or our learning of newinformation about the ownership of, and transactions in, our securities.

 

*5. We expect to be subject to the alternative minimum taxand our net loss carryforwards would not offset that tax in its entirety**.*

 

We do not plan to seek toqualify as a REIT under the Internal Revenue Code and we will thereforecontinue to be subject to state and federal income tax. However, as a result ofour capital loss carryforwards and net operating loss carryforwards, we anticipateour federal income tax liability for the current fiscal year as well as forseveral years into the future to be substantially reduced. We do expect to besubject to the alternative minimum tax provisions of the Internal Revenue Codewhich limits the use of net operating loss carryforwards. These provisionswould result, in effect, in 10% of our alternative minimum taxable income beingsubject to the 20% alternative minimum tax assessed on corporations. Thisamounts to a 2% effective tax rate on our alternative minimum taxable income.

 

*6. The IRS may seek to impose the accumulated earnings taxon some or all of the taxable income we retain**.*

 

As a component of our MBSinvestment strategy, we expect to retain all or a substantial portion of futureearnings over the next several years to finance the development and growth ofour business. As a result, we may not declare or pay any significant dividendson shares of our common stock for an extended period. If the IRS were tobelieve we were accumulating earnings beyond our reasonable business needs, theIRS could seek to impose an accumulated earnings tax, or AET, of 15% on ouraccumulated taxable income. We do not believe that we will be subject to theAET due to various reasons, including the existence of our large deficit inaccumulated earnings and profits. However, the IRS may disagree with us on thispoint, and the IRS may attempt to impose the AET on all or a portion of ourtaxable income. In such event, we would expect to challenge any attempt by theIRS to impose the AET on our business, but the outcome of such a challenge isuncertain.

 

15

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If we were to distributeour accumulated taxable income for each year to our stockholders as dividends,we would not be subject to the AET for the amounts so distributed, but wouldonly be subject to the AET for the amount of earnings retained. If we were topay dividends to stockholders out of current earnings, these dividends would,generally speaking, be eligible to be treated as “qualified dividends” forfederal income tax purposes, taxed at the current maximum federal rate of 15%,assuming that the recipient stockholder meets the various requirements underthe Internal Revenue Code for such treatment. The maximum rate for qualifieddividends is currently projected to increase to the maximum federal income taxrate applicable to ordinary income (currently 35%) for tax years beginningafter December 31, 2008 inaccordance with the Jobs and Growth Tax Relief Reconciliation Act of 2003.

 

*7. Possible changes in legislation could negatively affectour investments**.*

 

Prospective investorsshould recognize that the present U.S. federal income tax treatment of aninvestment in our stock may be modified by legislative, judicial oradministrative action at any time, and that any such action may affectinvestments and commitments previously made. The rules dealing with U.S.federal income taxation are constantly under review by persons involved in thelegislative process and by the Internal Revenue Service and the U.S. TreasuryDepartment, resulting in revisions of regulations and revised interpretationsof established concepts as well as statutory changes. Revisions in U.S. federaltax laws and interpretations thereof could adversely affect the taxconsequences of an investment in our stock and could impair our ability to usethe tax benefits associated with our tax loss carryforwards. However, we arenot aware of any proposed changes in the tax laws or regulations that would materiallyimpact our ability to use our tax loss carryforwards.

 

*8. Limits on ownership of ourcommon stock could have an adverse consequence to you and could limit youropportunity to receive a premium on our stock**.*

 

As noted above, it isimportant that we avoid an ownership change under section 382 of theInternal Revenue Code, in order to retain the ability to use our net operatingloss carryforwards and capital loss carryforwards to offset future income. Thismeans that a potential buyer of our stock might be deterred from acquiring ourcommon stock while we still have significant tax losses being carried forward,because such an acquisition might trigger an ownership change and severelyimpair our ability to use our tax losses against future income. Thus, thispotential tax situation could have the effect of delaying, deferring orpreventing a change in control and, therefore, could adversely affect ourshareholders’ ability to realize a premium over the then prevailing marketprice for our common stock in connection with a change in control.

 

On July 12, 2005, thestockholders of Aether Systems approved a holding company reorganization ofAether Systems in which each share of Aether Systems common stock was exchangedfor one share of common stock of the Company and Aether Systems became awholly-owned subsidiary of the Company. Shares of the Company contain certaintransfer restrictions on the ownership of our common stock. Although thesetransfer restrictions are designed as a protective measure to avoid anownership change, they may have the effect of impeding or discouraging amerger, tender offer or proxy contest, even if such a transaction may befavorable to the interests of some or all of our shareholders. This effectmight prevent stockholders from realizing an opportunity to sell all or aportion of their common stock of the Company at a premium to the prevailingmarket price.

 

RisksAssociated With Our Historic Mobile and Wireless Data Businesses

 

*1. We may be required toindemnify the purchasers of our EMS, Transportation and Mobile Governmentbusinesses.*

 

Wemay be required to indemnify Telecommunication System, Inc. (“TCS”), GeologicSolutions, Inc. (f/k/a Slingshot Acquisition Corporation) (“Geologic”) and/orBIO-key International Inc. (“BIO-key”) for certain breaches of representationsand warranties and other covenants that we gave to TCS, Geologic and BIO-keywith respect to the sales of the EMS, Transportation and Mobile Governmentbusinesses, respectively.

 

Our indemnification liability to Geologic under the asset purchaseagreement is limited to $10.0 million, other than in the case of fraud and withrespect to a small number of specific representations, such as those relatingto taxes owed for periods prior to the closing of the sale of theTransportation segment.  In addition, weremain fully liable for any claims that may arise relating to our operation ofthe Transportation business prior to the date on which Geologic acquired thatbusiness from us.  As previouslydisclosed, in the third quarter of 2005, Geologic notified us of, and weresponded to, various indemnification claims for alleged breaches ofrepresentations and warranties under the asset purchase agreement pursuant towhich we sold our Transportation business to Geologic.  The parties have been unable to resolve theirdisagreement over Geologic’s claim for indemnification and on March 13, 2006, Geologicfiled a lawsuit against the Company in the Supreme Court of the State of NewYork.  Geologic’s claims primarilyinvolve allegations that we did not fully disclose certain aspects of ourTransportation business’ relationships with one of its major customers and twoof its major suppliers that allegedly resulted in the devaluation of inventoryand other adverse effects to the Transportation business after the sale.  Geologic contends that it has suffereddamages in excess of $30 million as a result of these alleged breaches.  We believe that Geologic’s claims are withoutmerit and intend to vigorously defend against them. However, we cannot predictthe outcome of  this litigation, and anadverse resolution of such claims could require us to make a significant cashpayment to Geologic.  In such event, wewould record a charge against earnings, further increasing the loss on the saleof the Transportation segment.

 

Most of the indemnification provisions relating to the sale of our EMSsegment have now expired.  Most of theindemnification provisions relating to the other two businesses will continuethrough the first quarter of 2006.

 

16

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Our indemnification liability to BIO-key under theasset purchase agreement is limited to $2.0 million, other than in the case offraud and with respect to a small number of specific representations, such asthose relating to taxes owed for periods prior to the closing of the sale ofthe Mobile Government segment. We also remain fully liable for any claims thatmay arise relating to our operation of the Mobile Government business prior tothe date on which BIO-key acquired that business from us. We have agreed tomaintain certain credit support and performance assurance arrangements onbehalf of BIO-key. Under a sales agreement with Hamilton County, Ohio, ourpotential liability is secured by a $7.9 million letter of credit to assureperformance under the terms of that sales agreement. We also have been requiredto sublease (rather than assign) to BIO-key the Mobile Government leasedfacility in Marlborough, Massachusetts, and to keep in place a $749,000 letterof credit in favor of the landlord under the lease. On January 23, 2006, weentered into two agreements that amend the collateral security and creditarrangements originally entered into with BIO-key. In the agreements, ifcertain conditions are met, we agreed to release to BIO-key up to $1 million ofcash collateral currently held by us and will have expanded rights relating toBIO-key’s $749,000 security deposit for the sublease by BIO-key ofMassachusetts office space. For a further discussion of these matters involvingGeologic and BIO-key, see Notes 14 and17 of the notes to the Consolidated Financial Statements included in Item 8 of this Report.

 

Wemay also be required to indemnify TCS under the asset purchase agreementfor certain breaches of representationsand warranties and other covenants that we gave to TCS with respect to the saleof our EMS segment. This liability is limited to $7.6 million, other than inthe case of fraud and with respect to a small number of specificrepresentations, such as those relating to taxes owed for periods prior to theclosing of the sale of the EMS segment. In addition, we remain fully liable forany claims that may arise relating to our operation of the EMS business priorto the date on which TCS acquired that business from us, including anyliability arising from our past sales of the blackberry devices manufactured byResearch In Motion (“RIM”). Recently, the U.S. Court of Appeals ruled that RIMviolated 16 patents owned by intellectual property holding company NTP, Inc. (“NTP”).The case was remanded on February 24, 2006 to the District Court to determinewhether or not RIM should be enjoined selling the violating products. It hasbeen reported that the parties have since reached a settlement agreement.

 

Other than our dispute with Geologic, we are notcurrently aware of any potential claims that we would expect to be significant.However, claims may arise in the future that could impose substantialliabilities on us.

 

OtherRisks of Our Business

 

*1. Our success inidentifying and implementing strategic alternatives may impact our business.*

 

We may incur additional costs and expenses inevaluating and pursuing potential new business opportunities. As a result, ourexpenses may increase above current levels. There can be no assurance that wewill locate a suitable business opportunity or that any transition of ourbusiness will be successful or enable us to utilize our loss carryforwards.

 

*2. Compliance with changingregulation of corporate governance and public disclosure may result inadditional expenses**.*

 

Because we have arelatively small corporate staff, we rely heavily on outside professionaladvisers to assist us with the various governance and compliance obligations wehave as a public company. As a result, our operating expenses in 2003, 2004,and 2005 include significant outside professional fees, and we expect tocontinue to incur such expenses in the future. These costs have includedincreased accounting related fees associated with preparing the attestationreport on our internal control over financial reporting as required underSection 404 of the Sarbanes-Oxley Act of 2002. These costs have offset aportion of the savings we realized through our expense reduction program. Inaddition, more recent, regulations and standards are subject to varyinginterpretations, as well as modifications by the SEC and the Nasdaq. The way inwhich these laws, regulations and standards are applied and implemented maychange over time, which could result in even higher costs to address andimplement revisions to compliance (including disclosure) and governancepractices.

 

We arecommitted to maintaining high standards of corporate governance and publicdisclosure. As a result, we intend to invest resources to comply with evolvinglaws, regulations and standards, and in addition to increased general andadministrative expenses, this investment will require management to devote timeand attention that will not be available for other matters. If our efforts tocomply with new or changed laws, regulations and standards differ from theactivities intended by regulatory or governing bodies due to ambiguitiesrelated to practice, our reputation may be harmed and we could be exposed topotential liabilities.

 

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**ITEM 1B. UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM 2. PROPERTIES**

 

Ourprincipal offices total 3,955 square feet and are located in Baltimore,Maryland. In addition, we maintain a lease for space in Marlborough,Massachusetts that we used as the headquarters for our Mobile Governmentbusiness. We have sublet this office space to BIO-Key International, Inc., thecompany that purchased our Mobile Government business. We believe that ourretained facilities are adequate for the purposes for which they are presentlyused and that replacement facilities are available at comparable cost, shouldthe need arise.

 

**ITEM 3. LEGALPROCEEDINGS**

 

Aetheris among the hundreds of defendants named in nine class action lawsuits seekingdamages on account of alleged violations of securities law.  The case isbeing heard in the United States District Court for the Southern District ofNew York.  The court has consolidated the actions by all of the nameddefendants that actually issued the securities in question and there are nowapproximately 310 consolidated cases before Judge Scheindlin, including theAether action, under the caption In Re Initial Public Offerings Litigation, MasterFile 21 MC 92 (SAS).

 

Theseactions were filed on behalf of persons and entities that acquired the Company’sstock after its initial public offering in October 20, 1999.  Amongother things, the complaints claim that prospectuses, dated October 20,1999 and September 27, 2000 and issued by Aether in connection with thepublic offerings of common stock, allegedly contained untrue statements ofmaterial fact or

omissionsof material fact in violation of securities laws because the prospectusesallegedly failed to disclose that the offerings’ underwriters had solicited andreceived additional and excessive fees, commissions and benefits beyond thoselisted in the arrangements with certain of their customers which were designedto maintain, distort and/or inflate the market price of the Company’s commonstock in the aftermarket.  The actions seek unspecified monetary damagesand rescission.  Aether believes the claims are without merit and isvigorously contesting these actions.

 

Initialmotions to dismiss the case were filed and the court held oral argument on themotions to dismiss on November 1, 2002.  On February 19, 2003,the court issued an Opinion and Order on defendants’ motions to dismiss, whichgranted the motions in part and denied the motions in part.  As to Aether,the motion to dismiss the claims against it was denied in its entirety. Discovery has now commenced.  The plaintiffs voluntarilydismissed without prejudice the officer and director defendants ofAether.  On June 26, 2003, the Plaintiff’s Executive Committee inthis case announced a proposed settlement with the issuers.  The proposedsettlement is a settlement among the plaintiffs, theissuer-defendants, including Aether, and the officer and director defendants ofthe issuers.  The plaintiffs will continue litigating their claims againstthe underwriter-defendants.  Under terms of the proposed settlement,Aether would not incur any material financial or other liability.  OnJune 14, 2004, the plaintiffs and issuer defendants presented the executedsettlement agreement to Judge Scheindlin during a court conference. Subsequently, plaintiffs and issuers made a motion for preliminaryapproval of the settlement agreement.  On July 14, 2004, theunderwriter defendants filed a memorandum of law in opposition to plaintiffs’motion for preliminary approval of the settlement agreement.  Reply briefsin support of the settlement were submitted to the court.  InDecember 2004, the court ordered additional briefing on the motion. All of the additional briefs were submitted to the court.  OnFebruary 15, 2005, Judge Scheindlin issued an Opinion and Order grantingpreliminary approval to the settlement agreement. The process ofcommunicating formal notice of the proposed settlement to the plaintiff classeshas been initiated. The court has scheduled a fairness hearing on the proposedsettlement for April 24, 2006, and subsequently will decide whether togrant final approval to the settlement agreement.   There can beno assurance such approval will be granted.

 

On March 13, 2006, a complaint captioned Geologic Solutions, Inc., v. AetherHoldings, Inc., (Index No. 600856/06) was filed against the Company in theSupreme Court for the State of New York, New York County.  The complaint generally alleges thatplaintiff Geologic was damaged as a result of certain alleged breaches of contractand fraudulent inducement arising out of Aether’s alleged misrepresentationsand failure to disclose certain information in the asset purchase agreementdated as of July 20, 2004 for the purchase and sale of our Transportationbusiness.  The allegations in Geologic’scomplaint are substantially similar to claims Geologic made in a previousrequest to the Company for indemnification. The complaint seeks monetary damages “in an amount not less than $30million” and other relief.  We plan tovigorously defend against this action but cannot predict its outcome.

 

Aether is also a party to other legal proceedings in the normal courseof business. Based on evaluation of these matters and discussions with counsel,the Company believes that any additional liabilities arising from these matterswill not have a material adverse effect on the consolidated results of itsoperations or financial position. See Note 14 of the notes to our ConsolidatedFinancial Statements included in Item 8 of this Report, for additionaldiscussion of claims relating to the sale of the Transportation business.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matters were submitted to Aether’s stockholdersfor consideration during the fourth quarter of the fiscal year endedDecember 31, 2005.

 

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**PART II**

 

**ITEM 5. MARKET FOR AETHER’S COMMON EQUITY, RELATEDSTOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

PRICE RANGE OF COMMON STOCK

 

Our common stock has beenquoted on the Nasdaq National Market under the symbol AETH since our initialpublic offering on October 20, 1999. Prior to that time, there was nopublic market for our common stock. The following table sets forth, for theperiods indicated, the high and low prices per share of the common stock asreported on the Nasdaq National Market.

 
| ** **        | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------|------------|----------|------------|----------|------------|
| **QUARTER ENDED** | ** ** | **HIGH** | ** ** | **LOW**  | ** ** | **HIGH** | ** ** | **LOW** | ** ** |
| March 31     |       | $        | 3.51       |     | $          | 3.24 |   | $ | 5.91 |   | $ | 3.92 |   |
| June 30      |       | $        | 3.45       |     | $          | 3.04 |   | $ | 4.93 |   | $ | 3.23 |   |
| September 30 |       | $        | 3.67       |     | $          | 3.27 |   | $ | 3.45 |   | $ | 2.72 |   |
| December 31  |       | $        | 3.57       |     | $          | 3.27 |   | $ | 4.00 |   | $ | 3.27 |   |

 

APPROXIMATE NUMBER OF EQUITYSECURITY HOLDERS

 

The number of holders ofrecord of Aether’s common stock as of February 28, 2006 was 482.

 

DIVIDENDS

 

We have never declared orpaid any cash dividends on our capital stock nor, when we were organized as alimited liability company, did we make any distributions to our members. Asdiscussed above in Item 1 under the heading “Business – Introduction,” for theperiod that our accumulated tax loss carryforwards remain available for use, weexpect to retain earnings, if any, to support the development of our business,rather than pay periodic cash dividends. Our Board of Directors may reconsideror change this policy in the future. Payment of future dividends, if any, willbe at the discretion of our Board of Directors, after taking into account suchfactors as it considers relevant, including our financial condition, theperformance of our business, the perceived benefits to the Company and ourstockholders of re-investing earnings, anticipated future cash needs of ourbusiness, the tax consequences of retaining earnings and the tax consequencesto the Company and its stockholders of making dividend payments.

 

SECURITIES AUTHORIZED FORISSUANCE UNDER EQUITY COMPENSATION PLANS

 
| **Plan Category**                                           | ** ** | **Plan Name**              | ** ** | **Number of  securities  to  be issued upon  exercise  of outstanding  options,  and  restricted stock** | ** ** | **Weighted-average  exercise price of  outstanding  options,  and restricted stock** | ** ** | **Number of  securities  remaining  available for  future  issuance under  equity  compensation  plans** | ** ** |
|-------------------------------------------------------------|------------|----------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
|                                                        |       |                       |       |                                                                                                     |       |                                                                                 |       |                                                                                                     |       |
| Equity compensation plans approved by  security holders     |       | 1999 Equity Incentive Plan |       | 1,077,334                                                                                                |       | $                                                                                    | 4.77       |                                                                                                     | 3,866,896  |   |
|                                                        |       |                       |       |                                                                                                     |       |                                                                                 |       |                                                                                                     |       |
| Equity compensation plans not approved by  security holders |       | Acquisition Incentive Plan |       | 0                                                                                                        |       | 0.00                                                                                 |       | 1,317,877                                                                                                |       |
|                                                        |       |                       |       |                                                                                                     |       |                                                                                 |       |                                                                                                     |       |
| Total                                                       |       |                       |       | 1,077,334                                                                                                |       | $                                                                                    | 4.77       |                                                                                                     | 5,184,773  |   |

 

The 1999 Equity IncentivePlan provides for the issuance of Aether common stock, pursuant to grants ofstock options or restricted stock, in an amount equal to 20% of the Company’soutstanding shares. On September 2, 2005, the Company filed a registrationstatement with the Securities and Exchange Commission on Form S-8 registeringan additional 973,866 shares under the 1999 Equity Incentive Plan.

 

*Acquisition Incentive Plan*

 

The Acquisition IncentivePlan was effective December 15, 2000. Grants under the AcquisitionIncentive Plan may be made to all 

 

19

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employees, consultants andcertain other service providers (other than directors and executive officers)of the Company. Under the Acquisition Incentive Plan, Aether’s Board ofDirectors has authorized the issuance of up to 1,900,000 shares of Aethercommon stock in connection with the grant of stock options or restricted stock.All options granted under the Acquisition Incentive Plan must be nonqualifiedstock options. Any shares covered by an award that are used to pay the exerciseprice or any required withholding tax will become available for re-issuanceunder the plan. In the event of a “change of control” as such term is definedin the Acquisition Incentive Plan, awards of restricted stock and stock optionswill become fully vested or exercisable, as applicable, to the extent the awardagreement granting such restricted stock or options provides for suchacceleration. (Individuals receive an award agreement upon grant of an awardunder the Acquisition Incentive Plan.)  Aparticipant will immediately forfeit any and all unvested options and forfeitall unvested restricted stock at the time of termination from Aether, unlessthe award agreement provides otherwise. No participant may exercise vestedoptions after the 90th day from the date of termination from Aether,unless the award grant provides otherwise. No awards may be made pursuant tothe Acquisition Incentive Plan after December 14, 2010. The AcquisitionIncentive Plan is administered by Aether’s compensation committee.

 

UNREGISTERED SALES OFSECURITIES 

 

None

 

20

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**ITEM 6. SELECTED FINANCIAL DATA**

 

The table that followspresents portions of our Consolidated Financial Statements and is not acomplete presentation in accordance with accounting principles generallyaccepted in the United States of America. You should read the followingSelected Financial Data together with our Consolidated Financial Statements andrelated notes and with “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” included in Item 7 of this Report. Thehistorical results presented below are not necessarily indicative of theresults to be expected for any future fiscal year.

 

The results of operationsin the following Selected Financial Data, as well as in our ConsolidatedFinancial Statements, present the results of our EMS, Transportation and MobileGovernment businesses, which we sold during 2004, as discontinued operations. Lossfrom continuing operations does not include any financial results of the EMS,Transportation or Mobile Government businesses.

 
| ** **                                                                                                                                                     | ** ** | **YEAR ENDED DECEMBER 31,**             | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                                                     | ** ** | **2001**                                     | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                     | ** ** | **(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)** | ** ** |
| CONSOLIDATED STATEMENT OF OPERATIONS DATA:                                                                                                                     |       |                                         |       |   |   |   |   |   |   |   |   |
|                                                                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Interest income from mortgage-backed  securities                                                                                                               |       | $                                            | —     |   | $ | — |   | $ | — |   | $ | 481 |   | $ | 9,775 |   |
| Interest income from cash and cash  equivalents                                                                                                                |       | —                                       |       | — |   | — |   | 447 |   | 328 |   |
| Interest expense on repurchase agreements                                                                                                                      |       | —                                       |       | — |   | — |   | — |   | (5,435 | ) |
| Net interest income                                                                                                                                            |       | —                                       |       | — |   | — |   | 928 |   | 4,668 |   |
| Gain on sale of mortgage-backed securities                                                                                                                     |       | —                                       |       | — |   | — |   | 1,826 |   | 264 |   |
| Other than temporary impairment on  mortgage-backed securities                                                                                                 |       | —                                       |       | — |   | — |   | — |   | (3,993 | ) |
| Operating income (expenses)                                                                                                                                    |       |                                         |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative (1)                                                                                                                        |       | (38,340                                      | )          | (22,862 | ) | (15,779 | ) | (12,083 | ) | (5,013 | ) |
| Investment advisor fees                                                                                                                                        |       | —                                       |       | — |   | — |   | (67 | ) | (386 | ) |
| Depreciation and amortization                                                                                                                                  |       | (7,802                                       | )          | (6,319 | ) | (2,672 | ) | (2,212 | ) | (159 | ) |
| Stock compensation expense                                                                                                                                     |       | (1,990                                       | )          | (1,735 | ) | (928 | ) | (594 | ) | (76 | ) |
| Impairment of other assets                                                                                                                                     |       | (2,807                                       | )          | (7,589 | ) | (1,367 | ) | — |   | — |   |
| Other (expense) income                                                                                                                                         |       | —                                       |       | — |   | (744 | ) | (60 | ) | 231 |   |
| Restructuring charge                                                                                                                                           |       | (875                                         | )          | (558 | ) | (306 | ) | (1,054 | ) | 7 |   |
| Total operating expenses                                                                                                                                       |       | (51,814                                      | )          | (39,063 | ) | (21,796 | ) | (16,070 | ) | (5,396 | ) |
|                                                                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Operating loss                                                                                                                                                 |       | (51,814                                      | )          | (39,063 | ) | (21,796 | ) | (13,316 | ) | (4,457 | ) |
|                                                                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Non-operating income (expense)                                                                                                                                 |       |                                         |       |   |   |   |   |   |   |   |   |
| Other interest income                                                                                                                                          |       | 27,556                                       |       | 9,921 |   | 6,037 |   | 3,508 |   | 1,150 |   |
| Interest expense from subordinated notes                                                                                                                       |       | (20,402                                      | )          | (15,827 | ) | (10,427 | ) | (7,917 | ) | — |   |
| Equity in losses of investments                                                                                                                                |       | (57,523                                      | )          | (4,744 | ) | (97 | ) | — |   | — |   |
| Gain (loss) on early extinguishment of debt                                                                                                                    |       | 7,684                                        |       | 42,765 |   | — |   | (2,419 | ) | — |   |
| Investment gain (loss), including  impairments, net                                                                                                            |       | (143,384                                     | )          | (14,412 | ) | 587 |   | (3,559 | ) | (19 | ) |
| Total non-operating income (loss)                                                                                                                              |       | (186,069                                     | )          | 17,703 |   | (3,900 | ) | (10,387 | ) | 1,131 |   |
|                                                                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Loss from continuing operations                                                                                                                                |       | (237,883                                     | )          | (21,360 | ) | (25,696 | ) | (23,703 | ) | (3,326 | ) |
| Loss from discontinued operations, net of  tax expense (benefit) of $(10.7 million), $(535,000), $75,000, and $0 for  2001, 2002, 2003, and 2004, respectively |       | (1,422,776                                   | )          | (304,062 | ) | (23,756 | ) | (45,450 | ) | — |   |
| Gain (loss) on sale of discontinued  operations                                                                                                                |       | —                                       |       | — |   | — |   | 20,825 |   | (1,194 | ) |
| Cumulative effect of change in accounting  principle relating to adoption of SFAS No. 133 in 2001                                                              |       | 6,564                                        |       | — |   | — |   | — |   | — |   |
| Net loss                                                                                                                                                       |       | $                                            | (1,654,095 | ) | $ | (325,422 | ) | $ | (49,452 | ) | $ | (48,328 | ) | $ | (4,520 | ) |
| Net loss per share (basic and diluted) from  continuing operations                                                                                             |       | $                                            | (5.84      | ) | $ | (0.51 | ) | $ | (0.60 | ) | $ | (0.54 | ) | $ | (0.07 | ) |
| Net loss per share (basic and diluted) from  discontinued operations                                                                                           |       | (34.93                                       | )          | (7.22 | ) | (0.56 | ) | (1.04 | ) | — |   |
| Gain (loss) per share (basic and diluted)  on sale of discontinued operations                                                                                  |       | —                                       |       | — |   | — |   | 0.47 |   | (0.03 | ) |
| Cumulative effect of change in accounting  principle                                                                                                           |       | 0.16                                         |       | — |   | — |   | — |   | — |   |
| Net loss per share – basic and diluted                                                                                                                    |       | $                                            | (40.61     | ) | $ | (7.73 | ) | $ | (1.16 | ) | $ | (1.11 | ) | $ | (0.10 | ) |
|                                                                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding – basic  and diluted                                                                                                  |       | 40,732                                       |       | 42,117 |   | 42,616 |   | 43,713 |   | 44,006 |   |
|                                                                                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |
| CONSOLIDATED BALANCE SHEET DATA:                                                                                                                               |       |                                         |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents (including  restricted cash)                                                                                                         |       | $                                            | 527,430    |   | $ | 68,593 |   | $ | 39,682 |   | $ | 69,555 |   | $ | 9,725 |   |
| Investments available for sale                                                                                                                                 |       | 2,490                                        |       | 255,825 |   | 220,849 |   | — |   | — |   |
| Mortgage-backed securities, at fair value                                                                                                                      |       | —                                       |       | — |   | — |   | 62,184 |   | 253,900 |   |
| Total assets                                                                                                                                                   |       | 951,419                                      |       | 475,407 |   | 398,105 |   | 136,586 |   | 265,951 |   |
| Repurchase agreements                                                                                                                                          |       | —                                       |       | — |   | — |   | — |   | 133,924 |   |
| Total debt                                                                                                                                                     |       | 306,138                                      |       | 154,945 |   | 154,942 |   | — |   | — |   |
| Stockholders’ equity                                                                                                                                      |       | $                                            | 544,526    |   | $ | 229,398 |   | $ | 179,301 |   | $ | 130,590 |   | $ | 126,387 |   |

 

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(1)Exclusive of option and warrant expense - see consolidated financialstatements.

 

ThroughDecember 31, 2001, we recorded approximately $1.7 billion in goodwill andother intangibles in discontinued operations related to acquisitions of mobileand wireless data businesses. Based on a variety of indicators, we determinedduring 2001 that the goodwill and other intangibles from our acquisitions may havebecome impaired. As a result of our review, we determined that the carryingvalue of goodwill and certain other assets related to our acquisitions were notfully recoverable. In addition, during 2001, we recorded impairment charges incontinuing operations of approximately $2.8 million, which represented thedifference between the carrying value and fair value of other investments. Alsoduring 2001, we recorded impairment charges in discontinued operations ofapproximately $1.1 billion, which represented the difference between thecarrying value and fair value of the goodwill, intangible and other assets.

 

**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

The following discussion andanalysis should be read in conjunction with the Selected Financial Data in Item6 above and our Consolidated Financial Statements and the related notes, whichappear in Item 8 of this Report.

 

In this discussion andanalysis, we explain our financial condition and results of operations. We haveorganized our discussion and analysis as follows:

 

•      We provide an introduction and overview ofour business activities.

•      We discuss additional factors affectingcomparability of results and operations.

•      We discuss our critical accounting policies.

•      We discuss recent accountingpronouncements.

•      We discuss the results of our continuingoperations for the year ended December 31, 2005, compared with results forthe years ended December 31, 2004 and 2003.

•      We discuss our financial condition,liquidity and capital resources and our contractual obligations.

 

INTRODUCTION AND OVERVIEW

 

Ourbusiness has undergone significant change, and consequently our financialresults and condition are difficult to compare from one year to the next. Asdiscussed in Item 1 under “Recent Developments,” our business may changefurther in the future. To the extent we make additional changes to our businessor our strategy, future year-to-year comparisons may continue to be difficultand our financial condition and results may continue to change.

 

In2004, we sold our mobile and wireless data businesses. For information on thesedispositions, see Note 15 of the notes to our Consolidated Financial Statementsincluded in Item 8 of this Report. The results of these businesses arepresented as “discontinued 

 

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operations.”  These businesses accounted for all of theoperating revenue and a significant portion of the operating expenses that wereported prior to commencing our MBS business in 2004. As required by generallyaccepted accounting principles, we have restated prior periods to reflect thepresentation of the mobile and wireless data businesses as “discontinuedoperations,” so that year-to-year results are comparable.

 

As a company that owns and manages a portfolio ofMBS, we no longer report revenue, cost of revenue or gross profit. Instead, ourincome statement consists primarily of interest income and expense, realizedand unrealized gains on MBS transactions, other than temporary impairments, ifany, and selling, general and administrative expenses. Our balance sheetincludes primarily cash and cash equivalents, investments, repurchaseagreements (reflecting funds borrowed to leverage our MBS portfolio), interest receivableand payable and other less significant assets and liabilities. In October 2004we repurchased the outstanding portion of our 6% convertible subordinated notesthat were due in March 2005. Prior to this time, the interest expense on thesenotes, $154.9 million of which were outstanding during 2004, represented amaterial portion of our expenses.

 

Webegan implementing our MBS strategy at the end of June 2004. Since that time,there have been significant changes in the size of our MBS portfolio, theamount of interest income we receive from those investments, and the amount ofinterest expense we pay. See Item 1 “Business” for a discussion of recentmarket conditions that have led to a decline in the size of our MBS portfolioand the amount of our leverage since the middle of 2005.

 

Inthe course of repositioning our business, we reduced the size of our corporatestaff significantly and currently have a staff of seven employees. Ourcorporate office is located in a leased facility in Baltimore, Maryland. Thislocation is our sole operating location. All other existing leases, except forthe lease of the Massachusetts facility that we have sublet to the buyer of ourMobile Government business, expired during the first quarter of 2005. Ourgeneral and administrative expenses have been significantly lowered, althoughwe will still incur costs associated with being a public company, includinginsurance, audit and other outside professional services, compliance andvarious regulatory fees. We also will continue to incur fees for our outsideinvestment and financial advisors.

 

ADDITIONAL FACTORS AFFECTINGTHE COMPARABILITY OF RESULTS AND OPERATIONS

 

Certain items included inour results of operations have varied significantly from one year to the next,making it difficult to compare our overall results from year to year. Theseitems are discussed below. In general, as discussed below, we do not expectthese items to have a material impact on our results of operations in thefuture.

 

•      We recorded an impairment charge of $129.3million ($29.7 million to goodwill and $99.6 million to intangible assets)related to discontinued operations during 2001. We repeated the impairmentanalysis each year, beginning with a recurring annual measurement date chosenby us and the 2002 review resulted in an additional impairment charge togoodwill of $26.8 million. Allof these amounts are included in loss from discontinued operations. Weperformed this analysis again in September 2003 and determined that therewas no further impairment of goodwill at that time.

 

Duringthe second quarter of 2004, with the potential future sale of theTransportation and Mobile Government businesses, we reassessed the value of theTransportation and Mobile Government goodwill and recorded impairment chargesrelated to goodwill of $12.2 million and $8.9 million, respectively. Theseimpairments are reflected in discontinued operations. After the sale of theEMS, Transportation and Mobile Government businesses, we no longer have anygoodwill on our balance sheet.

 

•      During2003, we recorded impairment charges to intangibles and other long-lived assetsof $2.7 million. Of this charge, $1.4 million related to continuing operationsand $629,000 and $677,000 related to EMS and Transportation, respectively,which are reported as discontinued operations.

 

During 2004, with the potential future sale of theTransportation and Mobile Government businesses, we reassessed the value of theTransportation and Mobile Government intangibles and other long-lived assetsand recorded non-cash impairment charges related to Transportation intangiblesand other assets of $3.1million and $11.3 million,respectively and reported as discontinued operations. After the sale of theEMS, Transportation and Mobile Government businesses, we no longer have anyintangible assets on our balance sheet.

 

•      During 2003, we recorded a net gain of$587,000, which included impairment charges of $71,000 related to our equityinvestments. The remainder of the net gain resulted from sales of investments.In 2004, we recorded a net loss of $3.6 million, which included a $5.4 million loss on the liquidationof our investments available for sale consisting of highly liquid U.S.Government Agency-sponsored securities. The loss was partially offset by a gainof $1.8 million relating to thesale of other equity investments.

 

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Asof December 31, 2004 and 2005, our investment balances were primarilyrelated to MBS and cash equivalents. As a result of the decline in theprofitability of our leveraged MBS portfolio, our recent decision to repay theleveraged portion of our MBS portfolio, and our decision to evaluate additionaland alternative business opportunities that may require the sale of some or allof our remaining MBS, management does not continue to have the firm intentionto hold existing MBS investments until maturity (or until such time as themarket value of those securities has recovered). Accordingly, we determinedthat unrealized losses in the MBS portfolio at December 31, 2005 should beconsidered “other than temporary” impairments under Statement of AccountingStandards 115 and should be charged against operating results as of that date. Thisdecision reflects a change in our intention to hold all MBS until a recovery offair value occurs. During the fourth quarter of 2005, the Company recognizedthe unrealized loss of approximately $2.1 million and wrote-off the unamortizedpremium of $1.9 million for the total other than temporary impairment charge ofapproximately 4.0 million. Thefair value of the MBS portfolio will continued to be evaluated and anyadditional reductions in market values that are determined to be “other thantemporary” impairments will be included in results from continuing operations.

 

•      From2001 through 2004, we implemented expense reduction plans as part of ourintegration strategy focused on improving operational efficiencies, theimplementation of other measures in order to reduce planned expenses andultimately facilitate the transition to our MBS business. These effortsincluded in the consolidation of excess facilities and a significant reductionin our workforce. As of December 31, 2005, we had a total of sevenemployees, and all of them were located at our principal office in Baltimore,Maryland. Employee separation benefits under the restructuring plans includeseverance, medical, and other benefits. Facility closure costs and other costsincluded expected losses on subleases, brokerage commissions, asset impairmentcharges, contract termination costs and other costs.

 

Asof December 31, 2005, there was no accrued liability related torestructuring activities.

 

CRITICALACCOUNTING POLICIES

 

Our critical accountingpolicies affect the amount of income and expense we record in each period aswell as the value of our assets and liabilities and our disclosures regardingcontingent assets and liabilities. In applying these critical accountingpolicies, we must make estimates and assumptions to prepare our financialstatements that, if made differently, could have a positive or negative effecton our financial results. We believe that our estimates and assumptions areboth reasonable and appropriate, in light of applicable accounting rules. However,estimates involve judgments with respect tonumerous factors that are difficult to predict and are beyond management’scontrol. As a result, actual amounts could materially differ from estimates.

 

Management believes that thefollowing accounting policies represent “critical accounting policies,” whichthe Securities and Exchange Commission defines as those that are most importantto the portrayal of a company’s financial condition and results of operationsand require management’s most difficult, subjective, or complex judgments,often because management must make estimates about uncertain and changingmatters.

 

*Mortgage-backed securities*

 

Statement of FinancialAccounting Standards (SFAS) No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*, requires theCompany to classify its investments as trading investments, available-for-saleinvestments or held-to-maturity investments. Currently, the Company classifiesall of its MBS as available for sale. All assets classified as available forsale are reported at fair value, based on market pricing estimates provided byindependent pricing services and dealers who make markets in these financialinstruments, with unrealized gains and losses excluded from earnings andreported as a separate component of stockholders’ equity. Unrealized losses onmortgage-backed securities that are considered “other than temporary,” asmeasured by the amount of decline in fair value attributable to factors otherthan temporary, are recognized in operating results and the cost basis of thesecurities is adjusted.

 

Interest income is accruedbased on the outstanding principal amount of the securities and theircontractual terms. Premiums and discounts associated with the purchase of thesecurities are amortized/accreted into interest income over the lives of thesecurities using the interest method in accordance with Financial AccountingStandard No. 91, *Accounting forNonrefundable Fees and Costs Associated with Originating or Acquiring Loans andInitial Direct Costs of Leases.*Our policy for estimating prepayment speeds for calculating theeffective yield is to evaluate historical performance, market place consensusprepayment speeds, and current market conditions. In general, as prepaymentspeeds on our MBS increase, related purchase premium amortization increases,thereby reducing our net yield on MBS. If we used different prepaymentestimates, the amounts we report for interest income could be materiallydifferent.

 

MBS transactions arerecorded on the trade date. Purchases of newly issued securities are recordedwhen all significant uncertainties regarding the characteristics of thesecurities are removed, generally shortly before settlement date. Realizedgains and losses on sales transactions are determined on the specificidentification basis.

 

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*Valuation of deferred tax assets*

 

We have deferred tax assetsas a result of years of accumulated tax loss carryforwards. Management believeswe will achieve profitable operations in future years that may enable us torecover the benefit of our deferred tax assets. However, we presently do nothave sufficient objective evidence to support management’s belief and,accordingly, we maintain a full valuation allowance for our net deferred taxassets as required by generally accepted accounting principles.

 

*Guarantees*

 

We have certain guaranteesrelated to assigned leases. We also agreed to maintain a letter of credit ascollateral assurance of performance for a significant customer contract thatwas assigned to the buyer of our Mobile Government business in connection withthe sale of that business. These arrangements have been evaluated in accordancewith FASB Interpretation No. 45, “Guarantors Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers” (FIN 45), and we have recorded a total liability of approximately$308,000 in respect to these arrangements. This liability is included in “Otherliabilities” on our balance sheet. The estimated fair value of the liabilitywas calculated based on an analysis of multiple scenarios and the estimatedprobability of those scenarios based on discussions with personnel closelyinvolved with the project. Had we used different estimates, the liability thatwe recorded could have differed materially.

 

RECENT ACCOUNTING PRONOUNCMENTS

 

InDecember 2004, the FASB issued a revision of Statement of FinancialAccounting Standards No. 123, titled “Share-Based Payments” (“Statement No.123R”). Statement No. 123R requires that share-based payments, such as grantsof stock options, restricted shares, and stock appreciation rights, be measuredat fair value and reported as expense in a company’s financial statements overthe requisite service period. The Company periodically issues share-basedpayments to employees under its compensation programs and has elected to makepro forma disclosures under the current accounting guidance. The Company isrequired to adopt Statement No. 123R for the quarter beginning January 1, 2006.Beginning in that quarter, the Company will recognize expense over the serviceperiod for the fair value of all grants issued after January 1, 2006, as wellas expense attributable to the remaining service period for all prior grantsthat have not fully vested by that date. At this time, the Company does notexpect the effect of adopting Statement No. 123R to be significantly differentfrom the impact on net earnings reported under the disclosure provisions of theexisting accounting literature.

 

RESULTSOF CONTINUING OPERATIONS

 

In this section, when wediscuss the results of our operations, we will be talking about our MBSbusiness, which we refer to as “continuing operations.” We did not begin implementing our MBSbusiness until the end of June 2004 and accordingly, earnings related to ourMBS business were significantly higher during the year ended December 31, 2005,as compared to 2004.

 

*LossFrom Continuing Operations*

 

Loss from continuing operations decreased $20.4million, or 86.0%, to $3.3 million in 2005 from a loss of $23.7 million in2004. The reduction in the amount ofthe loss reflects an increase in earnings from our MBS portfolio, as wesubstantially expanded the size of that portfolio in the first half of 2005,and a decline in expenses as we streamlined our corporate infrastructure in thefirst half of 2005 to reflect the needs of our MBS business.

 

As discussed above, because managementhas now concluded that it does not continue to have the firm intention to holdexisting MBS investments until maturity, or such time as the market value hasrecovered, we determined (consistent with the requirements of GAAP) thatunrealized losses in the portfolio should be considered “other than temporary”impairments. Accordingly, in the fourth quarter of 2005, we recorded animpairment charge of approximately$4.0 million, which is included in loss from continuing operations. The write-off of unamortizedpremiums of $1,945,000 that we paid to purchase MBS was included as part ofthis $4.0 million impairment charge. Hadwe not incurred this charge, we would have reported net income from continuingoperations of approximately $667,000 for 2005.

 

The outstanding balance ofour MBS portfolio will decline significantly during 2006 as a result of thesale approximately $140 million of MBS that we entered into onMarch 8, 2006 to de-lever our MBS portfolio, along with principal repaymentsthat we will continue to receive during the year. Consequently, absent asignificant change in market conditions and a decision to purchase additionalMBS, our interest income from our MBS portfolio also will decline. Although wedo not anticipate significant losses from continuing operations in 2006, costsincurred in connection with our examination of additional strategic businessopportunities are likely to increase our expenses in 2006.

 

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Losses from continuingoperations decreased $2.0 million, or 7.76%, to $23.7 million in 2004 from $25.7 million in 2003. This declinewas primarily due to a reduction in operating expenses resulting from ourrestructuring activities. InOctober 2004, we redeemed all of the then- outstanding 6%convertible subordinated notes at a price of 101.2% and realized a $2.4 millionloss on the early extinguishment. The loss, however, was offset by lowerinterest expense as a result of the redemption. If we had not redeemed thesenotes, we would have been required to pay $4.3 million of interest on the notesthrough their maturity in March 2005.

 

*Interest Income from MBSPortfolio*

 

We began implementing our MBS strategy in late June of 2004, and as ofDecember 31, 2004, we owned approximately $62.2 million of MBS. We purchasedadditional MBS during the first half of 2005, and after investing $100 millionof our cash in MBS utilized borrowings under our repurchase agreements tofinance additional MBS purchases. During 2005, the interest earned on theportfolio was approximately $9.8 million, net of premium amortization andcustodian fees. In the fourth quarter of 2005 because the interest wewere earning on our short-term investments was less than the interest  we were paying on short-term borrowings toleverage our MBS portfolio, we used approximately $20 million of available cash to repay a portion of borrowings. These repaymentsand the corresponding reduction in leverage on our portfolio increased our netequity in MBS to approximately $120 million.  After completion of thesales of MBS in March 2006 the repayment of  all of our outstanding borrowings under ourrepurchase agreements and receipt of normal prepayments on our MBS receivedduring the first quarter of 2006,  our net investment in MBS will again be$100 million or less. Interest income from our MBS increased $9.3million to $9.8 million in 2005 from $481,000 in 2004. Our MBS portfolio at thebeginning of 2005 consisted of two MBS. During the first two quarters of 2005,we invested an additional $387.4 million in MBS and began to leverage theportfolio. In light ofincreasing short-term interest rates and the reduction in the spread betweenthe interest income we earn on our MBS portfolio and the interest expense weincur to finance our purchases, we have not purchased any MBS since May 2005. Inaddition, since May 2005, our MBS portfolio has declined from $433 million to$254 million at December 31, 2005 as a result of MBS sales totaling $106.7million(on which we realized net gains of $264,000) and principal repayments on ourMBS in the ordinary course.

 

Interestearned on MBS varies as a result of changes in interest rates, prepaymentspeeds as well as the size of our MBS portfolio. Changes in both interest ratesand prepayment speeds are uncertain and represent principal risks of our MBSstrategy. Prepayment speeds, as reflected by the constant prepayment rate (“CPR”),and interest rates vary according to the type of MBS, conditions in financialmarkets, competition and other factors, none of which can be predicted. Ingeneral, as prepayment speeds on our MBS increase, related purchase premiumamortization increases, thereby reducing the net yield on MBS. CPR’s in futureperiods will depend, in part, on changes in and the level of market interestrates across the yield curve. In general, CPR’s tend to fall during periods ofrising interest rates. Although rates have increased throughout the second halfof 2005, the CPR’s for our MBS have not declined as would be expected. This maybe the result of borrowers refinancing to convert adjustable-rate loans tofixed rates loans.

 

Theweighted average yield on our MBS portfolio was 3.94% for the year endingDecember 31, 2005, compared to 3.76% for the year ending December 31,2004. The weighted average yield on theMBS portfolio increased during 2005 as a result of higher interest ratespayable on the MBS securities that we purchased in the first and second quarterof 2005. This increase was partially offset by an increase in premiumamortization due to higher weighted average CPR during this period. In thesecond half of 2005, our weighted average yield on our MBS portfolio declinedslightly as a result of sales of certain higher coupon MBS in June andSeptember 2005 along with additional premium amortization resulting fromincreases in weighted average CPR.

 

Thefollowing table presents key metrics of our MBS, for the quarterly periodspresented:

 
| **Quarter Ended**      | ** ** | **Weighted  Average Coupon** | ** ** | **Weighted  Average CPR** | ** ** | **Weighted  Average  Yield** | ** ** |
|------------------------|------------|------------------------------|------------|---------------------------|------------|------------------------------|------------|
| December 31, 2004      |       | 3.92                         | %          | 7.3                       | %          | 3.76                         | %          |
| March 31, 2005         |       | 4.01                         | %          | 16.5                      | %          | 3.64                         | %          |
| June 30, 2005          |       | 4.44                         | %          | 17.0                      | %          | 4.12                         | %          |
| September 30, 2005     |       | 4.35                         | %          | 32.1                      | %          | 4.01                         | %          |
| December 31, 2005 |       | 4.28                         | %          | 30.0                      | %          | 3.99                         | %          |

 

*InterestIncome from Cash and Cash Equivalents*

 

Interestincome from cash and cash equivalents was $328,000 in 2005 compared to $447,000in 2004. This represents cash allocated to our MBS business that wastemporarily invested in short-term U.S. Government Agency-sponsored cashequivalents, rather than in MBS. The decrease in interest income from thesetemporary investments was the result in a decline in the average balance ofsuch investments during the period.

 

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*Interest Expense on Repurchase Agreements*

 

Interest expense on repurchase agreements varies based upon theinterest rates we are charged as well as the average amount of borrowings thatwe have outstanding. The amount of outstanding borrowings varies based uponpurchases and sales of MBS and MBS prepayments received. Our borrowings underrepurchase agreements have been short-term obligations, which have generallymatured on a monthly basis. As a result, as short-term interest rates increasedduring 2005, the interest rates charged under our repurchase agreementsincreased.

 

Interest expense onrepurchase agreements was $5.4 million in 2005. We did not begin leveraging ourMBS portfolio until the first quarter of 2005; therefore, there was no comparableinterest expense incurred in 2004. While interest rates charged on ourshort-term borrowings under repurchase agreements increased during the secondhalf of 2005, the average amount borrowed during this period declined, as weused proceeds from sales of MBS and prepayments to repay a portion of ouroutstanding borrowings.

 

Thefollowing table presents key metrics of our repurchase agreements, for theperiods presented:

 
| **Quarter Ended**  | ** ** | **Average Outstanding Balance of  Borrowings** | ** ** | **Weighted****Average****Interest  Rate at Quarter End** | ** ** | **Weighted  Average Days to  Maturity at Quarter End** | ** ** | **Weighted****Average****Cost  of Funds  for the Quarter Ended** | ** ** |
|--------------------|------------|------------------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **         | ** ** | **(in thousands)**                             | ** ** | ** **                                               | ** ** | ** **                                             | ** ** | ** **                                                       | ** ** |
| December 31, 2004  |       | —                                         |       | —                                                   |       | —                                                 |       | —                                                           |       |
| March 31, 2005     |       | $                                              | 19,443     |                                                     | 2.83       | %                                                      | 25         |                                                             | 2.83       | % |
| June 30, 2005      |       | $                                              | 281,128    |                                                     | 3.31       | %                                                      | 26         |                                                             | 3.03       | % |
| September 30, 2005 |       | $                                              | 219,711    |                                                     | 3.84       | %                                                      | 18         |                                                             | 3.51       | % |
| December 31, 2005  |       | $                                              | 144,117    |                                                     | 4.23       | %                                                      | 25         |                                                             | 4.06       | % |

 

*Net Interest Spread*

 

Our interest rate spread, which represents thedifference between the weighted average yield on our MBS and the weightedaverage cost of funds on our repurchase agreements, was negative (0.07%) forthe quarter ended December 31, 2005, compared to a positive spread of 0.50%,1.09% and 0.81% for the quarters ended September 30, 2005, June 30, 2005 and March31, 2005, respectively. The decline in interest rate spread during the secondhalf of 2005 reflects the increase in short-term interest rates and thedecrease in yield resulting from sales of higher coupon MBS in late June of2005. The increase in the interest rate spread during the second quarter of2005 resulted primarily from the purchase of higher coupon MBS during thesecond quarter, which was partially offset by increases in our short-termborrowing rates during the quarter.

 

*Gain on Sale of Mortgaged-backed Securities*

 

In 2005, we recognized a net gain of $264,000 on sales of $106.7million in MBS as compared to a net gain of $1.8 million on sales of $264.3million in the estimated face value of MBS forward purchase commitments duringthe third quarter of 2004.

 

In September 2005, we sold approximately $33.1 million of MBS andrecognized a loss of $159,000. In June 2005, we sold approximately $73.3million of MBS and recognized a gain of $423,000. In July 2004, we sold MBSforward purchase commitments and recognized a gain of $1.8 million.

 

*Other Than Temporary Impairmenton Mortgage-backed Securities*

 

As of December31, 2005, in accordance with SFAS No. 115, the Company recognized theunrealized loss of approximately $2.1 million and wrote-off the unamortizedpremium of $1.9 million for the total other than temporary impairment charge ofapproximately $4.0 million, as discussed in Item 1 under the heading “RecentDevelopments.”

 

*Operating Expenses*

 

During the first quarter of2005 we substantially completed transitional activities that related to ongoingobligations we had to the buyers of our Transportation and Mobile Governmentbusinesses. We have streamlined our corporate infrastructure to the levelrequired to support our ongoing MBS business and do not anticipate anysignificant further declines in operating expenses. Costs incurred in connection with ourexamination and additional or alternative strategic business opportunities, asdiscussed above in Item 1A “Risk Factors - Other Risk of Our Business,” mayresult in an increase in our expenses during 2006 from current levels.

 

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Ouroperating expenses declined significantly in 2003 and 2004, primarily due tothe results of our restructuring efforts, in which we streamlined ourorganization and reduced our workforce.

 

*Selling, General andAdministrative Expenses*

 

Selling, general andadministrative (“SG&A”) expenses consist primarily of compensation andpersonnel related costs, rent, facility related support costs, along with costsof outside professionals,****includinglegal counsel, accountants and investment bankers.

 

SG&A expenses decreased$7.1 million, or 58.3%, to $5.0 million in 2005 from $12.1 million in 2004. Thedecline reflects primarily the results of streamlining our corporateinfrastructure to align it with the needs of our MBS business and as a resultof the sale of our mobile and wireless data businesses. Of the decrease,approximately $2.5 million was related to personnel reductions. Other majorcomponents of the decrease include reductions in insurance of $727,000,professional fees of $1.4 million, facility costs of $551, 000 andtelecommunications costs of $336,000. In 2004, we incurred approximately $1.3 million of investment banking andadvisory fees associated with the evaluation and implementation of our MBSstrategy and the sale of our historic operating businesses. We did not incursimilar fees in 2005.

 

SG&A expenses decreased$3.7 million, or 23.4%, to $12.1 million in 2004 from $15.8 million in 2003. Ofthe decrease, $1.4 million is primarily due to reductions in personnel costs asa result of our reduction in workforce. Facility and travel costs decreasedapproximately $978,000 and $447,000, respectively. Additional expense reductionswere partially offset by a $1.0 million increase in investment banking feespaid in 2004. These investment banking fees included $900,000 related to theimplementation of our MBS strategy, including $500,000 paid to our investmentadvisor (FBR) for assisting with the development and launch of the MBSstrategy, and $400,000 paid to a third-party investment banker to provide ourmanagement and our Board of Directors with a report on evaluating the proposedMBS strategy.

 

*Investmentadvisor fees*

 

Fees paid toFBR our outside investment manager, to manage and provide advice relative toour MBS portfolio, were $386,000 for 2005, compared to $67,000 for 2004. Theincrease in fees reflects the growth of our MBS portfolio, as FBR’s fee isbased on the amount of MBS we own. In addition, FBR was only engaged forapproximately six months during 2004 compared to a full year in 2005. FBR isalso entitled to an incentive fee based upon overall returns from the MBSportfolio, but did not qualify for such incentive fee during 2005 or 2004. Basedupon the current size of our MBS portfolio and , the commitment we entered intowith Jefferies to sell approximately $140 million of our MBS (with settlementon March 27, 2006), we do not expect FBR to qualify for the incentive fee in2006 unless market conditions change significantly and we decide to purchasesignificant additional MBS and leverage our portfolio.

 

*Depreciation*

* *

Depreciation expenses arisefrom property and equipment purchased for use in our operations.

 

Depreciation decreased $2.1million, or 92.8%, to $159, 000 in 2005 from $2.2 million in 2004. The decreasereflects primarily the impact of our transition from our mobile andwireless data businesses to our MBS business (including the associatedstreamlining of our corporate infrastructure). This included disposing of fixedassets that were no longer needed to support our continuing operations. As wehave now completed the streamlining process, we expect our depreciation expenseto remain at approximately its current level in the future.

 

Depreciation decreased$460,000, or 17.22%, to $2.2 million in 2004 from $2.7 million in 2003. As aresult of asset impairment charges recorded during 2002 and 2003, the carryingvalue of our long-lived assets declined, resulting in lower depreciation. Thiswas offset partially by accelerated depreciation on certain assets that we tookout of service during 2004.

 

*Stock Compensation Expense*

* *

*Stock compensation expense represents the costassociated with the grants of restricted stock and decreased approximately$518,000 from 2004 to 2005 and by approximately $334,000 from 2003 to 2004. Thedecreases result primarily from the reduction of our work force and the vestingof restricted stock grants.*

* *

Weare required to adopt SFAS No. 123R, “Share-Based Payment” in the first quarterof 2006. Beginning in that quarter, we will recognize compensation expense overthe service period for the fair value of all grants issued after January 1,2006, as well as expense attributable to the remaining service period for allprior grants that have not fully vested by that date. In accordance with SFASNo. 123R, we will no longer be able to recognize forfeitures as they occur, butwill be required to estimate the number of forfeitures. As of 

 

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December31, 2005, we had unamortized compensation expense of approximately $156,000,based on the grant-date fair value of the awards. The change in the method ofrecognizing forfeitures is not expected to have a material impact on ourfinancial statements. Of the total unamortized expense, the majority of theremaining expense is expected to be recognized during 2006. Therefore, we donot expect the effect of adopting SFAS No. 123R to be significantly differentfrom the impact on net earnings reported under the disclosure provisions of theexisting accounting literature.

 

*Other (Expense)Income*

 

Other income in 2005 was approximately $231,000 and representsprimarily income from the sale of fully depreciated fixed assets (such ascomputer equipment and furniture) that were taken out of service during ourrestructuring efforts associated with the transition to our MBS business. InSeptember 2005, we received a royalty payment of $49,000 relating to a priorinvestment in a company that we acquired in 2004.

 

Other expense for 2004 wasapproximately $60,000, primarily attributable to the cost of a litigationsettlement.

 

Other expense wasapproximately $744,000 for 2003, reflecting primarily a loss on disposal of ourcorporate aircraft, partially offset by gains on the disposal of other assetsthat we sold in 2003.

 

*Other Interest Income*

 

In 2005, otherinterest income consists primarily of interest income on the $6.9 millionsubordinated secured promissory note issued by BIO-Key in connection with thesale of our Mobile Government business and interest income on cash equivalentsand investments with maturities of less than 12 months. Other interest incomewas $1.2 million for 2005, as compared to $3.5 million in 2004. The decreaseresults primarily from a decline in the average cash and investment balancesnot employed by our MBS business during the year, partially offset by risinginterest rates. During the fourth quarter of 2005, we used $17.3 million of ouravailable cash to pay down borrowings associated with our MBS portfolio.

 

During 2003 and 2004, other interest income consistsprimarily of interest from cash equivalents and investments with a maturity ofless than 12 months. Other interest income decreased approximately $2.5 millionfrom 2003 to 2004 as the result of a decreasing cash and investment balance (aswe continued to consume cash to fund our business and to redeem (in 2004) our6% convertible subordinated notes), combined with decreased interest rates. During2004, we invested a substantial portion of our available cash in our MBSportfolio, and interest on such amounts is reported as “Interest income fromMBS portfolio,” as discussed above.

 

*Interest Expense on SubordinatedNotes Payable, Gain (Loss) on Early Extinguishment of Debt*

 

In October 2004, we redeemedall of our outstanding 6% convertible subordinated notes. Prior to that time,we incurred interest expense on these subordinated notes which decreased by$2.5 million from 2003 to 2004 because of the redemption of the subordinatednotes in October 2004. No further interest expense was incurred after theredemption of the notes.

 

When we redeemed all of ourthen-outstanding 6% convertible subordinated notes at a price of 101.2% (inaccordance with the terms of those notes), we realized a $2.4 million loss,which consisted of a $1.9 million premium on the redemption and the recognitionof approximately $560,000 in unamortized deferred financing costs. The earlyretirement of the debt resulted in a savings of $4.3 million in interestexpense on the notes that we would have been required to pay through theirmaturity in March 2005.

 

*Equity in Losses of Investments*

 

Equity in losses ofinvestments were $97,000 during 2003 and consisted of our proportionate shareof the net losses in our investments over which we exercised significantinfluence and as such accounted for under the equity method of accounting. Wehave not held any of these investments since 2003 and do not currentlyanticipate making additional investments of this type in the future.

 

*Investment Gain (Loss), Net*

 

Investmentloss was $19,000 in 2005, as compared to $3,559,000 in 2004. The loss of$19,000 in 2005 reflected lossesrealized upon the sale of all of the remaining long-term investments****we had in 2005 that were****notrelated to our MBS portfolio. The investment loss in 2004consisted of a $5.4 million loss on theliquidation of our investments available for sale consisting of highly liquidU.S. Government Agency-sponsored securities. The loss was partially offset by again of $1.8 million relating to the sale of other investments.

 

In 2003, we realized netinvestment gains of $587,000 from the sale of eight venture investments. Wesold our last remaining venture investment in 2004.

 

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SALES OF DISCONTINUED OPERATIONS

 

In2004, we sold our mobile and wireless data businesses, which were organizedinto three operating segments. In January 2004, we sold our EMS segmentfor $18.0 million in cash and a $1.0 million note (which was paid in full inAugust 2004). In September 2004 we sold our Transportation and MobileGovernment businesses for $25.0 million in cash and $10.0 million in cash,respectively. For information on these dispositions, see Notes 14, 15 and 17 ofthe notes to our Consolidated Financial Statements included in Item 8 of thisReport.

 

FINANCIAL CONDITION

 

During 2005, our totalassets increased by approximately $129.4 million, while our total liabilitiesincreased by approximately $133.6 million.  These changes reflectprimarily the fact that we borrowed funds pursuant to short-term repurchaseagreements to purchase additional MBS.  Our borrowings at December 31,2005 were approximately $133.9 million; we had no borrowings at December 31,2004.  While we used all of these borrowings (and most of our remainingcash and cash equivalents) to purchase MBS we recognized the unrealizedloss of approximately $2.1 million and wrote-off the unamortized premium of$1.9 million for the total other than temporary impairment charge ofapproximately $4.0 million.

 

Changesin our assets other than cash and cash equivalents and MBS, and changes in ourliabilities other than repurchase agreements were limited in 2005.  Themost significant change was a $3.1 million decline in prepaid expenses andother assets.  This decline reflects the sale proceeds of $1.5 million forvarious non-MBS investments, which we sold in late 2004 but for which we didnot receive proceeds until 2005, plus the write-off of a $738,000 receivableand a $235,000 working capital adjustment in connection with the resolution ofa post-closing purchase price adjustment relating to the sale of ourTransportation business to Geologic.

 

*Liquidity and Capital Resources*

 

# **Liquidity isthe ability of the Company to meet its financial obligations that arise duringthe normal course of business. Liquidity is provided from cash generated byoperations, principal and interest payments received on MBS and additionalfinancing, as necessary. Sources of liquidity include cash and cashequivalents, short-term investments, and available repurchase agreements. TheCompany believes it currently has sufficient liquidity to meet currentoperations and planned business growth. However, if we decide to pursue one ormore new business opportunities we may need to sell some or all of our MBSinvestments to fund the acquisition or development of such new businessopportunities. See Item 1 “Risk Factors –Risks of our Current Business” for adiscussion of the risks associated with selling our MBS under adverse marketconditions. In such situations, we may realize additional losses on ourinvestments.**

#  

The following table reflects use of net cash foroperations, investing, and financing activities:

 
| **(IN THOUSANDS)**                                    | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net cash provided by (used in) operating  activities  |       | $        | (60,274    | )        | $          | (17,623  | )          | $ | 2,128 |   |
| Net cash provided by (used in) investing  activities  |       | 33,731   |       | 202,278  |       | (195,907 | )          |
| Net cash provided by (used in) financing  activities  |       | (3,462   | )          | (150,154 | )          | 134,148  |       |
| Net increase (decrease) in cash and cash  equivalents |       | $        | (30,005    | )        | $          | 34,501   |       | $ | (59,631 | ) |
|                                                       |            |          |            |          |            |          |            |  |  |  |  |

 

Net cash provided byoperating activities was approximately $2.1 million in 2005, compared to netcash used in operating activities of approximately $17.6 million and approximately $60.3 million for 2004and 2003, respectively. Historically, our operations have not been profitable;however, due to a substantial reduction in operating expenses, the operatingactivities from our MBS business provided net cash in 2005. Our current MBSbusiness requires significantly less operational expenses compared to ourprevious mobile and wireless data business. In addition, our mobile andwireless data business had significant net losses compared to our MBS business.

 

Net cash used in investing activities was approximately $195.9 million for2005, which primarily related to approximately $387.4 million used to purchaseMBS, partially offset by approximately $84.8 million of principal repayments onour MBS that we received and the sale of approximately $106.7 million of MBS. Netcash provided by investing activities wasapproximately $202.3 million for 2004, consisting primarily of a netamount of approximately $218.9million from the purchase and sale of investments (primarily United StatesGovernment Agency-sponsored securities). Additionally, we used approximately $63.8 million topurchase MBS and receivedapproximately $18.9 million, approximately$23.0 million, and approximately$8.8 million from the sale of our EMS, Transportation, and Mobile Governmentbusinesses, respectively, net of transaction expenses, and received approximately $2.4 million in netproceeds from the sale of other investments. Net cash provided by investingactivities was approximately $33.7million in 2003. We received approximately$33.2 million for the net sale of short-term and non-current investmentinstruments (primarily United States Government Agency-sponsored securities),and we used approximately $600,000 for the purchase of property and equipment(which was sold as part of the dispositions we completed in 2004) and receivedapproximately $4.1 million from sales of certain property and equipment.

 

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Net cash provided byfinancing activities was approximately$134.1 million for 2005, which primarily related to the funding wereceived through repurchase agreements to purchase MBS. Net cash used in financing activities was approximately $150.2 million for2004, consisting primarily of approximately$156.8 million used to redeem the remaining outstanding 6% convertiblesubordinated notes, as discussed above under the heading “Interest Expense onSubordinated Notes Payable, Gain (Loss) on Early Extinguishment of Debt.”  We also received approximately $4.6 million of cash upon the release ofcollateral relating to certain letters of credit that expired in 2004. Net cashused in financing activities was approximately$3.5 million for 2003. During 2003, financing activities included the investmentof approximately $4.5 million of cash in certificates of deposit, which wasused as collateral against certain letters of credit. In addition, we received approximately $1.1 million from theexercise of employee options and warrants.

 

During 2005, the Company’s principal sources ofliquidity consisted of borrowings under repurchase agreements, principal andinterest payments received on its portfolio of MBS, and other cash flowsgenerated by operations. The Company’s most significant uses of cash have includedpurchases of MBS and continue to include payments to fund operations.

 

We believe that our cash and cash equivalents andshort-term investments, combined with the cash flows from operations and theutilization of available borrowings, will be sufficient to enable us to meetanticipated liquidity requirements. At December 31, 2005, we had masterrepurchase arrangements in place with five counterparties, covering up to anaggregate of at least $850.0 million of borrowings. As of that date, we had approximately $133.9 million ofborrowings outstanding. On March 8, 2006, we entered into to commitment withJefferies to sell $140 million of our MBS. The terms we received from Jefferieswere as good as or better than the terms offered by other investment banks. Thissale will settle on March 27, 2006, and we intend to use approximately $120million to repay all of our remaining outstanding borrowings under repurchaseagreements.

 

Ourfinancial condition may also be affected by claims relating to the mobile andwireless data businesses that we sold during 2004. Under the definitivepurchase agreements that we signed to affect those sales, we have agreed toindemnify the buyers of those businesses for certain breaches ofrepresentations and warranties and other covenants that we provided to themwith respect to the sales of the businesses. In addition, we remain liable forthe operation of each of the business segments prior to their dispositions. Wealso have retained liability for certain continuing obligations associated withthe Mobile Government segment.. In addition, as discussed in Note 14 of thenotes to our Consolidated Financial Statements included in Item 8 of thisReport, we have resolved one dispute with Geologic, the buyer of ourTransportation segment, and have been notified by Geologic of additionalsignificant potential indemnity claims against us. On March 13, 2006, Geologicfiled a claim against us in the supreme court for the State of New York. Webelieve that Geologic's claims are without merit and intend to vigorouslydefend against them; however, we cannot predict the outcome of this litigation,and an adverse resolution of such claims could require us to make a significantcash payment to Geologic. In such event, we would record a charge againstdiscontinued operations, further increasing the loss on the sale of theTransportation segment. We have not received any indemnity claims from thebuyers of our other two mobile and wireless data businesses, and most of theindemnification provisions relating to the sale of our EMS segment have nowexpired. Most of the indemnification provisions relating to the other twobusinesses will continue through the first quarter of 2006.

 

*Contractual Obligations*

 

The following table reflectsour contractual commitments, including our future minimum lease payments as ofDecember 31, 2005:

 
| ** **                                  | ** ** | **Payments due by period** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations (in  thousands)** | ** ** | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More  than  5 years** | ** ** |
| ** **                                  | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Long-Term Debt Obligations                  |       | $                          | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Facility Leases                             |       | 3,647                      |       | 1,342 |   | 2,304 |   | — |   | — |   |
| Less: Subleases                             |       | (3,329                     | )          | (1,218 | ) | (2,111 | ) | — |   | — |   |
| Facility Leases, Net                        |       | 318                        |       | 124 |   | 193 |   |   |   |   |   |
| Other Purchase Obligations                  |       | 239                        |       | 239 |   | — |   | — |   | — |   |
|                                        |       |                       |       |   |   |   |   |   |   |   |   |
| **Total**                                   |       | $                          | 557        |   | $ | 363 |   | $ | 193 |   | $ | — |   | $ | — |   |

 

The chart above does not include guarantee obligations that the Companycontinues to have with respect to two leases used for discontinued operationsthat the Company has assigned to third parties. The Company is no longer theprimary lessee. The maximum aggregate amount owed under these leases isapproximately $177,000, and both leases expire in 2006. The fair value of theguarantee is not material as of December 31, 2005.

 

As of December 31, 2005, $7.9 million of the ourcertificates of deposit were held on deposit to collateralize an irrevocablestandby 

 

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letter of credit that was put in place when our formerMobile Government business entered into a sales agreement with Hamilton County,Ohio to provide an automated field reporting solution and real time wirelessdata infrastructure under a sales agreement. The letter of credit providescollateral assurance of performance under the sales agreement. The terms of thesales agreement and the standby letter of credit state that Hamilton County canonly draw on the letter of credit after (1) completing the internal disputeresolution process set forth in the sales agreement and (2) providing notice toMobile Government of its intent to declare a default under the sales agreementand proceed against the letter of credit. A draw of the funds under the standbyletter of credit is subject to the limitations of liability contained in thesales agreement. The letter of credit is required to remain in place throughDecember 31, 2006. For a more detailed discussion of these matters, see Notes 14 and 17 of the notes to theConsolidated Financial Statements included in Item 8 of this Report.

 

We have not includedcontracts for maintenance support on hardware or software that we own becausewe generally pay in advance for these services and have the option of choosingwhether or not to renew these services each year. We have also not included inthis table potential contingent liabilities that we may have to the buyers ofour EMS, Transportation or Mobile Government businesses, under the terms of thepurchase agreements with the buyers and we cannot readily estimate thepotential amount of liabilities that might arise in the future, if any. Potentialliabilities to the buyers of our mobile and wireless data businesses arediscussed in Item 1A under the heading “Risk Factors – Risks associated withour mobile and wireless data businesses.”

 

*Off Balance Sheet Arrangements*

 

Other than the leaseguarantees and the collateral assurance in support of BIO-Key’s performanceobligations under the Hamilton County, Ohio project, which are described abovewe do not have any off-balance sheet arrangements.

 

**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

The following discussionabout our market risk disclosures involves forward-looking statements. Actualresults could differ materially from those projected in these forward-lookingstatements.

 

We seek to manage theinterest rate, market value, liquidity, and prepayment risks inherent in ourMBS strategy in a responsible manner designed to promote our growth and successwhile, at the same time, seeking to maximize stockholder value. We are notplanning to be averse to risk, but are aiming to assume only those risks webelieve we can manage and which we believe will produce a sufficient return tojustify taking those risks. At December 31, 2005, the value of our MBSportfolio exceeded our outstanding borrowings by 1.9 times.

 

Since July 2004, the FederalReserve has increased the Federal Funds Rate by 3.25%, which has causedcorresponding increases in short-term interest rates and directly impacted ourborrowing costs associated with leveraging our MBS portfolio. In addition, duringthat same period, the interest rate yield curve has flattened and is currentlyinverted, as short-term interest rates have increased more then increases inlonger term interest rates. As a result of these market conditions, the spreadbetween the interest income we earn on additional MBS purchases and the relatedborrowing cost associated with funding those purchases was negative as ofDecember 31, 2005. These current market conditions have adversely impacted thevaluation of our MBS portfolio, which has negatively affected our results ofoperations.

 

*Interest Rate Risk*

 

All of our existing MBS are hybrid, adjustable-rate MBS and are subjectto periodic and lifetime interest rate caps that limit the interest ratepayable on our MBS. Hybrid adjustable-rate MBS typically includeperiodic caps on the interest rates on the underlying mortgages (generally,rate adjustments are limited to 2% every twelve months following the initialrate adjustment), as well as lifetime caps. Our borrowings are notsubject to similar restrictions and therefore, in a period of rising short-terminterest rates, such as currently exist; the interest rates on our borrowingsincrease without limitation, while the interest rates on our MBS may notexperience corresponding increases As discussed above, we expect to have nooutstanding borrowings associated with our MBS portfolio by the end of thefirst quarter of 2006. Although the repayment of debt would eliminate the risksassociated with changes in our interest expense, interest income on MBS still will vary as a result of changes in interestrates, prepayment speeds and the size of our MBS portfolio. Changes in bothinterest rates and prepayment speeds are uncertain and represent principalrisks of our MBS strategy.

 

If we do not repay our outstanding borrowings under repurchaseagreements or incur additional borrowings in the future, and if short-terminterest rates continue to rise, we may continue to experience (or may in thefuture again experience) a negative interest rate spread on the leveragedportion of our MBS portfolio. As explained above, our borrowings do not haveperiodic or lifetime interest rate capssimilar to our MBS. As a result, the interest rate on our borrowings (and thecosts associated with such borrowings) can increase without limitation, whichwould negatively impact our earnings. The unleveraged MBS in our portfolio willcontinue to be 

 

32

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subject to additional fluctuations in market value. As a result, anyfuture declines that are determined to be “other than temporary”**would be chargedagainst future operating results*.*

 

*Market Value Risk*

 

Our MBS investments areclassified as available-for-sale assets. As such, they are reflected at fairvalue (i.e. market value), with any adjustment between cost and fair value, notconsidered to be “other than temporary,” reflected as part of accumulated othercomprehensive income that is included in the balance sheet . As discussedabove, for a number of reasons resulting from recent events and decisions, wedetermined that unrealized losses in its MBS portfolio at December 31, 2005should be considered “other than temporary” impairments. As of December 31,2005, the cost basis of our MBS was written down to fair value, and we recordeda $4.0 million impairment charge in our operating results (included within lossfrom continuing operations) in the fourth quarter of 2005.

 

The chart below illustratesthe effect on portfolio value should interest rates rapidly increase or decreaseby 50, 100, and 200 basis points. We have estimated the impact of rate shockswill be parallel to each other, based on the current yield curve. Changes ininterest rates that cause a declinein the projected market value in the MBS portfolio, as noted below, will also have a corresponding impact onour future earnings should the declines be considered “other thantemporary” impairments under Statement of Accounting Standards 115. Our portfolio of MBS as of December 31, 2005was valued at $253.9 million, and MBS market values have continued to declinein the first quarter of 2006. Assumptions made in calculating the impact on ourMBS portfolio value from interest rate shocks include interest rates,prepayments and yield spread of MBS relative to prevailing interest rates.

 
| **Change in Interest Rate** | ** ** | **Projected %  Change in  MBS Portfolio  Value** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| - 200 basis points          |       | 1.12                                             | %          |   |
| - 100 basis points          |       | 1.03                                             | %          |   |
| - 50 basis points           |       | 0.56                                             | %          |   |
| Base interest rate          |       | —                                           |       |   |
| + 50 basis points           |       | (0.62                                            | )%         |   |
| +100 basis points           |       | (1.29                                            | )%         |   |
| + 200 basis points          |       | (2.11                                            | )%         |   |

 

*Liquidity Risk*

 

Our primary liquidity riskarises from financing long-maturity MBS with short-term borrowings, asdiscussed above an in Item 1A “Risk Factors.”. Continued increases inshort-term interest rates have negatively impacted the valuation of our MBS,which could limit our borrowing ability or cause our counter-parties under ourmaster repurchase arrangements to initiate margin calls. This would increaseour liquidity needs and could reduce our ability to borrow or require us tosell a portion of our MBS investments at a time when their market value isbelow our cost. In addition, continued increases in short-term interest rateswill increase our interest costs and reduce future earnings. The anticipatedrepayment of all of our remaining MBS-related debt in the first quarter of 2006will eliminate the interest costs associated with the borrowings However, selling a portion of our MBSportfolio to repay our debt will also reduce future cash flows we receive fromrepayments and prepayments on our securities because of the reduction in thetotal amount of our MBS portfolio.

 

*Prepayment Risk*

 

Weare also subject to prepayment risk. Prepayments are the full or partialrepayment of unscheduled principal amounts and typically occur due torefinancing of that mortgage loan. Prepayment rates on MBS vary from time totime and may cause changes in the amount of our net interest income. Prepaymentsof adjustable-rate and hybrid MBS generally increase when mortgage interestrates fall and generally decrease when mortgage interest rates exceed thethen-current interest rate on such mortgages. Prepayments on adjustable-ratemortgages may also increase in a rising rate environment as borrowers tend tomove to fixed rate products. Prepayment experience also may be affected by theconditions in the housing and financial markets, general economic conditions,seasonal changes and the relative interest rates on fixed-rate andadjustable-rate mortgage loans underlying MBS. The price we pay for MBS ispartially determined by our expectations of the amounts and rates ofprepayments. If we expect fewer prepayments, we may pay a premium for the MBSwe acquire. If our assumptions are wrong and the actual amount of prepaymentsis greater than expected, we could experience reduced earnings or losses. In general, as prepayment speeds (measured asthe constant prepayment rate, or CPR) on our MBS increase, related purchasepremium amortization increases, thereby reducing the net yield on MBS.

 

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**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

TABLE OF CONTENTS

 

Thefollowing financial statements required by this item are included in the Reportbeginning on page 35.

 
| Report  of Management on Internal Control over Financial Reporting                                                        |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|
| Reports  of Independent Registered Public Accounting Firm                                                                 |   |
| Consolidated  Balance Sheets as of December 31, 2004 and 2005                                                        |   |
| Consolidated  Statements of Operations and Comprehensive Loss for the years ended  December 31, 2003, 2004, and 2005 |   |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31,  2003, 2004 and 2005          |   |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2003, 2004 and  2005                         |   |
| Notes  to Consolidated Financial Statements                                                                               |   |

 

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# **Report of Management on Internal Control overFinancial Reporting**

#  

TheBoard of Directors and Stockholders

AetherHoldings, Inc.

 

Weare responsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Exchange Act Rules 13a-15(f)for Aether Systems, Inc. (the “Company”). We conducted an evaluation of theeffectiveness of our internal control over financial reporting as of December31, 2005 based on the framework in *InternalControl-Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (the “COSO Framework”). As noted inthe COSO Framework, an internal control system, no matter how well conceivedand operated, can provide only reasonable and not absolute assurance tomanagement and the board of directors regarding achievement of an entity’sfinancial reporting objectives. Based our evaluation under the COSO Framework,we concluded that the Company’s internal control over financial reporting waseffective as of December 31, 2005. KPMG LLP, an independent registeredaccounting firm, has audited management’s assessment of the effectiveness ofthe Company’s internal control over financial reporting at December 31, 2005.

 

 
| /s/ David S. Oros                                   |   |
|-----------------------------------------------------|--------|
| *Chairman of the Board and Chief Executive Officer* |
|                                                |
|                                                |
| /s/ David C. Reymann                                |   |
| *Chief Financial Officer*                           |
|                                                |
| Baltimore, Maryland                                 |
| March 14, 2006                                      |
|                                                     |        |  |

 

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# **Report of Independent Registered Public AccountingFirm**

#  

TheBoard of Directors and Stockholders

AetherHoldings, Inc.

 

Wehave audited management’s assessment, included in the accompanying *Report of Management on Internal Control over Financial Reporting*,**that Aether Holdings, Inc. andsubsidiaries (“Aether”) maintained effective internal control over financialreporting as of December 31, 2005, based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO).**Aether’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting.Our responsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of Aether’s internal control over financialreporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

 

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Inour opinion, management’s assessment that Aether maintained effective internalcontrol over financial reporting as of December 31, 2005, is fairlystated, in all material respects, based on the criteria established in *Internal Control—Integrated Framework* issued by  COSO. Also, in our opinion, Aethermaintained, in all material respects, effective internal control over financialreporting as of December 31, 2005, based on criteria established in *Internal Control—Integrated Framework* issued by COSO.

 

Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets ofAether and subsidiaries as of December 31, 2005 and 2004, and the relatedconsolidated statements of operations and comprehensive loss, stockholders’equity, and cash flows for each of the years in the three-year period endedDecember 31, 2005, and our report dated March 14, 2006 expressed anunqualified opinion on those consolidated financial statements.

 

 
| /s/ KPMG LLP        |   |
|---------------------|--------|
|                |
|                |
| Baltimore, Maryland |
| March 14,  2006     |

 

36

----

 

**Reportof Independent Registered Public Accounting Firm**

 

TheBoard of Directors and Stockholders

AetherHoldings, Inc.:

 

Wehave audited the accompanying consolidated balance sheets of Aether Holdings,Inc. and subsidiaries (Aether), as of December 31, 2005 and 2004, and therelated consolidated statements of operations and comprehensive loss,stockholders’ equity, and cash flows for each of the years in the three-yearperiod ended December 31, 2005. These consolidated financial statementsare the responsibility of the Aether’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Aether Holdings, Inc. and subsidiaries as of December 31, 2005and 2004, and the results of their operations and their cash flows for each ofthe years in the three-year period ended December 31, 2005, in conformitywith U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the effectiveness of Aether’sinternal control over financial reporting as of December 31, 2005, based oncriteria established in *Internal Control –Integrated Framework*issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO), and our report dated March 14, 2006 expressed an unqualifiedopinion on management’s assessment of, and the effective operation of, internalcontrol over financial reporting.

 

 
| /s/ KPMG LLP        |   |
|---------------------|--------|
|                |
|                |
| Baltimore, Maryland |
| _March 14, 2006     |

 

37

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**AETHER HOLDINGS, INC.**

**CONSOLIDATED BALANCE SHEETS**

(IN THOUSANDS, EXCEPT SHARE DATA)

 
| ** **                                                                                                                                                                 | ** ** | **DECEMBER 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **2004**              | ** ** | **2005** | ** ** |
| ASSETS                                                                                                                                                                     |       |                  |       |   |   |
|                                                                                                                                                                       |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                  |       | $                     | 60,723     |   | $ | 1,092 |   |
| Mortgage-backed securities, at fair value                                                                                                                                  |       | 62,184                |       | 253,900 |   |
| Interest receivable                                                                                                                                                        |       | 356                   |       | 1,174 |   |
| Restricted cash                                                                                                                                                            |       | 8,832                 |       | 8,633 |   |
| Property and equipment, net                                                                                                                                                |       | 367                   |       | 255 |   |
| Prepaid expenses and other assets                                                                                                                                          |       | 4,124                 |       | 954 |   |
| Total Assets                                                                                                                                                               |       | $                     | 136,586    |   | $ | 266,008 |   |
|                                                                                                                                                                       |       |                  |       |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                  |       |                  |       |   |   |
|                                                                                                                                                                       |       |                  |       |   |   |
| Accounts payable and accrued expenses                                                                                                                                      |       | $                     | 3,494      |   | $ | 4,465 |   |
| Repurchase agreements                                                                                                                                                      |       | —                |       | 133,924 |   |
| Accrued employee compensation and benefits                                                                                                                                 |       | 186                   |       | 70 |   |
| Restructuring accruals                                                                                                                                                     |       | 259                   |       | — |   |
| Accrued interest payable                                                                                                                                                   |       | —                |       | 48 |   |
| Other liabilities                                                                                                                                                          |       | 2,057                 |       | 1,114 |   |
| Total liabilities                                                                                                                                                          |       | 5,996                 |       | 139,621 |   |
|                                                                                                                                                                       |       |                  |       |   |   |
| Commitments and Contingencies                                                                                                                                              |       |                  |       |   |   |
|                                                                                                                                                                       |       |                  |       |   |   |
| Stockholders’ equity:                                                                                                                                                 |       |                  |       |   |   |
| Preferred stock, $0.01 par value; 1,000,000  shares authorized; 0 shares issued and outstanding at December 31, 2004  and 2005                                        |       | —                |       | — |   |
| Common stock, $0.01 par value;  1,000,000,000 shares authorized; 43,963,963 and 44,018,946 shares issued and  outstanding at December 31, 2004 and 2005, respectively |       | 440                   |       | 440 |   |
| Additional paid-in capital                                                                                                                                                 |       | 2,592,977             |       | 2,593,085 |   |
| Accumulated deficit                                                                                                                                                        |       | (2,462,611            | )          | (2,467,138 | ) |
| Unrealized loss on investments available  for sale                                                                                                                         |       | (216                  | )          | — |   |
| Total stockholders’ equity                                                                                                                                            |       | 130,590               |       | 126,387 |   |
| Total liabilities and stockholders’ equity                                                                                                                            |       | $                     | 136,586    |   | $ | 266,008 |   |

 

See accompanying notes to consolidated financial statements.

 

38

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**AETHER HOLDINGS, INC.**

### CONSOLIDATED STATEMENTSOF OPERATIONS AND COMPREHENSIVE LOSS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

 
| ** **                                                                                                                 | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                 | ** ** | **2003**                         | ** ** | **2004** | ** ** | **2005** | ** ** |
| Interest income from mortgage-backed  securities                                                                           |       | $                                | —     |   | $ | 481 |   | $ | 9,775 |   |
| Interest income from cash and cash  equivalents                                                                            |       | —                           |       | 447 |   | 328 |   |
| Interest expense on repurchase agreements                                                                                  |       | —                           |       | — |   | (5,435 | ) |
| Net interest income                                                                                                        |       | —                           |       | 928 |   | 4,668 |   |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Gain on sale of mortgage-backed securities                                                                                 |       | —                           |       | 1,826 |   | 264 |   |
| Other than temporary impairment on  mortgage-backed securities                                                             |       | —                           |       | — |   | (3,993 | ) |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Operating (expenses) income:                                                                                               |       |                             |       |   |   |   |   |
| Selling, general and administrative  expenses                                                                              |       | (15,779                          | )          | (12,083 | ) | (5,013 | ) |
| Investment advisor fees                                                                                                    |       | —                           |       | (67 | ) | (386 | ) |
| Depreciation                                                                                                               |       | (2,672                           | )          | (2,212 | ) | (159 | ) |
| Stock compensation expense                                                                                                 |       | (928                             | )          | (594 | ) | (76 | ) |
| Impairment of other assets                                                                                                 |       | (1,367                           | )          | — |   | — |   |
| Other expense (income)                                                                                                     |       | (744                             | )          | (60 | ) | 231 |   |
| Restructuring charge                                                                                                       |       | (306                             | )          | (1,054 |   | 7 |   |
| Total operating expenses                                                                                                   |       | (21,796                          | )          | (16,070 | ) | (5,396 | ) |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Operating loss                                                                                                             |       | (21,796                          | )          | (13,316 | ) | (4,457 | ) |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Non-operating income (expense)                                                                                             |       |                             |       |   |   |   |   |
| Other interest income                                                                                                      |       | 6,037                            |       | 3,508 |   | 1,150 |   |
| Interest expense from subordinated notes                                                                                   |       | (10,427                          | )          | (7,917 | ) | — |   |
| Equity in losses of investments                                                                                            |       | (97                              | )          | — |   | — |   |
| Loss on early extinguishment of debt                                                                                       |       | —                           |       | (2,419 | ) | — |   |
| Investment gain (loss), net                                                                                                |       | 587                              |       | (3,559 | ) | (19 | ) |
| Total non-operating income (expense)                                                                                       |       | (3,900                           | )          | (10,387 | ) | 1,131 |   |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Loss from continuing operations                                                                                            |       | (25,696                          | )          | (23,703 | ) | (3,326 | ) |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Discontinued operations                                                                                                    |       |                             |       |   |   |   |   |
| Loss from discontinued operations, net of  tax expense (benefit) of ($535,000) and $75,000 for 2003 and 2004  respectively |       | (23,756                          | )          | (45,450 | ) | — |   |
| Gain (loss) on sale of discontinued  operations                                                                            |       | —                           |       | 20,825 |   | (1,194 | ) |
| Net loss                                                                                                                   |       | (49,452                          | )          | (48,328 | ) | (4,520 | ) |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Other comprehensive loss:                                                                                                  |       |                             |       |   |   |   |   |
| Foreign currency translation adjustment                                                                                    |       | 108                              |       | (3,830 | ) | — |   |
| Unrealized holding gain (loss) on investments  available for sale                                                          |       | (1,757                           | )          | 67 |   | — |   |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Comprehensive loss                                                                                                         |       | $                                | (51,101    | ) | $ | (52,091 | ) | $ | (4,520 | ) |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Loss per share (basic and diluted) from  continuing operations                                                             |       | $                                | (0.60      | ) | $ | (0.54 | ) | $ | (0.07 | ) |
| Loss per share (basic and diluted) from  discontinued operations                                                           |       | (0.56                            | )          | (1.04 | ) | — |   |
| Gain (loss) per share (basic and diluted)  on sale of discontinued operations                                              |       | —                           |       | 0.47 |   | (0.03 | ) |
| Net loss per share – basic and diluted                                                                                |       | $                                | (1.16      | ) | $ | (1.11 | ) | $ | (0.10 | ) |
|                                                                                                                       |       |                             |       |   |   |   |   |
| Weighted average shares outstanding: -basic  and diluted                                                                   |       | 42,616                           |       | 43,713 |   | 44,006 |   |

 

See accompanying notes to consolidated financial statements.

 

39

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**AETHER HOLDINGS, INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

(IN THOUSANDS)

 
| ** **                                         | ** ** | **PREFERRED  STOCK** | ** ** | **COMMON  STOCK** | ** ** | **ADDITIONAL  PAID-IN  CAPITAL** | ** ** | **ACCUMULATED  DEFICIT** | ** ** | **FOREIGN  CURRENCY  TRANSLATION  ADJUSTMENT** | ** ** | **UNREALIZED  GAIN (LOSS)  ON  INVESTMENTS** | ** ** | **TOTAL** | ** ** |
|----------------------------------------------------|------------|----------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|-----------|------------|
| Balance at  December 31, 2002                 |       | $                    | —     |              | $          | 422                              |       | $                        | 2,586,613  |                                           | $          | (2,364,831                                   | )          | $         | 3,722      |   | $ | 1,474 |   | $ | 227,400 |   |
| Exercise of  options and warrants                  |       | —               |       | 7                 |       | 1,071                            |       | —                   |       | —                                         |       | —                                       |       | 1,078     |       |
| Option and  warrant expense                        |       | —               |       | —            |       | 1,924                            |       | —                   |       | —                                         |       | —                                       |       | 1,924     |       |
| Unrealized gain  on investments available for sale |       | —               |       | —            |       | —                           |       | —                   |       | —                                         |       | (1,757                                       | )          | (1,757    | )          |
| Foreign currency  translation                      |       | —               |       | —            |       | —                           |       | —                   |       | 108                                            |       | —                                       |       | 108       |       |
| Net loss                                           |       |                 |       | —            |       | —                           |       | (49,452                  | )          | —                                         |       |                                         |       | (49,452   | )          |
| Balance at  December 31, 2003                 |       | $                    | —     |              | $          | 429                              |       | $                        | 2,589,608  |                                           | $          | (2,414,283                                   | )          | $         | 3,830      |   | $ | (283 | ) | $ | 179,301 |   |
| Exercise of  options and warrants                  |       | —               |       | 11                |       | 1,952                            |       | —                   |       | —                                         |       | —                                       |       | 1,963     |       |
| Option and  warrant expense                        |       | —               |       | —            |       | 1,417                            |       | —                   |       | —                                         |       | —                                       |       | 1,417     |       |
| Unrealized gain  on investments available for sale |       | —               |       | —            |       | —                           |       | —                   |       | —                                         |       | 67                                           |       | 67        |       |
| Foreign currency  translation                      |       | —               |       | —            |       | —                           |       | —                   |       | (3,830                                         | )          | —                                       |       | (3,830    | )          |
| Net loss                                           |       | —               |       | —            |       | —                           |       | (48,328                  | )          | —                                         |       |                                         |       | (48,328   | )          |
| Balance at  December 31, 2004                 |       | $                    | —     |              | $          | 440                              |       | $                        | 2,592,977  |                                           | $          | (2,462,611                                   | )          | $         | —     |   | $ | (216 | ) | $ | 130,590 |   |
| Exercise of  options and warrants                  |       | —               |       | —            |       | 32                               |       | (7                       | )          | —                                         |       | —                                       |       | 25        |       |
| Option and  warrant expense                        |       | —               |       | —            |       | 76                               |       | —                   |       | —                                         |       | —                                       |       | 76        |       |
| Unrealized gain  on investments available for sale |       | —               |       | —            |       | —                           |       | —                   |       | —                                         |       | 216                                          |       | 216       |       |
| Net loss                                           |       | —               |       | —            |       | —                           |       | (4,520                   | )          | —                                         |       | —                                       |       | (4,520    | )          |
| Balance at  December 31, 2005                 |       | $                    | —     |              | $          | 440                              |       | $                        | 2,593,085  |                                           | $          | (2,467,138                                   | )          | $         | —     |   | $ | 0 |   | $ | 126,387 |   |

 

See accompanying notes to consolidated financial statements.

 

40

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**AETHER HOLDINGS, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(IN THOUSANDS)

 
| ** **                                                                                                                           | ** ** | **2003**    | ** ** | **2004**    | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|------------|------------|
| ** **                                                                                                                           | ** ** | **Revised** | ** ** | **Revised** | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                                                                |       |        |       |        |       |       |       |
| Net loss from continuing operations                                                                                                  |       | $           | (25,696    | )           | $          | (23,703    | )          | $ | (3,326 | ) |
| Adjustments to reconcile net loss from  continuing operations to net cash (used in) provided by operating activities:                |       |        |       |        |       |       |       |
| Depreciation and amortization                                                                                                        |       | 2,672       |       | 2,212       |       | 159        |       |
| Amortization of loan fees                                                                                                            |       | 1,119       |       | 840         |       | —     |       |
| Amortization of mortgage premiums                                                                                                    |       | —      |       | 22          |       | 670        |       |
| Equity in losses of investments                                                                                                      |       | 97          |       | —      |       | —     |       |
| Other than temporary impairment loss on  mortgage-backed securities                                                                  |       | —      |       | —      |       | 3,993      |       |
| Option and warrant expense                                                                                                           |       | 928         |       | 594         |       | 76         |       |
| (Gain) loss on disposal of assets                                                                                                    |       | 744         |       | (80         | )          | —     |       |
| Loss on early extinguishment of debt                                                                                                 |       | —      |       | 2,419       |       | —     |       |
| Impairment of other assets                                                                                                           |       | 1,367       |       | —      |       | —     |       |
| Realized (gains) losses on long-term  investments, including impairments                                                             |       | (587        | )          | 3,559       |       | 19         |       |
| Realized gain on sale of MBS                                                                                                         |       | —      |       | (1,826      | )          | (2         | )          |
| Changes in assets and liabilities, net of  acquired assets and liabilities:                                                          |       |        |       |        |       |       |       |
| Decrease (increase) in prepaid expenses and  other assets                                                                            |       | (1,086      | )          | (513        | )          | 3,112      |       |
| Decrease (increase) in interest receivable                                                                                           |       | 335         |       | 1,211       |       | (818       | )          |
| Increase (decrease) in accounts payable,  accrued expenses, accrued employee compensation and benefits and accrued  interest payable |       | (2,167      | )          | (4,128      | )          | 903        |       |
| Increase (decrease) in restructuring  accruals and other liabilities                                                                 |       | (31,005     | )          | 836         |       | (1,202     | )          |
| Cash (used in) provided by discontinued  operations for operating activities                                                         |       | (6,995      | )          | 934         |       | (1,194     | )          |
| Net cash (used in) provided by operating  activities                                                                                 |       | (60,274     | )          | (17,623     | )          | 2,128      |       |
|                                                                                                                                 |       |        |       |        |       |       |       |
| Cash flows from investing activities:                                                                                                |       |        |       |        |       |       |       |
| Sales and maturities of investments  available for sale                                                                              |       | 530,829     |       | 1,171,641   |       | 45         |       |
| Purchases of investments available for sale                                                                                          |       | (497,630    | )          | (952,791    | )          | —     |       |
| Purchases of property and equipment                                                                                                  |       | (596        | )          | (331        | )          | (47        | )          |
| Proceeds from the sale of property and  equipment                                                                                    |       | 4,056       |       | 93          |       | —     |       |
| Sale of long-term investments                                                                                                        |       | 443         |       | 2,396       |       | —     |       |
| Sales of mortgage backed securities                                                                                                  |       | —      |       | —      |       | 106,679    |       |
| Purchase of mortgage backed securities                                                                                               |       | —      |       | (63,839     | )          | (387,350   | )          |
| Principal payments from mortgage-backed  securities                                                                                  |       | —      |       | 1,423       |       | 84,766     |       |
| Cash provided by (used in) discontinued  operations in investing activities                                                          |       | (3,371      | )          | 43,686      |       | —     |       |
| Net cash (used in) provided by investing  activities                                                                                 |       | 33,731      |       | 202,278     |       | (195,907   | )          |
| Cash flows from financing activities:                                                                                                |       |        |       |        |       |       |       |
| Repayment of notes payable including  redemption of convertible debt                                                                 |       | —      |       | (156,771    | )          | —     |       |
| (Increase) decrease in restricted cash                                                                                               |       | (4,537      | )          | 4,628       |       | 199        |       |
| Exercise of options and warrants                                                                                                     |       | 1,078       |       | 1,989       |       | 25         |       |
| Proceeds from repurchase agreements                                                                                                  |       | —      |       | —      |       | 133,924    |       |
| Cash used by discontinued operations in  financing activities                                                                        |       | (3          | )          | —      |       | —     |       |
| Net cash (used in) provided by financing  activities                                                                                 |       | (3,462      | )          | (150,154    | )          | 134,148    |       |
| Net increase (decrease) in cash and cash  equivalents                                                                                |       | (30,005     | )          | 34,501      |       | (59,631    | )          |
| Cash and cash equivalents, at beginning of  period                                                                                   |       | 56,227      |       | 26,222      |       | 60,723     |       |
| Cash and cash equivalents, at end of period                                                                                          |       | $           | 26,222     |        | $          | 60,723     |       | $ | 1,092 |   |
| Supplemental disclosure of cash flow  information:                                                                                   |       |        |       |        |       |       |       |
| Cash paid during the year for interest                                                                                               |       | $           | 9,295      |        | $          | 9,500      |       | $ | 5,387 |   |

Supplemental disclosure ofnon-cash investing and financing activities:

 

In 2003 and 2004, theCompany incurred unrealized holding gains (losses) associated with itsinvestments available for sale totaling $(1.8) million and $67,000,respectively. These amounts have been reported as increases (decreases) instockholders’ equity.

 

See accompanying notes to consolidated financial statements.

 

41

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**AETHER HOLDINGS, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

** **

**(1)   ORGANIZATION,DESCRIPTION OF THE BUSINESS, AND BASIS OF PRESENTATION**

 

Aether Holdings, Inc. (the “Company” or“Aether”) is a holding company that owns 100% of the stock of Aether Systems,Inc. The Company’s principal business activity is the investment inmortgage-backed securities (“MBS”).

 

Aether Systems was formed in January 1996. OnJuly 12, 2005, the stockholders of Aether Systems approved a holding companyreorganization of Aether Systems in which each share of Aether Systems commonstock was exchanged for one share of common stock of Aether Holdings and AetherSystems became a wholly-owned subsidiary of Aether Holdings. The sole activityof Aether Holdings is to hold 100% of the stock of Aether Systems. Immediatelyafter the reorganization, the consolidated assets, liabilities andstockholders’ equity of Aether Holdings were the same as the consolidatedassets, liabilities and stockholders’ equity of Aether Systems immediatelyprior to the reorganization. On July 13, 2005, the stock of Aether Systemsceased to trade on the Nasdaq National Market, and the stock of Aether Holdingsbegan trading under the symbol “AETH.” The reorganization was expected to help to protect the long-term valueto Aether of its substantial net operating loss and capital loss carryforwards.

 

During 2004, Aether Systems sold theoperations of its discontinued Enterprise Mobility Solutions (“EMS”),Transportation, and Mobile Government segments. The financial statements forall periods presented have been restated to present the results of operationsof the EMS, Transportation and Mobile Government segments as discontinuedoperations.

 

Aether’s continuing operations consist of asingle business segment – the mortgage-backed securities (“MBS”) business.

 

**(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES RELATEDTO CONTINUING OPERATIONS**

 

The following accounting principles have been used by management in thepreparation of the Company’s consolidated financial statements in accordance withU.S. generally accepted accounting principles:

 

(a) PRINCIPLES OF CONSOLIDATION

 

The consolidated financial statements include the accounts of theCompany and its majority-owned subsidiaries. All significant intercompanytransactions and balances have been eliminated in consolidation.

 

(b) CASH AND CASH EQUIVALENTS

 

Cash equivalents include all highly liquid investments purchased withoriginal maturities of three months or less. Cash and cash equivalentsconsisted of the following:

 

 
| **(in thousands)**                          | ** ** | **DECEMBER 31,  2004** | ** ** | **DECEMBER 31,  2005** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Cash                                        |       | $                           | 11,468     |                        | $          | 832 |   |
| Money market accounts                       |       | 9,703                       |       | 222                         |       |
| U.S. Government Agency-sponsored securities |       | 38,384                      |       | 38                          |       |
| Certificates of deposit                     |       | 1,168                       |       | —                      |       |
| Total                                       |       | $                           | 60,723     |                        | $          | 1,092 |   |

 

Interest income from cashand cash equivalents is presented in the Consolidated Statements of Operationsand Comprehensive Loss as follows;

 

•      Interest income from cash and cashequivalents allocated to our MBS business that were temporarily investedin short-term U.S. Government Agency-sponsored cash equivalents is included innet interest income.

 

•      Interest income on the subordinatedsecured promissory note and interest income on cash equivalents and investmentswith maturities of less than 12 months is included in non-operating income(expense).

 

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(c)INVESTMENTS AVAILABLE FOR SALE INCLUDING MORTGAGE-BACKED SECURITIES (“MBS”)

 

Investments available-for-sale consist of highly liquid investments inU.S. Government Agency-sponsored mortgaged-backed securities with originalmaturities greater than one year.

 

The Company invests in MBS representing interests in or obligationsbacked by pools of mortgage loans. Acquisitions of existing MBS are recorded onthe trade date. Purchases of newly issued MBS are recorded when all significantuncertainties regarding the characteristics of the securities are removed.Realized gains and losses on sales of MBS are determined on the specificidentification basis.

 

Statement of Financial Accounting Standards (SFAS) No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*, requires the Company to classify its investments astrading investments, available-for-sale investments or held-to-maturityinvestments. Currently, the Company classifies all of its MBS as available forsale. All assets classified as available for sale are reported at fair value,based on market pricing estimates provided by independent pricing services anddealers who make markets in these financial instruments, with unrealized gainsand losses excluded from earnings and reported as a separate component ofstockholders’ equity. Unrealized losses on mortgage-backed securities that areconsidered “other than temporary,” as measured by the amount of decline in fairvalue attributable to factors other than temporary, are recognized in incomeand the cost basis of the securities is adjusted.

 

Interest income is accrued based on the outstanding principal amount ofthe securities and their contractual terms. Premiums and discounts associatedwith the purchase of the securities are amortized into interest income over thelives of the securities using the interest method in accordance with Statementof Financial Accounting Standards No. 91, *Accountingfor Nonrefundable Fees and Costs Associated with Originating or Acquiring Loansand Initial Direct Costs of Leases.*Our policy for estimating prepayment speeds for calculating theeffective yield is to evaluate historical performance, marketplace consensusprepayment speeds, and current market conditions.

 

(d) PROPERTY AND EQUIPMENT

 

Property and equipment are stated at cost. Depreciation is calculatedusing the straight-line method over the estimated useful lives of the assets,which range from three to seven years. The costs of leasehold improvements arecapitalized and amortized using the straight-line method over the shorter ofthe lease term or the estimated useful life of the asset.

 

In accordance with SFAS No. 144 “*Accounting for the Impairment or Disposal of Long-Lived Assets*,”long-lived assets, such as property, plant, and equipment are reviewed forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. Recoverability of assets tobe held and used is measured by a comparison of the carrying amount of an assetto estimated undiscounted future cash flows expected to be generated by theasset. If the carrying amount of an asset exceeds its estimated future cashflows, an impairment charge is recognized by the amount by which the carryingamount of the asset exceeds the fair value of the asset. Assets to be disposedof would be separately presented on the balance sheet and reported at the lowerof the carrying amount or fair value less costs to sell, and are no longerdepreciated. The assets and liabilities of a disposed group classified as heldfor sale would be presented separately in the appropriate asset and liabilitysections of the balance sheet.

 

(e) INCOME TAXES

 

The Company recognizes income taxes using the asset and liabilitymethod, in accordance with SFAS No. 109, *Accounting For IncomeTaxes*. Under the asset and liability method, deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled. The effect of a tax rate change on deferred tax assetsand liabilities is recognized as income in the period that includes theenactment date. In assessing the likelihood of realization of deferred taxassets, the Company considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized. The ultimaterealization of deferred tax assets is dependent upon the generation of futuretaxable income during periods in which these temporary differences becomedeductible.

 

(f) FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The carrying amounts of the Company’s financialinstruments, which include cash equivalents, restricted cash, interestreceivable, interest payable, accounts payable, accrued expenses and repurchaseagreements, approximate their fair value due to the relatively short durationof the instruments. The fair value on the MBS portfolio is calculated usingpublished market values obtained through an independent broker on a monthlybasis.

 

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(g) CONCENTRATION OF CREDIT RISK

 

Financial instruments, which potentially subject the Company to creditrisk, consist primarily of cash, cash equivalents, interest receivable, andinvestments available-for-sale.

 

The Company invests cash not immediately needed for operations in moneymarket securities and high-grade U.S. Government Agency-sponsored securities.The Company’s investments available for sale may include commercial paperissued by financial institutions and other companies with high credit ratings,securities issued or sponsored by U.S. Government Agencies and money marketsecurities. These securities do not carry the full faith and credit of the U.S.Treasury.

 

(h) DERIVATIVES

 

The Company recognizes all derivatives on the balancesheet at fair value. Derivatives that are not hedges are adjusted to fair valuethrough the statement of operations. If the derivative is a hedge, depending onthe nature of the hedge, changes in fair value of derivatives will either beoffset against the change in fair value of the hedged assets, liabilities orfirm commitments through earnings, or recognized in other comprehensive income(loss) until the hedged item is recognized in earnings. The ineffective portionof a derivative’s change in fair value will be immediately recognized inearnings.

 

(i) STOCK OPTIONS AND WARRANTS

 

The Company accounts for equity-based employee compensationarrangements in accordance with the provisions of Accounting Principle Board(APB) Opinion No. 25, “*Accounting for StockIssued to Employees*,” and related interpretations including FIN 44 “*Accounting for Certain Transactions Involving Stock Compensation*.”Under APB No. 25, compensation expense is based upon the difference, if any, onthe date of grant, between the fair value of the Company’s stock and theexercise price. All equity-based awards to non-employees are accounted for attheir fair value in accordance with SFAS No. 123, *Accountingfor Stock Based Compensation.*SFAS No. 123 established accountingand disclosure requirements using a fair-value-based method of accounting forstock-based employee compensation plans. As allowed by SFAS No. 123, theCompany has elected to continue to apply the intrinsic-value-based method ofaccounting described above, and has adopted only the disclosure requirements ofSFAS No. 123 and SFAS No. 148, “*Accounting for Stock-basedCompensation Transition and Disclosure*”.

 

The following tableillustrates the effect on net loss from continuing operations if thefair-value-based method had been applied to all outstanding and unvested awardsin each of the years ended December 31, 2003, 2004 and 2005:

 

 
| **(in thousands)**                                                                                               | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net loss from continuing operations, as reported                                                                 |       | $        | (25,696    | )        | $          | (23,703  | )          | $ | (3,326 | ) |
| Add stock-based employee compensation expense included in reported  net loss                                     |       | 928      |       | 594      |       | 76       |       |
| Deduct total stock-based employee compensation expense determined  under fair-value-based method for all rewards |       | (2,056   | )          | (1,568   | )          | (526     | )          |
|                                                                                                             |       |     |       |     |       |     |       |
| Pro forma net loss from  continuing operations                                                                   |       | $        | (26,824    | )        | $          | (24,677  | )          | $ | (3,776 | ) |
|                                                                                                             |       |     |       |     |       |     |       |
| Pro forma net loss per  share from continuing operations                                                         |       | $        | (0.63      | )        | (0.56      | )        | (0.09      | ) |
|                                                                                                             |       |     |       |     |       |     |       |
| Weighted average basic  shares outstanding                                                                       |       | 42,616   |       | 43,713   |       | 44,006   |       |

 

The per share weighted-average value of options granted by the Companyduring 2003, 2004 and 2005 was $1.11, $2.53 and $0.99, respectively, on thedate of grant using the Black-Scholes option-pricing model. The amounts foreach year were calculated based on an expected option life of five years andvolatility of 70 percent for 2003 and 2004, and an expected option life of fiveyears and volatility rates from 16.8 percent to 30.2 percent for 2005. Inaddition, the calculations assumed risk-free interest rates from 2.46 percentto 3.25 percent in 2003, 2.80 percent to 3.81 percent in 2004 and 3.72 percentto 4.35 percent in 2005.

 

(j) EARNINGS PER SHARE

 

The Company computes net income (loss) per share in accordance withSFAS No. 128, “*Earnings Per Share*.”  Under the provisions of SFAS No. 128, basicnet income (loss) per share is computed by dividing net income (loss) for theperiod by the weighted average number of common shares outstanding during theperiod. Diluted net income (loss) per share is computed by dividing the netincome (loss) for the period by the weighted average number of common anddilutive common equivalent shares outstanding during the period. As the Companyhas had a net loss in each of the periods presented, basic and diluted net lossper share are the same. Options 

 

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and warrants to purchase 5.0 million, 2.1 million and 1.9 millionshares of the Company’s common stock during 2003, 2004, and 2005, respectively,have been excluded from the calculation of diluted net loss per share becausetheir inclusion would be anti-dilutive.

 

(k) OTHER COMPREHENSIVE INCOME (LOSS)

 

Comprehensive income, as defined, includes changes in equity of abusiness during a period from transactions and other events and circumstancesfrom non-owner sources. Other comprehensive income refers to revenue, expenses,gains and losses that under U.S. generally accepted accounting principles areincluded in comprehensive income, but excluded from net income.

 

For the years ended December 31, 2003 and 2004, othercomprehensive income (loss) consists of unrealized gains (losses) oninvestments available for sale and MBS; and foreign currency translationadjustments. For 2004, the Company’s foreign currency translation loss wasrecognized through the sale of the foreign operations. During 2005, the Companydetermined that the impairments on the MBS portfolio were “other thantemporary” and the losses were recognized by inclusion in loss from continuing operations.

 

(l) USE OF ESTIMATES

 

The preparation of consolidated financial statements in conformity withU.S. generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets and liabilitiesand disclosure of contingent assets and liabilities at the dates of theconsolidated financial statements and the reported amounts of income andexpenses during the reporting period. Actual results could differ from thoseestimates. Estimates are used in accounting for, among other things, valuationof MBS, guarantees, premium amortization, depreciation, restructuring accruals,valuation of deferred tax assets and contingencies. Estimates and assumptionsare reviewed periodically and the effects of revisions are reflected in theconsolidated financial statements in the period they are determined to benecessary.

 

(m) RECLASSIFICATIONS

 

Certain fiscal year 2003 and 2004 amounts have been reclassified toconform to the current year presentation. None of these reclassifications had amaterial effect on the Company’s consolidated financial statements.

 

(n)REVISED CASH FLOWS

 

For the years endedDecember 31, 2003, 2004, and 2005, the Company has separately disclosed theoperating, investing and financing portions of the cash flows attributed to itsdiscontinued operations, which in prior periods were reported on a combinedbasis as a single amount.

 

(o) RECENT ACCOUNTING PRONOUNCEMENTS

 

In December 2004, the FASB issued arevision of Statement of Financial Accounting Standards No. 123, titled “*Share-Based Payments*” (“Statement No. 123R”). Statement No.123R requires that share-based payments, such as grants of stock options,restricted shares, and stock appreciation rights, be measured at fair value andreported as expense in a company’s financial statements over the requisiteservice period. The Company periodically issues share-based payments toemployees under its compensation programs and has elected to make pro formadisclosures under the current accounting guidance. The Company is required toadopt Statement No. 123R for the quarter beginning January 1, 2006. Beginningin that quarter, the Company will recognize expense over the service period forthe fair value of all grants issued after January 1, 2006, as well as expenseattributable to the remaining service period for all prior grants that have notfully vested by that date. At this time, the Company does not expect the effectof adopting Statement No. 123R to be significantly different from the impact onnet earnings reported under the disclosure provisions of the existingaccounting literature.

 

**(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES RELATEDTO DISCONTINUED OPERATIONS**

 

The following additional accounting principles have been used by managementin the preparation of the Company’s consolidated financial statements andrelate principally to the Company’s discontinued operations:

 

(a)           GOODWILL AND OTHERLONG-LIVED ASSETS

 

Goodwill represents the excess of costs over the fairvalue of assets of businesses acquired. Identifiable intangible assetsconsisted of completed technology, trademarks, and acquired subscribers andwere amortized on a straight-line basis over five to seven years. Goodwill andintangible assets acquired in a purchase business combination and determined tohave an indefinite useful life are not 

 

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amortized, but instead tested for impairment at leastannually in accordance with the provisions of SFAS No. 142, “*Goodwill and Other Intangible Assets*.”  SFAS No. 142 also requires thatintangible assets with estimable useful lives be amortized over theirrespective estimated useful lives to their estimated residual values, andreviewed for impairment in accordance with SFAS No. 144. As of December31, 2004, all amounts allocated to goodwill and other intangible assets havebeen written-off.

 

(b) REVENUE RECOGNITION

 

*EMS*

 

The results of operations of the Company’s EMS segment have beenclassified as discontinued operations in the accompanying consolidatedfinancial statements. The Company derived revenue in its EMS segment from fourprimary sources. Subscriber revenue was generally recognized ratably over theterm of the customer agreement, typically one year. Engineering services revenueson time and materials contracts were recognized as the services were provided.Revenue on fixed-fee engineering services contracts was recognized on thepercentage-of-completion method based on costs incurred in relation to totalestimated costs. Software and related services revenues were recognized inaccordance with SOP 97-2. The Company recognized software revenue when thelicense agreement was signed, the license fee was fixed and determinable,delivery of the software had occurred, and collectibility of the fees wasconsidered probable. Device revenue was generally recognized upon delivery.

 

*Transportation*

 

The results of operations of the Company’s Transportation segment havebeen classified as discontinued operations in the accompanying consolidatedfinancial statements. The Company derived revenue in its Transportation segmentfrom two primary sources. Subscriber revenue was generally recognized on amonthly basis as service was provided. Activation fees were deferred andrecognized ratably over the expected life of the customer relationship. Devicerevenue was generally deferred and recognized over contract terms of three tofive years.

 

*Mobile Government*

 

The results of operations of the Company’s Mobile Government segmenthave been classified as discontinued operations in the accompanyingconsolidated financial statements. Software revenue was generally recognizedwhen the license agreement was signed, the license fee was fixed anddeterminable, delivery of the software had occurred, and when it could beestimated that collectibility of the fees was probable. At the time of thetransaction, Mobile Government assessed whether the fee associated with therevenue transactions was fixed and determinable and whether or not collectionwas reasonably assured. If a significant portion of a fee was due after thenormal payment terms, Mobile Government accounted for the fee as not beingfixed and determinable. In these cases, Mobile Government recognized revenue asthe fees became due. Mobile Government assessed collection based on a number offactors, including past transaction history with the customer and creditworthiness of the customer. Mobile Government did not request collateral fromcustomers. If it was determined that collection of a fee was not reasonablyassured, Mobile Government deferred the fee and recognized the revenue at thetime it became reasonably assured, which was generally upon receipt of cash. Ifcollectibility was assessed differently, the timing and amount of revenuerecognition may have differed materially from that reported.

 

Revenue from licensing software that required significant customizationand modification was recognized using the percentage of completion method,based on the hours incurred in relation to the total estimated hours. If MobileGovernment made different judgments or utilized different estimates of thetotal amount of work expected to be required to customize or modify thesoftware, the timing of revenue recognition, from period to period, and marginson the project in the reporting period, could have differed materially fromamounts reported. Anticipated contract losses were recognized as soon as theybecame known and estimable.

 

Revenues from maintenance and technical support agreements, whichprovided for unspecified when-and-if available product updates and customertelephone support services, were recognized ratably over the term of theservice period. For arrangements with multiple elements, Mobile Governmentallocated revenue to each component of the arrangement using the residual valuemethod. This means that Mobile Government deferred revenue from the total feesassociated with the arrangement equivalent to the fair value of the element(s)of the arrangement that had not yet been delivered. The fair value of anyundelivered elements was established by using historical evidence specific toMobile Government.

 

(c) USE OF ESTIMATES

 

The preparation of consolidated financial statements in conformity withU.S. generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the dates ofthe consolidated financial statements and the reported amounts of revenue andexpenses during the reporting period. Actual results could differ from thoseestimates. Estimates are used in accounting for, among other things, long-

 

46

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term contracts, allowances for uncollectible receivables, inventoryobsolescence, recoverability of goodwill, long-lived assets and investments,depreciation and amortization, employee benefits, restructuring accruals, taxesand contingencies. Estimates and assumptions are reviewed periodically and theeffects of revisions are reflected in the consolidated financial statements inthe period they are determined to be necessary.

 

**(4)MORTGAGE-BACKED SECURITIES, AT FAIR VALUE**

 

As of December 31, 2004 and 2005, the Companyowned hybrid adjustable-rate mortgage-backed securities issued by the FederalNational Mortgage Association (FNMA) and the Federal Home Loan MortgageCorporation (FHLMC). Hybrid adjustable-rate MBS are characterized by periodiccaps on the interest rates on the underlying mortgages (generally, rate adjustmentsare limited to 2% every twelve months following the initial rate adjustment) aswell as lifetime caps. The initial interest rate adjustment, on the securitieswe own, occurs 36-60 months following the date of origination.

 

During 2005, the decline in fair market valueof the MBS portfolio was driven by continued increases in short-term interestrates.  As a result of the decline in the profitability of ourleveraged MBS portfolio, our recent decision to repay the leveraged portion ofour MBS portfolio, and our decision to evaluate additional and alternativebusiness opportunities that may require the sale of some or all of ourremaining MBS, management does not continue to have the firm intention to holdexisting MBS investments until maturity (or until such time as the market valueof those securities has recovered). Accordingly, we determined that unrealizedlosses in the MBS portfolio at December 31, 2005 should be considered “otherthan temporary” impairments under Statement of Accounting Standards 115 andshould be charged against earnings as of that date. This decision reflects achange in our intention to hold all MBS until a recovery of fair value occurs.During the fourth quarter of 2005, the Company recognized the unrealized lossof approximately $2.1 million and wrote-off the unamortized premium of $1.9million for the total other than temporary impairment charge of approximately$4.0 million. The MBS portfolio will continue to be accounted for as availablefor sale. The fair value of theMBS portfolio will continued to be evaluated and any additional reductions inmarket values that are determined to be “other than temporary” impairments willbe included in results from continuing operations.

 

Mortgaged-backed securities are summarized asfollows:

 
| **December 31, 2004** | ** ** | **Amortized Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|---------------------------------|------------|-------------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| **(In thousands)**         | ** ** | ** **              | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **          | ** ** |
| FNMA                            |       | $                       | 61,680     |                         | $          | —                        |       | $                   | (210       | ) | $ | 61,470 |   |
| Unamortized premium             |       | 714                     |       |                         |       |                          |       | 714                 |       |
|                            |       | $                       | 62,394     |                         | $          | —                        |       | $                   | (210       | ) | $ | 62,184 |   |

 
| **December 31, 2005** | ** ** | **Amortized Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
|---------------------------------|------------|-------------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------|------------|
| **(In thousands)**         | ** ** | ** **              | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **          | ** ** |
| FNMA                            |       | $                       | 233,455    |                         | $          | —                        |       | $                   | —     |   | $ | 233,455 |   |
| FHLMC                           |       | 20,445                  |       | —                       |       | —                        |       | 20,445              |       |
|                            |       | $                       | 253,900    |                         | $          | —                        |       | $                   | —     |   | $ | 253,900 |   |

 

Interest income from mortgage-backedsecurities is as follows:

 
| **(in thousands)**                 | ** ** | **2004** | ** ** | **2005** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Interest earned on MBS             |       | $        | 505        |     | $          | 10,466 |   |
| Less: MBS premium amortization     |       | (22      | )          | (670     | )          |
| Less: Custodian fees               |       | (2       | )          | (21      | )          |
| Interest income from MBS portfolio |       | $        | 481        |     | $          | 9,775 |   |

 

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**(5) PROPERTY AND EQUIPMENT**

 

Property and equipment consists of the following:

 
| **(in thousands)**                                      | ** ** | **ESTIMATED  USEFUL  LIVES** | ** ** | **DECEMBER 31,** | ** ** |
|---------------------------------------------------------|------------|------------------------------|------------|-----------------------|------------|
| **2004**                                                | ** ** | **2005**                     |
| Furniture and fixtures                                  |       | 7 Years                      |       | $                     | 3          |   | $ | 31 |   |
| Computer and equipment                                  |       | 3 – 5 Years             |       | 29                    |       | 35 |   |
| Software                                                |       | 3 Years                      |       | 59                    |       | 62 |   |
| Leasehold improvements                                  |       | Term of Lease                |       | 1,630                 |       | 303 |   |
| Total property and equipment                            |       |                         |       | $                     | 1,721      |   | $ | 431 |   |
| Less  accumulated depreciation                          |       |                         |       | (1,354                | )          | (176 | ) |
| Property and  equipment net of accumulated depreciation |       |                         |       | $                     | 367        |   | $ | 255 |   |

 

Depreciation expense of property andequipment was $2.7 million, $2.2 million and $159,000 for 2003, 2004 and 2005,respectively.

 

**(6)ACCOUNTS PAYABLE AND ACCRUED EXPENSES**

 

Accounts payable and accrued expenses consist of the following:

 
| ** **                            | ** ** | **DECEMBER 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                    | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Professional fees                     |       | $                     | 1,110      |   | $ | 762 |   |
| Taxes other than payroll and income   |       | 1,781                 |       | 1,780 |   |
| Escrow account                        |       | —                |       | 1,000 |   |
| Other                                 |       | 603                   |       | 923 |   |
| Accounts payable and accrued expenses |       | $                     | 3,494      |   | $ | 4,465 |   |

 

**(7) REPURCHASE AGREEMENTS**

 

The Company finances the acquisition of its MBS through the use ofrepurchase agreements with the MBS serving as collateral. At December 31, 2005,all of the Company’s borrowings were fixed rate repurchase agreements withoriginal maturities of 28 days. The following table provides selectedinformation on the Company’s repurchase agreements at December 31, 2005.

 
| **(Dollars in thousands)**         | ** ** | **Amount** | ** ** | **Weighted  average rate** | ** ** |
|------------------------------------|------------|------------|------------|----------------------------|------------|
| Counterparty                       |       |       |       |                       |       |
| Daiwa Securities of America        |       | $          | 37,867     |                       | 4.35       | % |
| Countrywide Securities Corporation |       | 33,823     |       | 4.35                       | %          |
| UBS Financial Services, Inc.       |       | 62,234     |       | 4.34                       | %          |
|                               |       |       |       |                       |       |
| Total                              |       | $          | 133,924    |                       | 4.35       | % |

 

**(8)RESTRUCTURING CHARGES**

 

The Company recorded charges to earnings fromcontinuing operations which included employee separation benefits, facilityclosure and other restructuring costs. The calculation of the restructuringaccrual related to expected losses on subleases requires the Company to makeestimates concerning: (1) the expected length of time to sublease the facility;(2) the expected rental rates on subleases; and, (3) estimated brokerageexpenses associated with executing the sublease. The Company used theassistance of independent real estate brokerage firms in developing these estimatesand the Company’s estimates may be impacted by future economic trends. Theexpected losses on subleases have not been discounted.

 

A rollforward of the restructuring accrual isas follows:

 
| **(in thousands)**                                     | ** ** | **Employee  Separation  Benefits** | ** ** | **Facility  Closure  Costs and  Other** | ** ** | **Total** | ** ** |
|--------------------------------------------------------|------------|------------------------------------|------------|-----------------------------------------|------------|-----------|------------|
| **2004 Restructuring:**                                |       |                               |       |                                    |       |      |       |
| Restructuring liability as of  December 31, 2003  |       | $                                  | 400        |                                    | $          | 1,077     |       | $ | 1,477 |   |
| Charges to continuing operations                       |       | 634                                |       | 606                                     |       | 1,240     |       |
| Adjustments                                            |       | —                             |       | (186                                    | )          | (186      | )          |
| Net charge and adjustments to discontinued  operations |       | 84                                 |       | —                                  |       | 84        |       |
| Cash payments                                          |       | (1,050                             | )          | (1,306                                  | )          | (2,356    | )          |
| Restructuring liability as of  December 31, 2004  |       | 68                                 |       | 191                                     |       | 259       |       |
|                                                   |       |                               |       |                                    |       |      |       |
| **2005 Restructuring:**                                |       |                               |       |                                    |       |      |       |
| Credits reducing previously accrued amounts            |       | —                             |       | (7                                      | )          | (7        | )          |
| Cash payments and other                                |       | (68                                | )          | (184                                    | )          | (252      | )          |
| Restructuring liability as of  December 31, 2005  |       | $                                  | 0          |                                    | $          | 0         |       | $ | 0 |   |

 

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**(9) DEBT**

 

On October 4, 2004,the Company repurchased the remainder of its outstanding 6% subordinated notesdue March 2005 for a price of 101.2%. The total repurchase payment was$157.1 million, consisting of $154.9 million in principal, a $1.9 millionredemption premium and approximately $310,000 in accrued interest. Inconnection with the repurchase, the Company recorded a $2.4 million chargewhich is presented in the Consolidated Statements of Operations andComprehensive Loss as “Loss on early extinguishment of debt.”  The charge consisted of the $1.9 millionredemption premium and a non-cash charge of approximately $560,000 related tothe recognition of unamortized deferred financing costs.

 

##### **(10) INCOME TAXES**

##### ** **

The Company has provided no current income taxes due to the lossesincurred in 2003, 2004, and 2005.

 

A reconciliation of the statutory Federal income tax rate and theeffective income tax rate for continuing operations for the year ended

December 31, 2003, 2004and 2005 follows:

 
| ** **                        | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Statutory Federal income tax rate |       | (35.0    | )%         | (35.0    | )%         | (35.0    | )%         |
| Effect of:                        |       |     |       |     |       |     |       |
| Valuation allowance               |       | 41.1     |       | 27.9     |       | (136.4   | )          |
| Other                             |       | (6.1     | )          | 7.1      |       | 171.4    |       |
| Effective income tax rate         |       | 0.0      | %          | 0.0      | %          | 0.0      | %          |

 

The tax effects of temporary differences that give rise to significantportions of the deferred tax assets and liabilities at December 31, 2004and 2005, are presented below:

 
| ** **                                  | ** ** | **DECEMBER 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
| **(in thousands)**                          | ** ** | **2004**              | ** ** | **2005** | ** ** |
| Deferred tax assets:                        |       |                  |       |   |   |
| Net operating loss carryforwards            |       | $                     | 320,701    |   | $ | 325,851 |   |
| Investments                                 |       | 21,783                |       | 7,796 |   |
| Capital loss carryforwards                  |       | 103,010               |       | 120,892 |   |
| Depreciation and amortization               |       | 5,103                 |       | 40 |   |
| Tax credit carryforwards                    |       | 6,372                 |       | 4,150 |   |
| Other                                       |       | 7,643                 |       | 1,366 |   |
| Gross deferred tax assets                   |       | $                     | 464,612    |   | $ | 460,095 |   |
| Valuation allowance for deferred tax assets |       | (464,612              | )          | (460,095 | ) |
| Net deferred tax assets                     |       | $                     | —     |   | $ | — |   |

 

The net change in the valuation allowance for deferred tax assets wasan increase of $26.3 million in 2004 and a decrease of $4.5 million in 2005.During 2005, the Company’s deferred tax assets and related valuation allowancedecreased primarily due to adjustments related to deferred tax assets for stockcompensation and research credits as well as the expiration of certain capitalloss and charitable contribution carryforwards. In addition, amounts werereclassified between the deferred tax assets related to investments and capitalloss carryforwards. These reclassifications had no effect on the evaluationallowance.

 

Approximately $378.7 million of the valuation allowance for deferredtax assets as of December 31, 2005 will be allocated to “Income TaxBenefit” in the consolidated statements of operations and comprehensive lossupon realization. The remaining portion of the valuation allowance will beallocated to “Additional Paid-In Capital.”

 

In addressing the realizability of deferred tax assets, managementconsiders whether it is more likely than not that some portion or all of thedeferred tax assets will not be realized. The Company has deferred tax assetsprincipally as a result of accumulated net operating and capital losses. TheCompany will only be able to realize value from the accumulated net operatinglosses if it becomes 

 

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profitable and from the accumulated capital losses, only to the extentit can generate capital gains. In addition, its ability to realize value fromthese accumulated losses is subject to various risks and uncertainties,including regulations that, under certain circumstances, may limit the Company’sability to use these net losses to reduce future taxes that it might otherwiseowe. Management believes that as a result of its change in strategic direction,the Company will achieve profitable operations in future years that will enablethe Company to recover the benefit of all or a portion of its deferred taxassets. However, the Company presently does not have sufficient objectiveevidence to support management’s belief and, accordingly, maintains a full valuationallowance for its net deferred tax assets as required by generally acceptedaccounting principles.

 

Under federal and state tax laws, the Company may use its accumulatedlosses to substantially reduce the income taxes it otherwise would have to payon future taxable income. As a result, the Company could have little or noincome tax liability for a period of time. As of December 31, 2005, theCompany had accumulated federal net operating losses totaling approximately$777.8 million that it can “carry forward” as potential tax deductions untilthey expire between 2011 and 2025. In addition, the Company has accumulatedcapital losses of approximately $287.8 million that it can “carry forward” aspotential tax deductions (but only against net capital gains) until they expirebetween 2006 and 2010. In the event of future changes in common stock ownershipabove a certain threshold, the future realization of net operating losscarryforwards, capital loss carryforwards and certain other tax credits wouldbecome subject to limitation under the Internal Revenue Code.

 

**(11) PENSION PLANS**

 

The Company has a defined contribution plan under Section 401(k)of the Internal Revenue Code that provide for voluntary employee contributionsof 1 to 15 percent of compensation for substantially all employees. The Companycontributed the following amounts to the plans for the years endedDecember 31, 2003, 2004 and 2005, respectively:

 
| **(in thousands)**           | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Continuing operations        |       | $        | 105        |     | $          | 69       |       | $ | 60 |   |
| Discontinued operations      |       | 728      |       | 318      |       | —   |       |
| Total employer contributions |       | $        | 833        |     | $          | 387      |       | $ | 60 |   |

 

**(12) STOCK OPTIONS AND WARRANTS**

 

In September 1999, the Company adopted the 1999 Equity IncentivePlan (the “Plan”) to replace the Unit Option Plan. Under the Plan, the Companyhas the ability to grant options to acquire up to 20% of the outstanding sharesof common stock to its employees, directors, and service providers. Optionsunder the Plan generally expire after ten years and normally vest over a periodof up to four years. Options are generally granted at an exercise price equalto the fair value on the grant date. On September 2, 2005, the Companyregistered an additional 973,866 shares under the Plan to allow the Company’sto issue additional shares for incentive purposes. Effective December 15,2000, the Company adopted the Acquisition Incentive Plan (the “2000 Plan”) toprovide options or direct grants to employees and other service providers ofthe Company and its related companies with respect to the Company’s commonstock. The Company has the ability to grant options to acquire up to anadditional 5% of the outstanding shares of common stock under the 2000 Plan. Allemployees (except directors and officers of the Company and any eligibleaffiliates) are eligible for the awards under the 2000 Plan, withoutshareholder approval. Options are generally granted at an exercise price equalto the fair value of the common stock on the grant date.

 

A summary of the stock option activity for the years endedDecember 31, 2003, 2004 and 2005 is as follows:

 
| ** **                                      | ** ** | **2003**              | ** ** | **2004**                               | ** ** | **2005**              | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|----------------------------------------|------------|-----------------------|------------|
| **(In thousands, except  per share amounts)**   | ** ** | **NUMBER  OF SHARES** | ** ** | **WEIGHTED  AVERAGE  EXERCISE  PRICE** | ** ** | **NUMBER  OF SHARES** | ** ** | **WEIGHTED  AVERAGE  EXERCISE  PRICE** | ** ** | **NUMBER  OF SHARES** | ** ** | **WEIGHTED  AVERAGE  EXERCISE  PRICE** | ** ** |
| ** **                                      | ** ** | ** **            | ** ** | **(PER  SHARE)**                       | ** ** | ** **            | ** ** | **(PER  SHARE)** | ** ** | ** ** | ** ** | **(PER  SHARE)** | ** ** |
| Stock options outstanding at beginning of  year |       | 7,143                 |       | $                                      | 9.85       |                  | 5,112      |   | $ | 8.25 |   | 2,146 |   | $ | 3.98 |   |
|                                            |       |                  |       |                                   |       |                  |       |   |   |   |   |   |   |
| Granted                                         |       | 203                   |       | 2.11                                   |       | 127                   |       | 3.60 |   | 5 |   | 3.30 |   |
|                                            |       |                  |       |                                   |       |                  |       |   |   |   |   |   |   |
| Exercised                                       |       | (687                  | )          | 1.64                                   |       | (1,035                | )          | 4.66 |   | (38 | ) | 0.49 |   |
|                                            |       |                  |       |                                   |       |                  |       |   |   |   |   |   |   |
| Canceled                                        |       | (1,547                | )          | 17.82                                  |       | (2,058                | )          | 16.02 |   | (164 | ) | 10.29 |   |
| Outstanding at end of year                      |       | 5,112                 |       | $                                      | 8.25       |                  | 2,146      |   | $ | 3.98 |   | 1,949 |   | $ | 3.52 |   |
|                                            |       |                  |       |                                   |       |                  |       |   |   |   |   |   |   |
| Stock options exercisable at year-end           |       | 2,755                 |       | $                                      | 9.60       |                  | 1,689      |   | $ | 4.19 |   | 1,771 |   | $ | 3.57 |   |

 

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The following table summarizes information about stock options atDecember 31, 2005:

 
| ** **                     | ** **                         | **OPTIONS OUTSTANDING**               | ** ** | **OPTIONS EXERCISABLE**                              | ** ** |
|--------------------------------|------------------------------------|---------------------------------------|------------|------------------------------------------------------|------------|
| **RANGE OF  EXERCISE  PRICES** | ** **                         | **NUMBER AT  DECEMBER 31, 2005** | ** ** | **WEIGHTED-  AVERAGE  REMAINING  CONTRACTUAL  LIFE** | ** ** | **WEIGHTED-  AVERAGE  EXERCISE  PRICE** | ** ** | **NUMBER AT  DECEMBER 31,  2005** | ** ** | **WEIGHTED-  AVERAGE  EXERCISE  PRICE** | ** ** |
| ** **                     | ** **                         | **(in thousands)**                    | ** ** | **(in years)**                                       | ** ** | **(PER SHARE)** | ** ** | **(in thousands)** | ** ** | **(PER SHARE)** | ** ** |
| $                              |    1.49—$2.00  |                                  | 717        |                                                 | 3.5        |   | $ | 1.60 |   | 717 |   | $ | 1.60 |   |
| $                              |    2.01—$3.00  |                                  | 707        |                                                 | 6.5        |   | 2.90 |   | 556 |   | 2.89 |   |
| $                              |    3.01—$7.00  |                                  | 293        |                                                 | 5.1        |   | 3.87 |   | 266 |   | 3.90 |   |
| $                              |    7.01—$10.00 |                                  | 181        |                                                 | 5.2        |   | 8.44 |   | 181 |   | 8.44 |   |
| $                              |  10.01—$100.00           |                                  | 51         |                                                 | 3.9        |   | 19.77 |   | 51 |   | 19.77 |   |
|                           |                               | 1,949                                 |       | 5.0                                                  |       | $ | 3.52 |   | 1,771 |   | $ | 3.57 |   |

 

**(13)RELATED PARTY TRANSACTIONS**

 

Through February 2005, the Companyreceived benefit coordination services from Huber Oros,which was considered a related party because an owner of Huber Orosis related to a member of the Company’s senior management who also serves onthe Company’s Board of Directors. During February 2005, Huber Oros was acquiredby an unrelated entity and the individual who is a related party did not retainany continuing ownership interest in the acquiring entity. For the years endedDecember 31, 2003, 2004 and 2005, expenses related to Huber Oros wereapproximately $107,000, $108,000 and $7,000, respectively. As ofDecember 31, 2004 and 2005, there were no outstanding payables due toHuber Oros.

 

The Company receives legal servicesfrom Kirkland & Ellis LLP, which is considered a related partybecause a partner at that firm is a member of the Company’s Board ofDirectors.  For the years ended December 31, 2003, 2004 and2005 expenses related to Kirkland & Ellis LLP were approximately$1.4 million, $2.1 million and $640,000 respectively. For the year endedDecember 31, 2004, there were no outstanding payables due to Kirkland& Ellis LLP. For the year ended December 31, 2005, the Company hadoutstanding payables due to Kirkland & Ellis LLP of approximately $45,000.

 

**(14) COMMITMENTS AND CONTINGENCIES**

 

(a) LEGAL PROCEEDINGS

 

Aether is among the hundreds of defendantsnamed in nine class action lawsuits seeking damages on account of allegedviolations of securities law.  The case is being heard in the UnitedStates District Court for the Southern District of New York.  The courthas consolidated the actions by all of the named defendants that actuallyissued the securities in question.  There are approximately 310consolidated cases before Judge Scheindlin, including the Aether Systemsaction, under the caption In Re Initial Public Offerings Litigation, MasterFile 21 MC 92 (SAS).

 

These actions were filed on behalf of personsand entities that acquired the Company’s stock after its initial publicoffering in October 20, 1999.  Among other things, the complaintsclaim that prospectuses, dated October 20, 1999 and September 27,2000 and issued by Aether in connection with the public offerings of commonstock, allegedly contained untrue statements of material fact or omissions ofmaterial fact in violation of securities laws because the prospectusesallegedly failed to disclose that the offerings’ underwriters had solicited andreceived additional and excessive fees, commissions and benefits beyond thoselisted in the arrangements with certain of their customers which were designedto maintain, distort and/or inflate the market price of the Company’s commonstock in the aftermarket.  The actions seek unspecified monetary damagesand rescission.  Aether believes the claims are without merit and isvigorously contesting these actions.

 

Initial motions to dismiss the case werefiled and the court held oral argument on the motions to dismiss onNovember 1, 2002.  On February 19, 2003, the court issued anOpinion and Order on defendants’ motions to dismiss, which granted the motionsin part and denied the motions in part.  As to Aether Systems, the motionto dismiss the claims against it was denied in its entirety.  Discovery has nowcommenced.  The plaintiffs voluntarily dismissed without prejudice theofficer and director defendants of Aether.  On June 26, 2003, thePlaintiff’s Executive Committee in this case announced a proposed settlementwith the issuers.  The proposed settlement is a settlement amongthe plaintiffs, the issuer-defendants, including Aether, and the officer anddirector defendants of the issuers.  The plaintiffs will continuelitigating their claims against the underwriter-defendants.  Underterms of the proposed 

 

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settlement, Aether would not incur anymaterial financial or other liability.  On June 14, 2004, theplaintiffs and issuer defendants presented the executed settlement agreement toJudge Scheindlin during a court conference.  Subsequently,plaintiffs and issuers made a motion for preliminary approval of thesettlement agreement.  On July 14, 2004, the underwriter defendantsfiled a memorandum of law in opposition to plaintiffs’ motion for preliminaryapproval of the settlement agreement.  Reply briefs in support of thesettlement were submitted to the court.  In December 2004, the courtordered additional briefing on the motion.  All of the additionalbriefs were submitted to the court.  On February 15, 2005,Judge Scheindlin issued an Opinion and Order granting preliminary approval tothe settlement agreement.  The court has scheduled a fairness hearing onthe proposed settlement on April 24, 2006, and subsequently will decide whetherto grant final approval to the settlement agreement.  Thesettlement agreement is subject to the approval of the District Court. There can be no assurance such approval will be granted.

 

On March 13, 2006, a complaint captioned Geologic Solutions, Inc., v.Aether Holdings, Inc., (Index No. 600856/06) was filed against the Company inthe Supreme Court for the State of New York, New York County.  The complaint generally alleges thatplaintiff Geologic was damaged as a result of certain alleged breaches ofcontract and fraudulent inducement arising out of Aether’s allegedmisrepresentations and failure to disclose certain information in the assetpurchase agreement dated as of July 20, 2004 for the purchase and sale of ourTransportation business.  The allegationsin Geologic’s complaint are substantially similar to claims Geologic made in aprevious request to the Company for indemnification.  The complaint seeks monetary damages “in anamount not less than $30 million” and other relief.  We plan to vigorously defend against thisaction but cannot predict its outcome.

 

Aether is also a party to otherlegal proceedings in the normal course of business for which it has accrued$150,000 as of December 31, 2005 for costs relating to these proceedings. Basedon evaluation of these matters and discussions with counsel, the Companybelieves that any additional liabilities arising from these matters beyond whatit has accrued for will not have a material adverse effect on the consolidatedresults of its operations or financial position.

 

(b) CONTRACTUAL COMMITMENTS

 

In June 2004, the Company contracted with FBR InvestmentManagement Inc. (“FBR”) to obtain investment management services for its MBSportfolio for an initial term of one year. The agreement will continue ineffect beyond its initial term until terminated by the Company or FBR. As ofJuly 1, 2005, the initial one-year term of our agreement with FBR expired, andthis agreement is now continuing without a fixed term, subject to the right ofeither party to terminate the agreement with ninety days prior notice. Underthe terms of the agreement, the Company agreed to pay FBR a quarterlymanagement fee equal to 0.0375% of the aggregate cost basis of the securitiesin the portfolio. In addition, if FBR’s management of the Company’s portfolioresults in a return in excess of 10% per annum, the Company would pay FBR anincentive fee equal to 25% of the return in excess of 10% per annum.

 

(c) LEASES

 

The Company is obligated under noncancelable operating leases foroffice space that expire at various dates through 2008. Future minimum leasepayments under noncancelable operating leases and related sublease rentcommitments as of December 31,

 

2005 are as follows: (inthousands)

 
| **Years ending December 31:** | ** ** | **Gross  Commitments** | ** ** | **Subleased** | ** ** |
|------------------------------------|------------|------------------------|------------|---------------|------------|
| 2006                               |       | $                      | 1,342      |          | $          | 1,218 |   |
| 2007                               |       | 1,384                  |       | 1,256         |       |
| 2008                               |       | 920                    |       | 855           |       |
| Total minimum lease payments       |       | $                      | 3,646      |          | $          | 3,329 |   |

 

Rent expense from continuing operations under operating leases wasapproximately $653,000, $454,000, and $158,000 for the years endedDecember 31, 2003, 2004 and 2005, respectively.

 

The subleased payments shown above are related to the Mobile Governmentheadquarters lease in Massachusetts, which the Company has subleased to thebuyer of that business, BIO-Key International, Inc

 

(d) GUARANTEES

 

In November of 2002,the FASB issued FASB Interpretation No. 45, “Guarantors Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others.”  InterpretationNo. 45 discusses the necessary disclosures to be made by a guarantor in itsfinancial statements about its obligations under certain guarantees that it hasissued. It also discusses that the guarantor must recognize a liability, atfair value, at the inception of the guarantee for the obligation incurred inissuing the guarantee.

 

The Company has guaranteed the payment of assignedleases on properties related to discontinued operations. The maximum aggregateguarantee on these properties is approximately $177,000. The fair value of theguarantee is not material as of December 30, 2005.

 

As of December 31, 2005, $7.9 million of theCompany’s certificates of deposit were held on deposit to collateralize anirrevocable standby letter of credit that was put in place when its MobileGovernment segment entered into a sales agreement with Hamilton County, Ohio toprovide an automated field reporting solution and real time wireless datainfrastructure under a sales agreement. The letter of credit providescollateral assurance of performance under the sales agreement. The terms of thesales agreement and the 

 

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standby letter of credit state that Hamilton Countycan only draw on the letter of credit after (1) completing the internal disputeresolution process set forth in the sales agreement and (2) providing notice toMobile Government of its intent to declare a default under the sales agreementand proceed against the letter of credit. A draw of the funds under the letterof credit is subject to the limitations of liability contained in the salesagreement. The letter of credit is required to remain in place throughDecember 31, 2006.

 

Although Mobile Government was sold to BIO-KeyInternational, Inc. (“BIO-key”) on September 30, 2004, the Company agreedto maintain the $7.9 million letter of credit. In consideration of thisarrangement, and to assure the Company’s reimbursement of any amounts thatHamilton County collects by drawing on the letter of credit as a result of adefault by the buyer, BIO-key, BIO-key provided the Company with a $1.0 millioncash escrow and a $7.9 million subordinated secured promissory note (the “BIO-keyNote”). The Company is entitled to retain the $1.0 million and to demandpayment under the BIO-key Note if Hamilton County draws on the letter of credit.The BIO-key Note is secured by a second lien on substantially all of BIO-key’sassets. The lien is subordinated to $5.0 million of senior secured debt held bycertain of BIO-key’s lenders. The Company has recorded a liability ofapproximately $308,000 (included as part of other liabilities) which representsthe estimated of the fair value of our guarantee. We continue to monitor andevaluate this situation and when all performance conditions are satisfied thereversal of the remaining guarantee liability will be recorded throughdiscontinued operations. As of December 31, 2005 the Company reclassified the$1.0 million cash escrow as a current liability as the amount is payable toBIO-key on the expiration date of the $7.9 million letter of credit.

 

Additionally, the Company is maintaining the facilitylease for the Mobile Government headquarters in Massachusetts and sub-leasingit to BIO-key. As a condition to consenting to the sublease, the landlordrequired the Company to maintain a $749,000 letter of credit to the landlordsecuring performance under the lease. BIO-key has provided the Company with a$749,000 cash escrow that would be available in the event of BIO-key’s defaulton the sublease that results in a draw on the Company’s letter of credit. Thetotal remaining payments under both the lease and the sublease areapproximately $3.2 million. Both expire in August 2008.

 

The Mobile Government transactions discussed abovehave been included in the accompanying balance sheet as follows:

 
| **(in thousands)**                                       | ** ** | **Hamilton  County,  Ohio  Contract** | ** ** | **Massachusetts  Facility Lease** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|-----------------------------------|------------|-----------|------------|
| **Restricted cash:**                                     |       |                                  |       |                              |       |      |       |
| Discount note collateralizing letters of  credit         |       | $                                     | 7,884      |                              | $          | 749       |       | $ | 8,633 |   |
| **Accrued expense:**                                     |       |                                  |       |                              |       |      |       |
| Escrow deposit from BIO-Key                              |       | $                                     | 1,000      |                              | —     |      | $          | 1,000 |   |
| **Other liabilities:**                                   |       |                                  |       |                              |       |      |       |
| Deposits from BIO-Key available in the  event of default |       | $                                     | —     |                              | $          | 749       |       | $ | 749 |   |
| Other                                                    |       | 308                                   |       | —                            |       | 308       |       |
| Total                                                    |       | $                                     | 308        |                              | $          | 749       |       | $ | 1,057 |   |

 

(e) RESTRICTED CASH

 

Restricted cash includes the portion of theCompany’s short term discounted note that is secured by outstanding letters ofcredit established to secure certain of Mobile Government’s contracts andcertain facility leases. At December 31, 2005, the Company had an $8.7million discount note, which collateralized the letters of credit.

 

**(15) SALESOF DISCONTINUED OPERATIONS**

 

We recorded losses of $1,194,000 todiscontinued operations in 2005. To settle a dispute with Geologic, wewrote-off a receivable of $738,000 and paid $235,000 to Geologic. Additionally,we expensed $221,000 todiscontinued operations in the third quarter of 2004, related to thedisposition of our mobile and wireless data businesses.

 

During 2004, theCompany discontinued and sold its EMS, Transportation and Mobile Governmentsegments. The following table provides the detail of the gains (loss)recognized on the sales:

 
| **(in thousands)**                              | ** ** | **EMS** | ** ** | **Transportation** | ** ** | **Mobile  Government** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|---------|------------|--------------------|------------|------------------------|------------|-----------|------------|
| Proceeds                                        |       | $       | 20,143     |               | $          | 25,000                 |       | $         | 10,000     |   | $ | 55,143 |   |
| Estimated working capital adjustment            |       | —  |       | (106               | )          | 343                    |       | 237       |       |
| Expenses                                        |       | (1,287  | )          | (1,999             | )          | (1,206                 | )          | (4,492    | )          |
| Net assets                                      |       | (750    | )          | (22,986            | )          | (6,019                 | )          | (29,755   | )          |
| Other                                           |       | —  |       | —             |       | (308                   | )          | (308      | )          |
| Gain (loss) on sale of discontinued  operations |       | $       | 18,106     |               | $          | (91                    | )          | $         | 2,810      |   | $ | 20,825 |   |

 

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The summary of 2003 operating results fromdiscontinued operations is as follows:

 
| **(in thousands)**                         | ** ** | **EMS** | ** ** | **Transportation** | ** ** | **Mobile  Government** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|---------|------------|--------------------|------------|------------------------|------------|-----------|------------|
| Net sales                                  |       | $       | 53,403     |               | $          | 34,617                 |       | $         | 20,933     |   | $ | 108,953 |   |
| Income (loss) from discontinued operations |       | $       | (13,655    | )                  | $          | (10,634                | )          | $         | 533        |   | $ | (23,756 | ) |

 

Thesummary of 2004 operating results from discontinued operations is as follows:

 
| **(in thousands)**            | ** ** | **EMS** | ** ** | **Transportation** | ** ** | **Mobile  Government** | ** ** | **Total** | ** ** |
|------------------------------------|------------|---------|------------|--------------------|------------|------------------------|------------|-----------|------------|
| Net sales                          |       | $       | —     |               | $          | 21,858                 |       | $         | 13,776     |   | $ | 35,634 |   |
| Loss from  discontinued operations |       | $       | (481       | )                  | $          | (33,556                | )          | $         | (11,413    | ) | $ | (45,450 | ) |

 

The Company does not allocate any interestincome or expense to its discontinued businesses.

 

During 2003 and 2004, the Company performedthe impairment analysis required by SFAS No. 142 and SFAS No. 144. As a resultof these analyses, the Company recorded goodwill and asset impairment chargesduring the years ended December 31, 2003 and 2004, all of which arerecorded in discontinued operations in the Consolidated Statements ofOperations and Comprehensive Loss. The summary of impairment charges is asfollows:

 
| **(in thousands)**      | ** ** | **EMS** | ** ** | **Transportation** | ** ** | **Mobile  Government** | ** ** | **Total** | ** ** |
|-------------------------|------------|---------|------------|--------------------|------------|------------------------|------------|-----------|------------|
| 2003 impairment charges |       | (629    | )          | (667               | )          | —                 |       | (1,296    | )          |
| 2004 impairment charges |       | —  |       | (26,622            | )          | (8,928                 | )          | (35,550   | )          |

 

The EMS segment generated $800,000 of revenuefrom related parties in 2003. The related parties consisted of companies inwhich Aether had made an equity investment. The EMS segmentreceived data feeds from Reuters during 2003.   Reuters was considered a related party during2002 because they were a part owner of EMS’s international operation.  Asof December 31, 2003, the Company had no outstanding payables due toReuters and has not had any outstanding payables to Reuters since that time.

 

*EMS Sale*

 

On January 13, 2004, Aether completedthe sale of its EMS segment to TeleCommunication Systems, Inc. (“TCS”).Pursuant to the purchase agreement, as amended, Aether received $19.0 millionfor the EMS segment, consisting of $18.0 million in cash and a note in theprincipal amount of $1.0 million due in August 2004. Aether also received204,020 shares of TCS Class A common stock valued as of closing atapproximately $1.1 million. In April 2004, the Company sold thesesecurities and received approximately $1.4 million in cash. In addition, the$1.0 million note from TCS was repaid in full in August 2004.

 

We may be required to indemnify TCS underthe asset purchase agreement forcertain breaches of representations and warranties and other covenants that wegave to TCS with respect to the sale of our EMS segment. This liability islimited to $7.6 million, other than in the case of fraud and with respect to asmall number of specific representations, such as those relating to taxes owedfor periods prior to the closing of the sale of the EMS segment. In addition,we remain fully liable for any claims that may arise relating to our operationof the EMS business prior to the date on which TCS acquired that business fromus, including any liability arising from our past sales of the blackberrydevices manufactured by Research In Motion (“RIM”).Recently, the US Court ofAppeals ruled that RIM violated 16 patents owned by intellectual propertyholding company NTP, Inc. (“NTP”). The case was remanded on February 24, 2006to the District Court to determine whether or not RIM should be enjoinedselling the violating products. It has been reported that the parties havesince reached a settlement agreement.

 

*Transportation Sale*

 

On September 17, 2004, theCompany sold its Transportation segment to GeoLogic Solutions, Inc. (f/k/aSlingshot Acquisition Corporation (“GeoLogic”), an affiliate of Platinum EquityCapital Partners L.P., pursuant to an asset purchase agreement (the “AssetPurchase Agreement”), for $25.0 million in cash.  The purchase price wassubject to a post-closing adjustment based on the Transportation segment’s networking capital at August 31, 2004. The parties also agreed to a true-upof net cash receipts and disbursements relating to the Transportation segmentbetween September 1, 2004 and the closing date.   The transaction wasstructured as a sale of assets and assumption of certain liabilities.  Theassets sold consisted of all of the assets used primarily in the Transportationsegment.  GeoLogic assumed responsibility for substantially allpost-closing liabilities and certain historical liabilities, of theTransportation segment.

 

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During the fourth quarter of2004 and in January 2005, the Company and GeoLogic advised each other ofsignificant disagreements over both the working capital adjustment and the cashtrue up. The Company claimed that it was owed approximately $1 million, andGeoLogic contended that it was owed approximately $8.1 million. The parties hadperiodic discussions during 2005 but were unable to resolve their differences. Underthe terms of the Asset Purchase Agreement, if not resolved by agreement, theparties were required to submit the disputed matters to binding arbitrationbefore an independent accounting firm. Near the end of the third quarter, toavoid the expense and uncertainty of an arbitration proceeding, the Companyagreed to settle the working capital adjustment and the cash true-up by paying$235,000 to GeoLogic. On October 14, 2005, the parties entered into asettlement agreement to reflect this resolution, and the Company paid thesettlement amount to GeoLogic on October 17, 2005. As a result of thissettlement, as of the end of the third quarter, the Company wrote off $738,000in amounts due from GeoLogic that had been recorded as an asset on its balancesheet and recorded an additional expense of $235,000. These amounts areincluded in loss from discontinued operations for the third quarter.

 

Also, during the third quarter, GeoLogic notified the Company of, andthe Company responded to, various indemnification claims for alleged breachesof representations and warranties under the Asset Purchase Agreement.  The parties have been unable to resolve theirdisagreement over Geologic’s claim for indemnification and on March 13, 2006,Geologic filed a lawsuit against the Company in the Supreme Court of the Stateof New York.  Geologic’s claims generallyinvolve allegations that the Company failed to provide full disclosureregarding certain aspects of the Transportation segment’s businessrelationships with one of its major customers and two of its majorsuppliers.  GeoLogic contends that it hadsuffered damages in excess of $30 million as a result of these alleged breaches.  Although the Company cannot predict theoutcome of this litigation, the Company believes that the indemnificationclaims are without merit and intends to vigorously defend against them.  If the Company were unsuccessful in defendingagainst the claims by GeoLogic, the results could have a material adverseeffect on the Company’s business, financial results and financial condition.

 

*Mobile Government Sale*

 

On September 30, 2004, the Company soldits Mobile Government segment to BIO-key for $10.0 million in cash. Thepurchase price is subject to a post-closing adjustment based upon net workingcapital. The transaction was structured as a sale of assets and assumption ofcertain liabilities. The assets sold consisted of all the assets used in theMobile Government segment. BIO-key assumed responsibility for substantially allpost-closing liabilities, and certain historical liabilities, of the MobileGovernment segment. BIO-key and Aether also entered into a transition servicesagreement to provide for the orderly transition of the business to BIO-key,which is expected to be completed by early 2005.

 

In connection with the sale of the MobileGovernment segment, the Company recorded an $8.9 million non-cash impairmentcharge in the second quarter of 2004.

 

On October 25, 2004, the Companyinformed BIO-key that based on Aether’s calculation of net working capital; thepurchase price should be increased by approximately $343,000. During the fourthquarter of 2004, BIO-key paid the Company for the working capital adjustmentand substantially all other amounts due related to the sale.

 

**(16) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)**

 
| **(in thousands, except per share  amounts)**                                             | ** ** | **QUARTER  ENDED  MARCH 31,  2004** | ** ** | **QUARTER  ENDED  JUNE 30,  2004** | ** ** | **QUARTER  ENDED  SEPTEMBER 30,  2004** | ** ** | **QUARTER  ENDED  DECEMBER 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
|                                                                                      |       |                                |       |                                    |       |                                    |       |                                   |       |
| Loss from continuing operations                                                           |       | $                                   | (5,410     | )                                       | $          | (10,563                                 | )          | $                                      | (4,040     | ) | $ | (3,690 | ) |
| Loss from discontinued operations                                                         |       | (3,839                              | )          | (39,029                                 | )          | (2,582                                  | )          | —                                 |       |
| Gain (loss) on sale of discontinued  operations                                           |       | 18,396                              |       | (245                                    | )          | 2,876                                   |       | (202                                   | )          |
| Net income (loss)                                                                         |       | $                                   | 9,147      |                                    | $          | (49,837                                 | )          | $                                      | (3,746     | ) | $ | (3,892 | ) |
| Loss from continuing operations per common  share — basic and diluted                |       | $                                   | (0.13      | )                                       | $          | (0.24                                   | )          | $                                      | (0.09      | ) | $ | (0.08 | ) |
| Loss from discontinued operations per  common  share — basic and diluted             |       | (0.09                               | )          | (0.89                                   | )          | (0.06                                   | )          | —                                 |       |
| Gain (loss) on sale of discontinued  operations per common share — basic and diluted |       | 0.43                                |       | (0.01                                   | )          | 0.06                                    |       | (0.01                                  | )          |
| Net income (loss) per common share – basic  and diluted                              |       | $                                   | 0.21       |                                    | $          | (1.14                                   | )          | $                                      | (0.09      | ) | $ | (0.09 | ) |
| Weighted average shares outstanding - basic  and diluted                                  |       | 43,273                              |       | 43,802                                  |       | 43,840                                  |       | 43,904                                 |       |

 

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| **(in thousands, except per share  amounts)**                                       | ** ** | **QUARTER  ENDED  MARCH 31,  2005** | ** ** | **QUARTER  ENDED  JUNE 30,  2005** | ** ** | **QUARTER  ENDED  SEPTEMBER 30,  2005** | ** ** | **QUARTER  ENDED  DECEMBER 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
|                                                                                |       |                                     |       |                                    |       |                                    |       |                                   |       |
| Income (loss) from continuing operations                                            |       | $                                        | (658       | )                                       | $          | 899                                     |       | $                                      | 238        |   | $ | (3,805 | ) |
| Loss from discontinued operations                                                   |       | —                                   |       | —                                  |       | —                                  |       | —                                 |       |
| Loss on sale of discontinued operations                                             |       | —                                   |       | (121                                    | )          | (1,073                                  | )          | —                                 |       |
| Net income (loss)                                                                   |       | $                                        | (658       | )                                       | $          | 778                                     |       | $                                      | (835       | ) | $ | (3,805 | ) |
| Income (loss) from continuing operations  per common share — basic and diluted |       | $                                        | (0.01      | )                                       | $          | 0.02                                    |       | $                                      | 0.01       |   | $ | (0.09 | ) |
| Loss on sale of discontinued operations per  common share — basic and diluted  |       | —                                   |       | —                                  |       | (0.03                                   | )          | —                                 |       |
| Net income (loss) per common share — basic  and diluted                        |       | $                                        | (0.01      | )                                       | $          | 0.02                                    |       | $                                      | (0.02      | ) | $ | (0.09 | ) |
|                                                                                |       |                                     |       |                                    |       |                                    |       |                                   |       |
| Weighted average shares outstanding - basic  and diluted                            |       | 43,991                                   |       | 44,009                                  |       | 44,019                                  |       | 44,019                                 |       |

 

**(17) SUBSEQUENT EVENTS**

 

On January 23, 2006, theCompany entered into two agreements that amend certain collateral security andcredit arrangements originally entered into with BIO-key and one of itssubsidiaries in connection with BIO-key’s acquisition of Aether’s MobileGovernment business in September 2004. At BIO-key’s request and upon BIO-key’ssatisfaction of certain enumerated conditions set forth in the LetterAgreement, Aether will release to BIO-key up to $1.0 million of cash collateralcurrently held by Aether. In consideration of the foregoing, the principalamount of the Promissory Note will be increased from $6.9 million up to $7.9million as and to the extent the cash collateral is released to BIO-key. Aetheralso will have expanded rights relating to BIO-key’s $749,000 security depositfor the sublease by BIO-key of Massachusetts office space. This additionalcollateral will now be available to Aether to the extent BIO-key fails to makefuture payments to Aether under either the sublease or other agreements betweenthe parties. In addition, if BIO-key requests, and Aether in its solediscretion agrees to extend its $7.9 million letter of credit in favor ofHamilton County beyond December 31, 2006 (the current termination date),BIO-key will pay Aether an extension fee and will extend the duration of thePromissory Note to 30 days following the extended termination of the letter ofcredit.

 

On March 8, 2006, the Company entered into a commitment with Jefferies& Company, Inc. (“Jefferies”) to sell approximately $140 million of MBS(with settlement on March 27, 2006). The terms received from Jefferies were atleast as favorable to the Company as the terms offered by other investmentbanks, including the Company’s investment advisor, FBR. The Company will use approximately$120 million of the sale proceeds to repay all of its then-outstandingshort-term borrowings under repurchase agreements. The impairment charge ofapproximately $4.0 million that is included in loss from continuing operationsin the fourth quarter of 2005 includes $2.5 million of losses associated withthe specific MBS that the Company committed to sell on March 8, 2006. As aresult of the March 8 sale, the Company will record an additional loss on thesale of MBS of approximately $490,000 in the first quarter of 2006.

 

**ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A. CONTROLS & PROCEDURES**

 

***Evaluation of Disclosure Controlsand Procedures***

 

We have established disclosure controls andprocedures to ensure that material information relating to the Company,including its consolidated subsidiaries, is made known to the officers whocertify the Company’s financial reports and to other members of seniormanagement and the Board of Directors.

 

As required by Rule 13a-15(b) under theSecurities and Exchange Act of 1934, as amended (the “Exchange Act”),management carried out an evaluation, with the participation of the Company’schief financial officer and chief executive officer, of the effectiveness ofthe Company’s disclosure controls and procedures, as of December 31, 2005.Based on their evaluation as of December 31, 2005, the chief executiveofficer and chief financial officer of the Company have concluded that theCompany’s 

 

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disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are effectiveto ensure that the information required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in SEC rules andforms.

 

***Management’s Report on InternalControl Over Financial Reporting***

 

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Underthe supervision and with the participation of management, including our chiefexecutive officer and chief financial officer, we conducted an evaluation ofthe effectiveness of our internal control over financial reporting based on theframework in Internal Control Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (the “COSO Framework”). Asnoted in the COSO Framework, an internal control system, no matter how wellconceived and operated, can provide only reasonable assurance to management andthe board of directors regarding achievement of an entity’s objectives. Basedon the evaluation under the COSO Framework, our management concluded that ourinternal control over financial reporting was effective as of December 31,2005. Our report is included in Item 8 of this Report. Our management’sassessment of the effectiveness of our internal control over financialreporting as of December 31, 2005 has been audited by KPMG LLP, anindependent registered public accounting firm, as stated in their report whichis also included in Item 8 of this Report.

 

***Changes in Internal Control OverFinancial Reporting and Disclosure Controls and Procedures***

 

During the year ended December31, 2005, no change occurred in the Company’s internal control over financialreporting that materially affected, or is likely to materially affect, theCompany’s internal control over financial reporting. Our corporate controllerleft the Company in June 2005 and was replaced (after a transition periodduring which the former controller and the new controller worked together) by anew corporate controller who also has prior experience serving as a seniorfinancial officer of a publicly traded SEC reporting company. We do not believethe Company’s internal control over financial reporting has been, or is likelyto be, materially affected by this personnel change.

 

**ITEM 9(B). OTHER INFORMATION**

 

None.

 

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**PART III**

 

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

The following table shows,as of February 20, 2006, the names and ages of Aether’s directors and executiveofficers. Each director will continue in office until the next annual meetingor until his earlier resignation, removal or death.

 
| **Name**                   | ** ** | **Age** | ** ** | **Position**                                       | ** ** |
|----------------------------|------------|---------|------------|----------------------------------------------------|------------|
| David  S. Oros             |       | 46      |       | Chairman of the Board and  Chief Executive Officer |       |
| David  C. Reymann          |       | 47      |       | Chief Financial Officer                            |       |
| J.  Carter Beese, Jr. |       | 49      |       | Director                                           |       |
| James  T. Brady            |       | 65      |       | Director                                           |       |
| Jack  B. Dunn IV           |       | 54      |       | Director                                           |       |
| Edward  J. Mathias         |       | 64      |       | Director                                           |       |
| Truman  T. Semans          |       | 79      |       | Director                                           |       |
| George  P. Stamas          |       | 55      |       | Director                                           |       |

 

David S. Oros founded Aetherin 1996, and currently serves as our chairman and chief executive officer. From1994 until 1996, Mr. Oros was president of NexGen Technologies, L.L.C., awireless software development company that contributed all of its assets toAether. From 1992 until 1994, he was president of the Wireless Data Group atWestinghouse Electric. Prior to that, Mr. Oros spent from 1982 until 1992at Westinghouse Electric directing internal research and managing largeprograms in advanced airborne radar design and development. Mr. Oros receiveda B.S. in mathematics and physics from the University of Maryland, and holds aU.S. patent for a multi-function radar system. Mr. Oros currently serves on theBoard of Directors for Broadwing Corporation, the University of Maryland Schoolof Nursing, the Baltimore’s Port Discovery Children’s Museum, and on the Boardof Trustees for the University of Maryland Baltimore Foundation, Inc.

 

David C. Reymann has servedas our chief financial officer since joining us in June 1998. Beforejoining us, Mr. Reymann was director of finance and accounting for TheSweetheart Cup Company from June 1996 until May 1998, where hemanaged the financial analysis department and the accounting operations for 11North American manufacturing plants. Prior to that, Mr. Reymann spent 12years with Procter & Gamble, serving in several key finance,accounting and operations positions. Prior to Procter & Gamble,Mr. Reymann spent five years at Ernst & Young, where he mostrecently specialized in emerging growth companies. Mr. Reymann received aB.S. in accounting from the University of Baltimore, and is a certified publicaccountant.

 

J.Carter Beese, Jr. was elected a director of Aether on October 20,1999.  Mr. Beese currently serves as President of RCP Ventures Management,Inc., a venture capital management company, and as a Senior Advisor to LegacyPartners Group, an M&A investment bank.  From July 1998 toSeptember 2005, Mr. Beese served as President of Riggs Capital Partners, adivision of Riggs National Corp., which is a venture fund that manages inexcess of $100 million. Preceding his appointment to Riggs, fromSeptember 1997 until July 1998, Mr. Beese was vice chairman ofthe Global Banking Group at Bankers Trust.  Prior to the merger of BankersTrust and Alex. Brown, from November 1994 until September 1997,Mr. Beese was chairman of Alex. Brown International.  He originallyjoined Alex. Brown in 1978 became an officer in 1984, and a partner in1987.  Mr. Beese served as a commissioner of the U.S. Securities andExchange Commission from 1992 to 1994.  He serves as a director on theboards of Nastech Pharmaceutical Company and the National Stock Exchange. He also serves as a senior advisor to Allied Capital Corporation and theCenter for Strategic International Studies. In November 2003,Mr. Beese was named by U.S. District Court Judge Rakoff and the U.S.Securities and Exchange Commission as the manager of the $250 million of MCIstock to be distributed to the victims of accounting fraud pursuant to the fairfund provision of the Sarbanes-Oxley Act of 2002.  He also served as amember of President George W. Bush’s Information Technology AdvisoryCommittee.  Mr. Beese received a B.S. in Economics and a B.S. inPolitical Science from Rollins College, and has completed advanced studies atJohns Hopkins University and the U.S. Army War College.

 

James T. Brady was electeddirector of Aether on June 28, 2002. Mr. Brady has served as theManaging Director - Mid-Atlantic, for Ballantrae International, Ltd., amanagement consulting firm, since 2000 and was an independent businessconsultant from May 1998 until 2000. From May 1995 to May 1998,Mr. Brady was the Secretary of the Maryland Department of Business andEconomic Development. Prior to May 1995, Mr. Brady was a managingpartner with Arthur Andersen LLP in Baltimore, Maryland. Mr. Brady is adirector of McCormick & Company, Inc., Constellation Energy Groupand T. Rowe Price Group. Mr. Brady received a B.A. from Iona College.

 

Jack B. Dunn IV was electeddirector of Aether on June 28, 2002. Since October 1995,Mr. Dunn has been chief executive officer of FTI Consulting, Inc, amulti-disciplined consulting firm with practices in the areas of financialrestructuring, corporate finance, forensic accounting, litigation consultingand economic consulting. He joined FTI in 1992 as executive vice president andchief financial officer and has served as a director of FTI since May 1992and as chairman of the board from December 1998 to 

 

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September 2004.Mr. Dunn is a director of Pepco Holdings, Inc., a public utilitycompany, and is a limited partner of the Baltimore Orioles. Prior to joiningFTI, he was a member of the board of directors and a managing director of LeggMason Wood Walker, Inc. and directed its Baltimore corporate finance andinvestment banking activities. He received a B.A. from Princeton University anda J.D. from the University of Maryland Law School.

 

Edward J. Mathias waselected director of Aether on June 28, 2002. Mr. Mathias has been amanaging director of The Carlyle Group, a Washington, D.C. based privatemerchant bank, since 1994. Mr. Mathias served as a managing director of T.Rowe Price Associates, Inc., an investment management firm, from 1971 to1993. He received a B.A. from the University of Pennsylvania and an M.B.A. fromHarvard University.

 

Truman T. Semans wasappointed director of Aether by board resolution on September 19, 2002.Mr. Semans is founder and since 1993 has been Vice Chairman of BrownInvestment Advisory & Trust Company, or Brown Advisory, a full-servicefirm providing investment advisory services to families and individuals ofsubstantial wealth. Prior to founding Brown Advisory, Mr. Semans joinedAlex. Brown & Sons in August 1974 as general partner, and was amember of the executive committee, the Vice Chairman of the Board and a memberof the Executive and Organization Committee. He graduated from PrincetonUniversity and attended the University of Virginia Law School.

 

George P. Stamas was electeda director of Aether on October 20, 1999. Since January 2002,Mr. Stamas has been a senior partner with the law firm of Kirkland andEllis LLP. Also, since November 2001, Mr. Stamas has been a venturepartner with New Enterprise Associates. From December 1999 untilDecember 2001, Mr. Stamas served as the vice chairman of the boardand managing director of Deutsche Banc Alex. Brown (now Deutsche BankSecurities). From April 1996 until December 1999, Mr. Stamas wasa partner with the law firm of Wilmer, Cutler & Pickering and head oftheir corporate group. Mr. Stamas is counsel to, and a limited partner of,the Baltimore Orioles baseball team and also of Lincoln Holdings, which holdsinterests in the Washington Wizards and Washington Capitals. Mr. Stamas alsoserves on the board of directors of FTI Consulting, Inc. He received aB.S. in economics from the Wharton School of the University of Pennsylvania anda J.D. from the University of Maryland Law School.

 

*Audit Committee*. The audit committee currently consists ofMessrs. Brady, Semans and Beese, with Mr. Brady serving as its chairman. Theboard of directors has determined that the members of the audit committeesatisfy the  “independence” and“financial literacy” requirements for audit committee members as set forth bythe SEC and as adopted in the Nasdaq listing standards.

 

The board of directors hasalso determined that Mr. Brady is an audit committee financial expert andis independent of management, as required under Section 407 of theSarbanes-Oxley Act of 2002. We believe Mr. Brady is qualified to be an“audit committee financial expert” because he has the following attributes:(i) an understanding of generally accepted accounting principles, or GAAP,and financial statements, (ii) the ability to assess the generalapplication of such principles in connection with accounting for estimates,accruals and reserves, (iii) experience preparing, auditing, analyzing orevaluating financial statements that represent a breadth and level ofcomplexity and accounting issues that can reasonably be expected to be raisedby Aether’s financial statements, or actively supervising one or more personsengaged in such activities, (iv) an understanding of internal controlsover financial reporting and (v) an understanding of audit committeefunctions. Mr. Brady has acquired these attributes by means of having heldvarious positions that provided the relevant experience, including 33 yearswith Arthur Andersen (including twenty years as an audit partner) and membershipon the audit committees of several public companies since 1998. Mr. Bradyalso serves on the audit committees of three other public companies, but theboard of directors has determined that such service does not affect hisindependence, responsibilities or duties as a member of the audit committee.

 

**Section 16(a) BeneficialOwnership Reporting Compliance**

 

Section 16(a) ofthe Exchange Act requires our officers (as defined in regulations issued by theSEC) and directors, and persons who own more than ten percent of a registeredclass of Aether’s equity securities, to file initial reports of ownership andreports of changes in ownership of the common stock and other equity securitiesof Aether, with the SEC. Officers, directors and greater than ten percentstockholders are required by SEC regulation to furnish us with copies of allSection 16(a) forms they file.

 

Based solely on a review ofthe copies of such reports of ownership received by us and certifications fromexecutive officers and directors that no other reports were required for suchpersons, we believe that during fiscal year 2005 all filing requirementsapplicable to its executive officers, directors and such greater than tenpercent stockholders were complied with on a timely basis.

 

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**Code of Ethics**

 

Wehave adopted a general code of ethics for our business. We have also adopted acode of ethical conduct that applies solely to our principal executive officer,principal financial officer, principal accounting officer, controller andpersons performing similar functions. The board of directors is responsible forreviewing and authorizing any waivers from both the code of ethics and code ofethical conduct for senior financial officers and we will file any waiversfrom, or amendments to, these codes on our website at www.aetherholdings.com,the content of which website is not incorporated by reference into orconsidered a part of this document. Both the general code of ethics and thecode of ethical conduct for senior financial officers, as well as the chartersfor our audit committee, nominating committee and compensation committee, areavailable on Aether’s website, www.aetherholdings.com, the content of whichwebsite is not incorporated by reference into or considered a part of thisdocument. This information is also available in print upon written request toour secretary at our address.

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

**ExecutiveCompensation**

 

*SummaryCompensation*. Thefollowing table sets forth compensation for 2003, 2004 and 2005 awarded to,earned by or paid to our chief executive officer and chief financial officer,our only executive officers as of December 31, 2005. We refer to theseofficers as the “named executive officers.”

 
| ** **                      | ** ** | ** **              | ** ** | ** **                        | ** ** | ** **                          | ** ** | **Long-Term Compensation**       | ** ** | ** ** | ** ** |
|---------------------------------|------------|-------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|------------|------------|
| **Name and Principal Position** | ** ** | **Annual Compensation** | ** ** | **Restricted  Stock Awards  ($)** | ** ** | **Shares  Underlying  Options (#)** | ** ** | **All Other  Compensation  ($)** | ** ** |
| **Year**                        | ** ** | **Salary ($)**          | ** ** | **Bonus ($)**                     |
|                            |       |                    |       |                              |       |                                |       |                             |       |       |       |   |   |
| David S. Oros                   |       |                    |       |                              |       |                                |       |                             |       |       |       |   |   |
| Chairman and Chief              |       |                    |       |                              |       |                                |       |                             |       |       |       |   |   |
| Executive Officer               |       | 2005                    |       | $                                 | 200,000    |                                | —     |                             | —     |       | —     |   | $ | 28,408 | (2) |
|                            |       | 2004                    |       | $                                 | 200,000    |                                | —     |                             | —     |       | —     |   | $ | 16,815 |   |
|                            |       | 2003                    |       | $                                 | 200,000    |                                | —     |                             | —     |       | —     |   | $ | 17,740 |   |
|                            |       |                    |       |                              |       |                                |       |                             |       |       |       |   |   |
| David C. Reymann                |       |                    |       |                              |       |                                |       |                             |       |       |       |   |   |
| Chief Financial Officer         |       | 2005                    |       | $                                 | 180,000    |                                | $          | —                           |       | —     |       | — |   | $ | 25,865 | (3) |
|                            |       | 2004                    |       | $                                 | 180,000    |                                | 84,000     | (1)                              | —     |       | —     |   | $ | 16,244 |   |
|                            |       | 2003                    |       | $                                 | 180,000    |                                | $          | —                           |       | $          |       |   |   |   | $ | 16,924 |   |
|                                 |            |                         |            |                                   |            |                                     |            |                                  |            |            |            |  |  |  |  |  |  |

 

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| (1) | Mr. Reymann  was awarded a cash bonus in connection with the completion of the sales of  Aether’s mobile and wireless data businesses in 2004.                                                                                                                                                                         |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Includes  $12,000 for employer contributions to Aether’s 401(k) plan, and $12,385 paid  by Aether for health insurance (including dental and vision). The remaining  amount consists of the dollar amount of insurance premiums paid by Aether  with respect to term life insurance and business travel accident insurance. |
| (3) | Includes  $10,800 for employer contributions to Aether’s 401(k) plan, and $12,385 paid  by Aether for health insurance (including dental and vision). The remaining  amount consists of the dollar amount of insurance premiums paid by Aether  with respect to term life insurance and business travel accident insurance. |

 

*No Executive Loans**.*Aether does notextend loans to executive officers or directors.

 

*No Pension Plans**.*Aether currently does not have any pension plans ordefined benefit plans.

 

*Long-Term Incentive Plan Awards**.*No restricted shares were granted to eithernamed executive officer during the year ended December 31, 2005 under anyof Aether’s long-term incentive plan. The compensation committee has theauthority to grant options to Aether’s executive officers under the 1999 EquityIncentive Plan in order to align their interests with the long-term interestsof our stockholders. For more information, see the Compensation CommitteeReport below.

 

*Option Grants in Last Fiscal Year**.*No stock options or stock appreciation rightswere granted to either named executive officer during the year endedDecember 31, 2005.

 

*Aggregate Option Exercises and Holdings**.* The following table provides informationconcerning the shares represented by outstanding 

 

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options and warrants held byeach of the named executive officers as of December 31, 2005.

 
| **Name**            | ** ** | **Shares  Acquired on Exercise (#)** | ** **      | **Value  Realized   ($)** | ** **        | **Number of Shares  Underlying Unexercised  Options at Fiscal Year-End  (#)(1)** | ** ** | **Value of Unexercised In-The-  Money Options/SARs at  Fiscal Year-End(2)**  | ** ** |
|---------------------|------------|--------------------------------------|-----------------|---------------------------|-------------------|----------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| **Exercisable**     | ** ** | **Unexercisable**                    | **Exercisable** | ** **                | **Unexercisable** |
|                |       |                                 |            |                      |              | ** **                                                                       | ** ** | ** **                                                                        | ** ** | ** ** | ** ** | ** ** |   |
| David S. Oros(3)    |       | —                               |            | —                    |              | 918,100                                                                          |       | 25,000                                                                            |       | $ | 1,154,350 |   | $ | 9,250 |   |
| David C. Reymann(4) |       | —                               |            | —                    |              | 138,750                                                                          |       | —                                                                            |       | $ | 47,442 |   | — |   |
|                     |            |                                      |                 |                           |                   |                                                                                  |            |                                                                                   |            |  |  |  |  |  |  |

 

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(1)   Alloptions were issued under the 1999 Equity Incentive Plan and are in amounts andhave exercise prices as follows:

 
| **Name**          | ** ** | **Amount (#)** | ** ** | **Exercise Price** | ** ** |
|-------------------|------------|----------------|------------|--------------------|------------|
| David S.  Oros    |       | 655,000        |       | $                  | 1.60       |   |
|              |       | 157,500        |       | $                  | 4.00       |   |
|              |       | 12,600         |       | $                  | 16.00      |   |
|              |       | 18,000         |       | $                  | 8.54       |   |
|              |       | 75,000         |       | $                  | 2.95       |   |
| David C.  Reymann |       | 20,834         |       | $                  | 1.49       |   |
|              |       | 5,416          |       | $                  | 1.60       |   |
|              |       | 32,500         |       | $                  | 8.00       |   |
|              |       | 50,000         |       | $                  | 8.54       |   |
|              |       | 30,000         |       | $                  | 3.75       |   |

 

(2)   Options were “in the money” to the extent theclosing price of Aether’s common stock on December 31, 2005 exceeded theexercise price of the options. The value of unexercised options represents thedifference between the exercise price of net options and $3.32, which was thelast reported sale of Aether common stock on December 31, 2005.

(3)   Includes 812,500 shares ofcommon stock underlying warrants. These warrants issued to Mr. Oros were issuedprior to Aether’s initial public offering and have a strike price of $1.60 and$4.00 per share.

(4)   Includes5,416 shares of common stock underlying warrants. These warrants wereissued to Mr. Reymann for incentive and retention purposes and have a strikeprice of $1.60 per share.

 

**EmploymentAgreements and Additional Equity-Based Incentive Awards**

 

In June 1999, weentered into an employment contract with Mr. Oros. It provides for a basesalary of $200,000 per year, a performance bonus of up to $100,000 per year,and additional bonuses based on annual revenue targets. This base salary hasnever been increased, and Mr. Oros has not been awarded a cash bonus since1999. Mr. Oros’ employment agreement provides that he will not solicit for employment or hire away anyemployee of the Company for a period of six months after termination of hisemployment. The initial term of the employment contract expired in June 2002,and the term is automatically extended for additional one month incrementsuntil terminated by Aether or Mr. Oros on 15 days’ advance notice. We havecontinued to employ Mr. Oros since June 2002 pursuant to the terms of thisemployment agreement, with continuous month-to-month extensions.

 

Pursuant to thiscontract, in 1999 we granted Mr. Oros a warrant to acquire 1,000,000 shares ofour common stock. The warrant has an exercise price of $1.60 per share ofcommon stock. With our consent, Mr. Oros subsequently assigned warrants toacquire 225,000 shares of our common stock to key employees and retained awarrant to acquire 775,000 shares. In 1999, Mr. Oros also received a warrant toacquire 175,000 shares of our common stock at an exercise price of $4 pershare. From this second grant, Mr. Oros subsequently assigned a warrantexercisable for 17,500 shares of our common stock to a former board member ofthe Company and retained the warrant covering the remaining shares. Each of Mr.Oros’ warrants became exercisable upon completion of our initial publicoffering. Warrants that Mr. Oros continues to hold are included in the table aboveheaded “Aggregate Option Exercises and Holdings.

 

On March 9, 2006,our Board of Directors, at the recommendation of the Compensation Committee,approved changes to Mr. Oros’ employment agreement that will be reflectedeither in an amendment to the agreement or in a separate agreement that willsupplement his existing employment agreement and that Mr. Oros and the Companyexpects to finalize over the next several weeks. These changes replace theseverance provisions of Mr. Oros’ employment agreement, which provisions haveexpired and are no longer applicable. Specifically, the Company has agreed thatif Mr. Oros ceases to serve as chief executive officer of the Company for anyreason other than a termination of his employment by the Company for “Cause”, hisemployment with the Company will then 

 

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continue on apart-time basis for a period of three (3) years. “Cause” also would exist if, with respect tohis employment, Mr. Oros (i) he  was convicted of or plead guilty or nocontest to, any misdemeanor involving fraud, breach of trust ormisappropriation or any felony, (ii) commits an act of gross negligence orotherwise acts in blatant disregard of the Company’s best interests or (iii)fails or refuses to comply in any material respect  with specific writtendirections consistent with his job responsibilities and reasonably capable ofbeing performed.   Duringthis time, he will be obligated to provide the Company with up to 250 hours peryear of service, at the Company’s request, and he will be entitled to receivean annual base salary of $200,000, plus continued health and medical benefitsduring this period. The estimated cost to Aether of these severance payments isapproximately $629,000. Mr. Oros has agreed to abide by the terms of thenon-solicitation provision in his employment agreement for the three-year termof this part-time employment arrangement. He also has agreed to abide by arestriction on competing with the Company during this period.

 

In June 2001, weentered into an employment agreement with Mr. Reymann. The initial term of theagreement expired in June 2003, and the term automatically extends foradditional one-year terms until terminated by Aether or Mr. Reymann on no lessthan 90 days’ advance notice (which must be given before the end of theapplicable one-year extensions). We have continued to employ Mr. Reymann sinceJune 2003 pursuant to the terms of this employment agreement, with continuousannual extensions. The agreement provides for a base salary of not less than$150,000 per year and annual bonuses to be established by the board, thecompensation committee or, if the board directs, our chief executive officer orpresident. Mr. Reymann’s annual base salary was increased to $180,000 in 2002,and he has not been awarded a cash bonus since 2002, other than the bonus hereceived in 2004 in connection with the sale of Aether’s mobile and wirelessdata businesses.

 

Mr. Reymann mayresign upon 90 days’ advance notice to Aether. If we terminate Mr. Reymann’semployment without “cause,” or he resigns for “good reason” (each as defined inhis employment agreement), he is entitled to receive an amount equal to 12months’ base salary, COBRA group health coverage premium costs, immediate vestingof options, restricted stock or other equity instruments, and a pro rata shareof the maximum bonus he would have been eligible to receive in the year oftermination of his employment. Under the agreement, “good reason” would existif Aether materially breaches the agreement or materially reduces Mr. Reymann’stitle, authority or responsibilities, and “cause” would exist if Mr. Reymanncommits a material breach of the agreement, commits an act of gross negligencewith respect to Aether or otherwise acts with willful disregard for Aether’sbest interests, or is convicted of or pleads guilty or no contest to a felony.“Cause” also would exist if, with respect to his employment, Mr. Reymanncommits either a material dishonest act or common law fraud or knowinglyviolates any federal or state securities or tax laws. The agreement providesthat if there is a change in control of Aether and within 12 months after thechange of control, Mr. Reymann resigns for “good reason” or is terminatedwithout “cause,” all options, restricted stock or other equity instruments heldby Mr. Reymann will become fully exercisable. A “change in control” means theoccurrence of any of the following:  asale of all or substantially all of Aether’s assets, the dissolution orliquidation of Aether, a person or group purchasing over half of Aether’svoting securities, a merger or consolidation of Aether, a successful proxycontest replacing at least a majority of our board of directors, or during anytwo-year period the incumbent board ceasing to constitute a majority of theboard, provided that individuals that a majority of the incumbent directorsapprove for service on the board are treated as incumbent directors. Theagreement also provides that Mr. Reymann will not compete or interfere withAether within the United States or solicit for employment any employee of theCompany  for a period of one year afterhis termination of employment for any reason.

 

On March 9, 2006,our Board of Directors, at the recommendation of the Compensation Committee,approved an amendment to Mr. Reymann’s employment agreement, which Mr. Reymannand the Company expect to finalize over the next several weeks. As a result ofthis amendment, if Mr. Reymann’s employment is terminated by Aether without“cause,” or if Mr. Reymann resigns for “good reason,” he would be entitled toreceive his base salary and group health coverage premium costs for a period of24 months, rather than 12 months. The estimated cost to Aether of theseseverance payments is approximately $389,000. This amount does not include anyvalue for the accelerated vesting of equity awards and does not include anyamount for a pro-rated bonus, as described above. Mr. Reymann also has agreedto abide by the terms of the non-solicitation, non-competition andnon-interference provisions of his employment agreement for the 24 monthseverance period.

 

In connection withthe amendment of the employment agreements with Messrs. Oros and Reymann, theBoard of Directors, at the recommendation of the Compensation Committee,approved grants of 150,000 and 50,000 shares of restricted stock to Mess~~s~~rs.Oros and Reymann, respectively. The terms of such restricted shares arediscussed below in the Compensation Committee Report on Executive Compensation.

 

**Compensation Committee Report onExecutive Compensation**

 

The compensation committee of Aether’s board ofdirectors is responsible for establishing and evaluating salaries and othercompensation for the chief executive officer and other senior officers,including the named executive officers. The compensation committee is comprisedof the following three independent directors: Messrs. Beese, Dunn and Mathias, with Mr. Mathias serving as thecompensation committee chairman. This report relates to Aether’s compensationpolicy for its named executive officers for fiscal year 2005.

 

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This compensation committee report covers thefollowing topics:

 

•      roleof the compensation committee

 

•      executivecompensation guiding principles

 

•      componentsof Aether’s compensation program

 

•      compensationof David Oros, Aether’s chairman and chief executive officer

 

**Role of the Compensation Committee**

 

The compensation committee’s primary responsibility isto establish Aether’s compensation programs. The compensation committeedetermines all compensation paid or awarded to Aether’s key executive officerseach year, except that Aether’s board of directors has delegated to Mr. Oros,as a board committee of one, the ability to make grants of up to 40,000 sharesper individual pursuant to Aether’s 1999 Equity Incentive Plan and Aether’sAcquisition Incentive Plan, subject to his duty to report periodically to thecompensation committee.

 

The compensation committee’s goal is to retain andmotivate executives who can assist Aether with its operations and strategicactivities and advance the interests of our stockholders. To do so, thecompensation committee oversees Aether’s compensation system to ensure that theCompany is offering competitive and fair compensation that rewards executivesfor continued service and exceptional performance.

 

The compensation committee measures both corporate andindividual performance based primarily on objective factors that it believesare important in assessing performance including the achievement of strategicbusiness, corporate and financial goals. Additionally, the compensationcommittee considers more subjective factors that it believes are important inevaluating performance, including assisting Aether with managing its businessand exploring strategic alternatives.

 

**Executive Compensation GuidingPrinciples**

 

The compensation committee has established anexecutive compensation program designed to:

 

•      providecompetitive cash compensation and long-term incentives to attract and retainhigh-caliber executives;

 

•      encouragestrong performance of our executive officers through bonuses when achievingpre-determined goals and other long-term incentives; and

 

•      alignour executive officers’ interests with the long-term interests of stockholdersthrough awards of stock options and restricted stock.

 

The compensationcommittee’s charter reflects these responsibilities. The committee and Aether’sboard of directors periodically review the charter and consider appropriate revisions.Aether’s board of directors annually determines the compensation committee’smembership. The compensation committee meets as needed throughout the year andalso considers action by written request when appropriate. In addition, thecompensation committee has the authority to engage the services of outsideadvisors, including consultants and counsel.

 

**Components of Aether’s CompensationProgram**

 

Executive officers’ compensation consists primarily ofthree components: (i) base salary, (ii) cash bonus opportunity and (iii) grantsof stock options and restricted stock. In determining an executive’scompensation, the compensation committee considers all elements of anexecutive’s total compensation package, including employee benefits andinsurance.

 

*Base Salary*. Basesalaries for Aether’s executives are initially determined by evaluating theexecutive’s level of responsibility within Aether, prior experience and breadthof knowledge. Through the establishment of competitive base salaries, thecompensation committee strives to ensure that base salaries are set at levelsthat permit Aether to retain managers and executives with the qualificationsand abilities necessary to allow Aether to achieve its strategic business,corporate and financial goals. The compensation committee annually reviews anddiscusses the levels of base salary for Aether’s executive officers. Increasesto base salaries are driven primarily by performance and evaluated based onsustained levels of contribution to the company. The factors 

 

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impacting base salary decisions are not assignedspecific weight by the compensation committee, but are considered together inthe aggregate.

 

In 2005, the compensation committee did not make anychanges to the base salaries of the executive officers, concluding that suchsalaries remained appropriate in light of market conditions and the status ofAether’s business.

 

On March 9, 2006, the compensation committee reviewedthe base salaries of all of Aether’s officers and concluded that no changeswere necessary for 2006. The compensation committee concluded that the currentlevels of base salary being paid should be sufficient to enable Aether toretain these officers while Aether continues to develop its business andexplore potential new strategies. The committee acknowledged that if theCompany opted to pursue a new or different business strategy, changes tocompensation, including base salary, might be necessary or appropriate.

 

*Cash Bonus*. Annualperformance bonuses are based on the compensation committee’s evaluation of theexecutive’s performance in achieving annual corporate goals and specified goalsset by management or the board of directors for the year. In 2004, Aether’sprimary goal was to sell its operating business and Mr. Reymann, Aether’s chieffinancial officer, was awarded a cash bonus for his role in such sales. In2005, Aether’s primary goal was to fully implement its MBS strategy, but thecompensation committee did not award any cash bonuses to the Company’sexecutive officers, taking into account the status of the MBS business and theCompany’s financial results for 2005. As Aether pursues potential new strategicopportunities during 2006, the compensation committee may consider (and award)cash bonuses to reflect the successful implementation of new or additionalbusiness strategies.

 

*Stock Grants*. Thecompensation committee believes that achievement of Aether’s business andfinancial goals may be fostered by stock grant programs that reward employeeswho significantly enhance Aether’s value by tying the employees’ compensationto the value of Aether. Aether does not have a specific stock ownership policyfor its employees, executives or directors. The compensation committee has theauthority to grant options and issue restricted stock pursuant to Aether’s 1999Equity Incentive Plan and the 2002 Acquisition Incentive Plan. Option grantswill generally vest ratably over a period of several years, and thecompensation committee will not approve stock option grants with exerciseprices below the market price of Aether’s stock on the date of grant.

 

In 2005, the compensation committee did not grant any options or issueany restricted stock to our executive officers or directors. On March 9, 2006,the compensation committee concluded that a grant of restricted stock toAether’s senior officers, including the two named executive officers, would bean appropriate incentive that would further align the interests of Aether’smanagement with the interests of the stockholders and would properly rewardsenior management if it is able to succeed in implementing desirable newbusiness strategies. Accordingly, the compensation committee (acting with theapproval of the full board) granted 150,000 shares of restricted stock ofAether to Mr. Oros and 50,000 shares of restricted stock of Aether to Mr.Reymann. The shares granted to Mr. Oros will vest in three equal annualincrements over a three-year period, beginning on the date (the “Trigger Date”)on which Aether completes one or more transactions that meet specified minimum valuation, revenue or cash flow targets and ending on the thirdanniversary of such date. The shares granted to Mr. Reymann will vest in twoequal annual increments over a two-year period, beginning the Trigger Date.Vesting of these awards will continue during any period of part-time employmentof Mr. Oros and during the period that Mr. Reymann is entitled to receiveseverance (under the recently agreed changes to their respective employmentagreements).

 

From time to time, the compensation committee willalso grant non-employee directors stock options in recognition of their serviceon the board of directors. The compensation committee has not granted anyoptions to Aether’s non-employee directors since 2002 because it believes theoptions the directors were granted in 2002 are sufficient to promote Aether’sinterest in having its directors own stock in the company. In 2006, thecompensation committee will consider whether additional grants of stock optionsor the issuance of restricted stock are appropriate, taking into account thefact that all options that were granted in 2002 to non-employee directors willfully vest in June 2006.

 

*Other Compensation*.In addition to the compensation discussed above, Aether also provides itsemployees, including its named executive officers, with customary employeebenefits, including health, disability and life insurance. Aether also matchescontributions made by its employees and executive officers pursuant to Aether’s401K plan. Overall, the benefits available to Aether’s executives aresubstantially the same as those available to all of Aether’s employees. Thecompensation committee believes these employee benefits are necessary andsufficient to compensate and retain Aether’s employees.

 

*Chief Executive Officer’sCompensation*. In June 1999, Aether entered into an employmentcontract with Mr. Oros. The initial term of this agreement expired in June 2002and is automatically extended for additional one month increments untilterminated by Aether or Mr. Oros on 15 days advance notice. The compensationcommittee believes it is in the best interests of Aether and its stockholdersto continue to renew Mr. Oros’ employment agreement on a monthly basis and to compensateMr. Oros pursuant to the terms of this agreement. Mr. Oros’ employmentagreement provides for a base salary of $200,000 per year, a performance bonusof up to $100,000 per year, and additional bonuses based on annual revenuetargets.

 

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In 2005, Mr. Oros received a base salary of $200,000in accordance with the terms of his employment contract. Mr. Oros also receivedcertain employee benefits, such as life insurance coverage of $300,000, short-and long-term disability insurance, business travel accident insurance, healthinsurance and a 401(k) match, all of which were consistent with benefitsoffered to all other Aether employees. Consistent with Mr. Oros’ request, thecommittee did not award him a cash bonus or any equity grants in 2005.

 

On March 9, 2006, the compensation committee approveda modification to Mr. Oros’ employment agreement, which is described aboveunder “Employment Agreements, Other Agreements.”  The compensation committee also awarded Mr.Oros 150,000 shares of restricted stock, as described above.

 

The compensation committee believes that Mr. Oros’total compensation for 2005 was reasonable and appropriate based upon Aether’sresults of operations and will continue to monitor his overall compensation toensure that it supports the achievement of Aether’s future goals and objectivesas outlined by the board of directors. The compensation committee also believesthat the modifications to Mr.Oros’ employment agreement and the grant ofrestricted stock approved in March 2006 were reasonable and appropriate, basedon Mr. Oros’ past contributions to Aether and the value Mr. Oros is expected toadd as Aether explores and evaluates additional strategic businessopportunities.

 

*Compensation Deduction Limit*.Section 162(m) of the Internal Revenue Code generally limits the compensationthat a corporation can deduct for payments to a chief executive officer and thefour other most highly compensated executive officers to $1 million per officerper year. However, compensation that is “performance-based,” as defined bySection 162(m), is exempt from this limitation on deductibility. Optionexercises are typically deductible under the “performance-based” exemption ifthe option is granted with an exercise price at or above the market price whengranted. The compensation committee has designed Aether’s compensation programsto preserve the tax deductibility of the compensation paid to senior executiveofficers under section 162(m), while at the same time providing Aether’sexecutive officers with incentives to work with Aether and enhance its value.The compensation committee may, however, also award compensation that is notexempt from the limitations on deductibility under section 162(m) where it believessuch compensation is in the best interests of Aether and its stockholders,balancing tax efficiency with long-term strategic goals.

 

**Summary**

 

The compensation committee is committed to continuallyreviewing Aether’s compensation philosophy and programs to ensure that they aremeeting Aether’s objectives of providing compensation that attracts and retainsour executive officers and encourages them to advance the best interests ofstockholders and achieve Aether’s business and strategic goals. The committeeintends to remain particularly vigilant to considering how changes in Aether’sbusiness and strategy may warrant or require modifications to the level andcomposition of compensation offered to executives.

 

This compensation committee Report shall not be deemed“soliciting material,” to be “filed” with the SEC, subject to Regulation 14A or14C or to the liabilities Section 18 of the Exchange Act, except to the extentwe specifically request that the information be treated as soliciting material.This report shall not be deemed incorporated by reference in any documentpreviously or subsequently filed with the SEC that incorporates by referenceall or any portion of this proxy statement/prospectus, unless this report isspecifically incorporated by reference.

 

COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS

 

J. Carter Beese, Jr.

Jack B. Dunn, IV

Edward J. Mathias, Chairman

 

**CompensationCommittee Interlocks and Insider Participation**

 

None of the members of ourcompensation committee is or has ever been an officer or employee of Aether orany of its subsidiaries. None of our executive officers serves as a member ofthe board of directors or compensation committee of any entity that has one ormore executive officers serving on our board of directors or compensationcommittee.

 

 

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**Director Compensation**

 

In 2005,non-employee directors received $5,000 for each board meeting they attend,reimbursement for reasonable travel expenses relating to attendance at boardmeetings and discretionary grants of stock options. In 2005 audit committeemembers received $2,000 for each audit committee meeting they attend, and Mr.Brady, as chairman of the audit committee, received a $7,500 annual retainer.In March 2006, the Board approved increases in the compensation payable tonon-employee directors. Non-employee directors will now receive an annualretainer of $20,000 (paid quarterly) and receive $1,500 for each board meetingthey attend in person or by phone. The chairperson of each board committee(other than the audit committee) will receive an annual retainer of $2,500.Audit committee members will now receive $2,500 for each audit committeemeeting they attend, and the chairman of the audit committee will receive a $12,500annual retainer. Directors will continue to be reimbursed for reasonable travelexpenses relating to attendance at board meetings.

 

In the discretion of theboard of directors, the non-employee directors may receive stock options fortheir service on the board. In 2002, each director received a grant of 100,000stock options, of which 25,000 vested in each of June 2003, June 2004 andJune 2005, with the remaining 25,000 to vest in June 2006, except that theunvested options issued to Mr. Semans were fully vested in 2005. No optionshave been granted to our directors since 2002, but the Board of Directors plansto consider during 2006 whether to authorize additional equity awards tonon-employee directors. Directors who are employees of Aether do not receivecompensation for their services as directors or as members of board committees.

 

**StockPerformance Graph**

 

As part of disclosure requirements mandated by the SEC, we are requiredto provide a comparison of the cumulative total stockholder return on ourcommon stock with that of a broad equity market index and either a publishedindustry index or a peer group index.

 

The following graph providesa comparison of the cumulative total stockholder return on Aether’s commonstock since December 31, 2000 with the cumulative total return of theNasdaq Market Index and the Bloomberg REIT Mortgage Index, or the BBG REITMortgage Index, a published industry index of real estate investments trustsengaged in the business of mortgage investment.

 

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**CUMULATIVE TOTAL RETURN COMPARISON**

 

 

 
| ** **              | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| AETHER SYSTEMS, INC.    |       | $        | 100.00     |     | $          | 23.51    |       | $        | 9.61       |     | $          | 12.14    |       | $ | 8.54 |   | $ | 8.49 |   |
| BBG REIT MORTGAGE INDEX |       | $        | 100.00     |     | $          | 87.62    |       | $        | 130.70     |     | $          | 204.34   |       | $ | 285.70 |   | $ | 224.06 |   |
| NASDAQ MARKET INDEX     |       | $        | 100.00     |     | $          | 79.71    |       | $        | 55.60      |     | $          | 83.60    |       | $ | 90.63 |   | $ | 92.62 |   |

 

This graph assumes that $100was invested on December 31, 2000 in Aether’s common stock and in each ofthe above indices with reinvestment of any dividends. The cumulative total returns indicated in the graph are not necessarily indicative andare not intended to suggest future cumulative total returns.

 

This graph shall not bedeemed to be incorporated by reference into any prior or subsequent filing byAether under the Securities Act of 1933 or the Securities Exchange Act of 1934.

 

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**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

The followingtable sets forth certain information with respect to beneficial ownership ofour common stock as of February 20,****2006,as to:

 

•    each of our directors and named executiveofficers individually;

 

•    all our directors and executive officers asa group; and

 

•    each person (or group of affiliated persons)known by us to own beneficially more than 5% of our outstanding common stock.

 

For thepurposes of calculating percentage ownership as of February 20, 2006,44,018,946 shares were issued and outstanding and, for any individual whobeneficially owns shares of restricted stock that will vest or sharesrepresented by options that are or will become exercisable within 60 days ofFebruary 20, 2006, those shares are treated as if outstanding for that person,but not for any other person. In preparing the following table, we relied uponstatements filed with the SEC by beneficial owners of more than 5% of theoutstanding shares of our common stock pursuant to Section 13(d) or13(g) of the Exchange Act, unless we knew or had reason to believe thatthe information contained in such statements was not complete or accurate, inwhich case we relied upon information which we considered to be accurate andcomplete. Unless otherwise indicated, the address of each of the individualsand entities named below is: c/o Aether Holdings, Inc., 621 E. PrattStreet, Suite 601, Baltimore, Maryland 21202.

 

 
| **Name and Address**                                                                            | ** ** | **Beneficial Ownership  of Shares** | ** **  |
|-------------------------------------------------------------------------------------------------|------------|-------------------------------------|-------------|
| ** **                                                                                      | **Number** | ** **                          | **Percent** | ** ** |
| **Directors and executive officers:**                                                           |       |                                |        |   |   |
| David S. Oros(1)                                                                                |       | 4,664,000                           |        | 10.6 | % |
| David C. Reymann(2)                                                                             |       | 177,750                             |        |   | * |
| J. Carter Beese, Jr.(3)                                                                    |       | 268,702                             |        |   | * |
| James T. Brady(4)                                                                               |       | 77,500                              |        |   | * |
| Jack B. Dunn IV(5)                                                                              |       | 75,000                              |        |   | * |
| Edward J. Mathias(6)                                                                            |       | 131,700                             |        |   | * |
| Truman T. Semans(7)                                                                             |       | 148,650                             |        |   | * |
| George P. Stamas(8)                                                                             |       | 166,868                             |        |   | * |
|                                                                                            |       |                                |        |   |   |
| All directors and named executive officers  as a group (8 Persons)                              |       | 5,710,170                           |        | 13.0 | % |
|                                                                                            |       |                                |        |   |   |
| **5% stockholders:**                                                                            |       |                                |        |   |   |
| Amaranth, L.L.C.(9)  One American Lane  Greenwich, CT 06831                                     |       | 7,302,500                           |        | 16.6 | % |
| NexGen Technologies, L.L.C                                                                      |       | 2,506,697                           |        | 5.7 | % |
| Telcom-ATI Investors, L.L.C  211 N. Union St.,  Suite 300  Alexandria, VA 22314            |       | 2,902,027                           |        | 6.6 | % |
| Dimensional Fund Advisors Inc.(10)  1299 Ocean Avenue, 11th Floor  Santa Monica, CA 90401       |       | 3,678,683                           |        | 8.36 | % |
| CCM Master Qualified Fund, Ltd.(11)  One North Wacker Drive, Suite 4725  Chicago, IL 60606 |       | 2,154,338                           |        | 4.9 | % |

 

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| *      |       Less than 1%.                                                                          |
|--------|----------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                       |
| (1)    | Includes  2,506,697 shares of common stock owned by NexGen Technologies, L.L.C. over  which Mr. Oros exercises voting |

 

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|   | and investment  control by virtue of his position as managing member of NexGen. Also includes  exercisable warrants to purchase 812,500 shares of common stock and  exercisable options to purchase 105,600 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    | Includes exercisable  warrants to purchase 5,416 shares of common stock and exercisable options to  purchase 133,334 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| (3)    | Includes  exercisable options to purchase 123,600 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (4)    | Includes  exercisable options to purchase 75,000 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (5)    | Includes  exercisable options to purchase 75,000 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| (6)    | The address  for Mr. Mathias is c/o The Carlyle Group, 1001 Pennsylvania Avenue, NW,  Washington, DC 20004. Includes exercisable options to purchase 75,000 shares  of common stock, 19,000 shares of common stock held indirectly in a  retirement account and 4,700 shares of common stock held as custodian for  Ellen Mathias.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (7)    | Includes  30,000 shares of common stock held jointly by Mr. Semans and his wife,  and 18,650 shares of common stock held by the Semans Scholarship Fund at the  Lawrenceville School at which Mr. Semans is a trustee emeritus which Mr.  Semans disclaims beneficial ownership of such securities. Includes  exercisable options to purchase 100,000 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (8)    | Includes  exercisable options to purchase 110,600 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| (9)    | Based solely  on reports filed with the SEC as of February 3, 2006. Includes 7,302,500  shares beneficially owned by Amaranth, L.L.C., or, Amaranth Advisors, L.L.C.,  the investment manager of Amaranth, and Nicholas M. Manounis, the managing  member of Amaranth Advisors, L.L.C.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| (10)   | Based solely  on reports filed with the SEC as of February 6, 2006. Dimensional Fund  Advisors Inc. (“Dimensional”), an investment advisor registered under  Section 203 of the Investment Advisors Act of 1940, furnishes investment  advice to four investment companies registered under the Investment Company  Act of 1940, and serves as investment manager to certain other commingled group  trusts and separate accounts. These investment companies, trusts and accounts  are called the Investment Group. In its role as investment advisor or  manager, Dimensional possesses voting and/or investment power over the  securities described in this schedule that are owned by the Investment  Group, and may be deemed to be the beneficial owner of the shares of our  common stock held by the Investment Group. All securities reported in this  schedule are owned by the Investment Group, and Dimensional disclaims  beneficial ownership of such securities. |
| (11)   | Based solely  on reports filed with the SEC as of February 8, 2005. Includes 2,154,338  shares beneficially owned by CCM Master Qualified Fund, L.L.C., (“CCM”),  Coghill Capital Management, L.L.C., (“Coghill Managemen”), which serves as  the investment manager of CCM, and Clint D. Coghill who is the managing  member of Coghill Management.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

*Securities Authorized for IssuanceUnderEquity Compensation Plans*

 

See Item 5 ofPart II of this Report for information regarding securities authorized forissuance under equity compensation plans.

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

We have engaged in thefollowing transactions or there are currently proposed transactions with thefollowing persons:

 

•      directorsor executive officers;

•      beneficialowners of 5% or more of Aether’s common stock;

•      immediatefamily members of the above; and

•      entitiesin which the above persons have substantial interests.

 

Huber Oros &Company, LLC, or Huber Oros, served as the administrative agent of ourcorporate benefits program from the middle of 2000 until February 2005. MatthewOros, the chief executive officer and founder of Huber Oros, is the brother ofDavid S. Oros, our Chairman and Chief Executive Officer. In February2005, Huber Oros was acquired by an unrelated entity and the individual who isa related party did not retain any continuing ownership interest in theacquiring entity.  HuberOros billed Aether $7,000 in agency fees in 2005.

 

Since the middle of 2003, Kirkland &Ellis LLP has been Aether’s outside legal counsel. George P. Stamas, a directorof Aether, is a partner in the law firm of Kirkland & Ellis LLP.During 2005, Kirkland & Ellis LLP billed Aether approximately$640,000. For the year ended December 31, 2005, Aether had outstanding payablesdue Kirkland & Ellis LLP of approximately $45,000. The vast majority ofthese fees were incurred in connection with Aether’s corporate reorganizationand the implementation of transfer restrictions and the evaluation of a rangeof strategic options.

 

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**ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES**

 

**Audit Fees**

 

The aggregate fees billed forprofessional services rendered for Aether by KPMG LLP, Aether’s independent auditor,for the years ended December 31, 2005 and 2004 were:

 

| ** **         | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------|------------|----------|------------|----------|------------|
| Audit Fees         |       | $        | 223,000    |     | $          | 633,000 |   |
| Audit-Related Fees |       | —   |       | 495,000  |       |
| Tax Fees           |       | $        | 28,300     |     | 255,000    |   |
| All Other Fees     |       | —   |       | —   |       |
| Total Fees         |       | $        | 251,300    |     | $          | 1,383,000 |   |

 

“Audit Fees”include time billed to Aether for professional services rendered for the annualaudit for Aether’s consolidated financial statements, the quarterly reviews ofthe consolidated financial statements for fiscal years 2005 and 2004 and theaudit with respect to management’s assessment of the effectiveness of internalcontrol over financial reporting as of December 31, 2005 and 2004 and theeffectiveness of internal control over financial reporting as of December 31,2005 and 2004.

 

The aggregate amount billedfor all tax fees for the years ended December 31, 2005 and 2004 (see chartabove under heading “Tax Fees”) principally covered tax planning, taxconsulting and tax compliance services provided to Aether.

 

The aggregatefees billed for all audit related services rendered by KPMG for the year endingDecember 31, 2004 (see chart above under the heading “Audit-Related Fees”principally covered accounting consultations and audits and consultations inconnection with the disposition of Aether’s wireless businesses. No fees werebilled for “Audit Related Fees” for the year ended December 31, 2005.

 

Aether does not use itsindependent auditor as its internal auditor nor does it have an internalauditor.

 

No other professionalservices were rendered or fees were billed by KPMG for the most recent fiscalyear or for the year ending December 31, 2005 and 2004.

 

The audit committee hasadopted policies and procedures for the pre-approval of the above fees. Allrequests for services to be provided by KPMG are submitted to the auditcommittee. Requests for all non-audit related services require pre-approvalfrom the entire audit committee. A schedule of approved services is thenreviewed and approved by the entire audit committee at each audit committeemeeting.

 

Less than 50%of the hours expended on the audit engagement of KPMG were attributable topersons other than full-time, permanent employees of KPMG.

 

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**PART IV**

 

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 

FINANCIAL STATEMENTS ANDSCHEDULES

 

The following financial statements required by thisitem are included in the Report beginning on page 36.

 
|   | Report of Management on Internal Control over Financial Reporting                                                        |   |
|--------|--------------------------------------------------------------------------------------------------------------------------|--------|
|   | Reports of Independent Registered Public Accounting Firm                                                                 |   |
|   | Consolidated Balance Sheets as of December 31, 2004 and 20045                                                       |   |
|   | Consolidated Statements of Operations and Comprehensive Loss for the  years ended December 31, 2003, 2004, and 2005 |   |
|   | Consolidated Statements of Stockholders’ Equity for the years ended  December 31, 2003, 2004 and 2005          |   |
|   | Consolidated Statements of Cash Flows for the years ended  December 31, 2003, 2004 and 20045                        |   |
|   | Notes to Consolidated Financial Statements                                                                               |   |

 

All other schedules are omitted because they are notapplicable or the required information is shown in the Audited ConsolidatedFinancial Statements or the notes thereto.

 

EXHIBITS

 

The following exhibits are filed herewith or areincorporated by reference to exhibits previously filed with the SEC.

 

Exhibit Index

 
| *2.1   |   | Agreement and Plan of  Reorganization, dated as of May 4, 2005 (Designated as Exhibit 2.1 to the  Form S-4 dated May 4, 2005.)                                                                                                              |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                        |
| *2.2   |   | Asset Purchase  Agreement dated August 16, 2004 by and among Aether Systems Inc., Sunpro  Inc., Cerulean Technologies, Inc. and BIO-key International, Inc. (Designated  as Exhibit 2.1 to the Form 10-Q dated November 9, 2004.) |
|   |   |                                                                                                                                                                                                                                        |
| *2.3   |   | Asset Purchase  Agreement dated July 20, 2004 by and among Aether Systems Inc.,  Slingshot Acquisition Corporation and Platinum Equity Capital Partners, L.P.  (Designated as Exhibit 2.1 to the Form 10-Q dated August 9, 2004.) |
|   |   |                                                                                                                                                                                                                                        |
| *3.1   |   | Certificate of  Incorporation of Aether Holdings, Inc. (Designated as Exhibit 3.1 to the Form  S-4 dated May 4, 2005.)                                                                                                                      |
|   |   |                                                                                                                                                                                                                                        |
| *3.2   |   | Bylaws of Aether  Holdings, Inc. (Designated as Exhibit 3.2 to the Form S-4 dated May 4, 2005.)                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                        |
| *4.1   |   | Specimen Certificate  for Aether Holdings Common Stock (Designated as Exhibit 4.1 to the Form S-4  dated May 4, 2005.)                                                                                                                      |
|   |   |                                                                                                                                                                                                                                        |
| *10.1  |   | Employment Agreement  between Aether Technologies International, L.L.C. and David Oros dated  July 7, 1999. (Designated as Exhibit 10.7 to the Form S-1/A dated  September 10, 1999.)                                             |
|   |   |                                                                                                                                                                                                                                        |
| *10.2  |   | Employment Agreement  between Aether Systems, Inc. and David C. Reymann dated June 8, 2001.  (Designated as Exhibit 10.1 to the Form 10-Q dated August 14, 2001.)                                                                 |
|   |   |                                                                                                                                                                                                                                        |
| *10.3  |   | Aether Systems, Inc.  1999 Equity Incentive Plan as amended June 22, 2001. (Designated as  Exhibit 10.4 to the Form 10-K dated March 1, 2002.)                                                                                    |
|   |   |                                                                                                                                                                                                                                        |
| *10.4  |   | Aether Systems, Inc.  Senior Bonus Plan effective as of September 29, 1999. (Designated as  Exhibit 10.20 to the Form S-1/A dated October 19, 1999.)                                                                              |
|   |   |                                                                                                                                                                                                                                        |
| *10.5  |   | Aether Systems, Inc.  Acquisitions Incentive Plan effective as of December 15, 2000.  (Designated as Exhibit 4.1 to the Form S-8 dated December 20, 2000.)                                                                        |
|   |   |                                                                                                                                                                                                                                        |
| *10.6  |   | Investment Management  Agreement, dated June 8, 2004 by and between Aether Systems Inc., and  FBR Investment                                                                                                                           |

 

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|   |   | Management Inc.  (Designated as Exhibit 10.1 to the Form 10-Q dated August 9, 2004.)                                                                                                                                                            |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                 |
| *10.7  |   | Principal Stockholder  Agreement dated July 20, 2004 by and among David S. Oros, NexGen  Technologies, L.L.C. and Slingshot Acquisition Corporation. (Designated as  Exhibit 10.2 to the Form 10-Q dated August 9, 2004.)                  |
|   |   |                                                                                                                                                                                                                                                 |
| *10.8  |   | Secured Subordinated  Promissory Note in the principal amount of $6,884,588 dated  September 30, 2004 payable to Aether Systems, Inc by BIO-key  International, Inc. (Designated as Exhibit 10.2 to the Form 10-Q dated  November 9, 2004) |
|   |   |                                                                                                                                                                                                                                                 |
| *10.9  |   | Master Repurchase  Agreement between Aether Systems, Inc. (and FBR Investment Management Inc. as  Agent) and Daiwa Securities America, Inc. (Designated as Exhibit 10.12 to the  Form 10-K dated March 16, 2005.)                               |
|   |   |                                                                                                                                                                                                                                                 |
| *10.10 |   | Master Repurchase  Agreement between Aether Systems, Inc. (and FBR Investment Management Inc. as  Agent) and UBS Financial Services, Inc. (Designated as Exhibit 10.13 to the  Form 10-K dated March 16, 2005.)                                 |
|   |   |                                                                                                                                                                                                                                                 |
| *10.11 |   | Master Repurchase  Agreement between Aether Systems, Inc. (and FBR Investment Management Inc. as  Agent) and Countrywide Securities Corporation. (Designated as Exhibit 10.14  to the Form 10-K dated March 16, 2005.)                          |
|   |   |                                                                                                                                                                                                                                                 |
| *10.12 |   | Master Repurchase  Agreement between Aether Systems, Inc. (and FBR Investment Management Inc. as  Agent) and Nomura Securities International, Inc. (Designated as Exhibit 10.15  to the Form 10-K dated March 16, 2005.)                        |
|   |   |                                                                                                                                                                                                                                                 |
| 10.13  |   | Letter Agreement dated  January 23, 2006 by and among Aether Systems, Inc. and BIO-key International,  Inc.                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                 |
| 10.14  |   | Amendment No. 1 to the  Secured Subordinated Promissory Note in the principal amount of $7,884,588  dated January 23, 2006 payable to Aether Systems, Inc by BIO-key  International, Inc.                                                            |
|   |   |                                                                                                                                                                                                                                                 |
| 21.1   |   | Subsidiaries of Aether  Systems                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                 |
| 23.1   |   | Consent of KPMG LLP                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                 |
| 31.1   |   | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 (“Sarbanes-Oxley”)                                                                                                               |
|   |   |                                                                                                                                                                                                                                                 |
| 31.2   |   | Certification of Chief  Financial Officer pursuant to Section 302 of Sarbanes-Oxley                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                 |
| **32.1 |   | Certifications pursuant  to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the  Sarbanes– Oxley Act of 2002 for David S. Oros and David C. Reymann                                                                      |

 

----

*Incorporated byreference

 

** These certificationsare being furnished solely pursuant to Section 906 of the Sarbanes-OxleyAct of 2002 and are not being filed as part this Annual Report on Form 10-K oras a separate disclosure document.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly causedthis report on Form 10-K to be signed on its behalf by the undersigned,thereunto duly authorized on March 15, 2006.

 
|   | **AETHER HOLDINGS, INC.** |
|--------|---------------------------|
|   |                      |
|   |                      |
|   | *By:*                     | /s/ David S. Oros |   |
|   |                      | *DAVID  S. OROS* |   |
|   |                      | *Chairman  and Chief Executive Officer* |   |

 

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, this report has been signed by the following persons inthe capacities and on the dates indicated.

 

 
| **SIGNATURE**             | ** ** | **TITLE**                                      | ** ** | **DATE**        | ** ** |
|---------------------------|------------|------------------------------------------------|------------|-----------------|------------|
|                      |       |                                           |       |            |       |
| /s/ David S. Oros         |       | Chairman and Chief                             |       | March 15, 2006. |       |
| DAVID S. OROS             |       | Executive Officer                              |       |            |       |
|                      |       |                                           |       |            |       |
| /s/ David C. Reymann      |       | Chief Financial  Officer                       |       | March 15, 2006. |       |
| DAVID C. REYMANN          |       | (Principal Financial  and  Accounting Officer) |       |            |       |
|                      |       |                                           |       |            |       |
| /s/ J. Carter Beese,  Jr. |       | Director                                       |       | March 15, 2006. |       |
| J. CARTER BEESE, JR.      |       |                                           |       |            |       |
|                      |       |                                           |       |            |       |
| /s/ James T. Brady        |       | Director                                       |       | March 15, 2006. |       |
| JAMES T. BRADY            |       |                                           |       |            |       |
|                      |       |                                           |       |            |       |
| /s/ George P. Stamas      |       | Director                                       |       | March 15, 2006. |       |
| GEORGE P. STAMAS          |       |                                           |       |            |       |
|                      |       |                                           |       |            |       |
| /s/ Jack B. Dunn, IV      |       | Director                                       |       | March 15, 2006. |       |
| JACK B. DUNN, IV          |       |                                           |       |            |       |
|                      |       |                                           |       |            |       |
| /s/ Edward J. Mathias     |       | Director                                       |       | March 15, 2006. |       |
| EDWARD J. MATHIAS         |       |                                           |       |            |       |
|                      |       |                                           |       |            |       |
| /s/ Truman T. Semans      |       | Director                                       |       | March 15, 2006. |       |
| TRUMAN T. SEMANS          |       |                                           |       |            |       |

 

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