**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM10-K**

 
| **ý****ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|------------------------------------------------------------------------------------------------------|
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| **FOR  THE FISCAL YEAR ENDED DECEMBER 31, 2002**                                                     |
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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  SYSTEMS, INC.**                                                       |
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| (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) |
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| **11460 CRONRIDGE DR. OWINGS MILLS, MD**                                        |   | **21117** |
| (Address of principal executive offices)                                        |   | (Zip Code) |
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| (Registrant’s telephone  number, including area code): **(410)  654-6400** |
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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  CONVERTIBLE SUBORDINATED NOTES DUE 2005**      |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes ý No o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III of theForm 10-K or any amendment of this Form 10-K. o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Act). Yes ý No o

 

Theaggregate market value of voting stock held by nonaffiliates of the registrantwas $124,482,714 as of June 28, 2002 ($2.95 per share).

 

The aggregate market value of the voting stock held bynonaffiliates of the registrant as of March 5, 2003 was $139,102,681.

 

As of March 5, 2003, 42,280,450 shares of theregistrant’s common stock, $.01 par value per share, were outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Proxy Statement for the 2003 Annual Meeting of theregistrant, which will be filed with the Commission within 120 days after the closeof the fiscal year, is incorporated by reference into Part III.

 

 

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**AETHERSYSTEMS, INC.**

**ANNUALREPORT ON FORM 10-K**

**FOR THEYEAR ENDED DECEMBER 31, 2002**

 

**INDEX**

 
| PART I   |
|----------|
|     |   |
| Item 1   | Business |
|     |   |
| 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 and Related Security Holder Matters |
|     |   |
| 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  | Change  In and Disagreements with Accountants on Accounting and Financial Disclosure |
|     |   |
| 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 |
|     |   |
| Item  13 | Certain  Relationships and Related Transactions |
|     |   |
| Item 14  | Controls and  Procedures |
|     |   |
| PART IV  |
|     |   |
| Item 15  | Exhibits, Financial Statement Schedules and Reports  on Form 8-K |

 

THIS ANNUAL REPORT ON FORM 10-K CONTAINSFORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. WHEN USEDHEREIN, THE WORDS ANTICIPATE, BELIEVE, ESTIMATE, INTEND, MAY, WILL, AND EXPECTAND SIMILAR EXPRESSIONS AS THEY RELATE TO AETHER SYSTEMS, INC. (AETHER) OR ITSMANAGEMENT ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THECOMPANY’S ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS COULD DIFFER MATERIALLYFROM THE RESULTS EXPRESSED IN, OR IMPLIED BY, THESE FORWARD-LOOKING STATEMENTS.FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSEDISCUSSED IN MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS AND BUSINESS. AETHER UNDERTAKES NO OBLIGATION TO UPDATEOR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEWINFORMATION, FUTURE EVENTS OR OTHERWISE.

 

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**PART I**

 

**ITEM 1.BUSINESS**

 

# **OVERVIEW**

 

Aether Systems, Inc. provides wireless and mobile workforce automationsolutions that are designed to make people more productive and theirorganizations more profitable.  Ourproducts and services are built on Aether Fusion (TM), our technology platformthat allows for secure, reliable extension of critical information to virtuallyany wireless or mobile environment

 

We provide the technologyand services necessary for businesses and government agencies to extendexisting and future applications and data from the desktop to almost anywireless or mobile device.  Aetherdelivers these capabilities through its technology foundation, Aether Fusion(TM), which provides enterprise class security, scalability (the ability togrow more effectively as customer needs grow), device and network independence,and ease of use.  The Aether Fusion(TM)technology platform also is designed to enable flexible mobile and wirelesssolutions that will grow and adapt as the enterprise itself grows andchanges.  Our market strategy is todevelop, deploy and manage mobile and wireless solutions built on industrystandard technology and backed by expertise in wireless hosting, software andservices.

 

Aether was originallyformed as Aeros, L.L.C. in January 1996. We changed our name to Aether Technologies International, L.L.C.effective August 1996 and to Aether Systems L.L.C. effective September1999.  Immediately prior to thecompletion of our initial public offering of common stock on October 21, 1999,we converted our organizational structure from a limited liability company to aDelaware corporation and changed our name to Aether Systems Inc Our Internetaddress is www.aethersystems.com.  SinceNovember 15, 2002, we have made available free of charge, on or through ourwebsite, our annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, and amendments to those reports filed or furnishedto the Securities and Exchange Commission pursuant to Section 13(a) or Section15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicableafter we electronically file such material with, or furnish it to, theSEC.  We are providing the address ofour internet site solely for the information of investors.  We do not intend the internet address to bean active link, and the contents of the website is not a part of this report.

 

THEAETHER SOLUTION

 

Since its inception in1996, Aether has recognized that wireless and mobile data applications are notjust the extension of systems and applications used in environments whereinfrastructure is physically connected. The continuing adoption of wireless and mobile data is driven byapplications built to work in a mobile environment from the start.  Most applications require access toinformation from many back-end systems. Aether’s expertise and focus has always been on the optimization ofaccessing and exchanging data in a mobile environment.

 

As an early entrant inthe emerging wireless data solutions market, Aether has helped drive technologyinnovation while adapting to market change. Over the last 18-24 months, growth in spending on wireless initiativeshas been slower than anticipated.  As aresult, Aether has focused its business strategy on markets that Aetherbelieves have demonstrated near-term growth potential based on return oninvestment (ROI) from wireless and mobile solutions.  In the markets we have identified, we are focused on building arevenue base and achieving maximum customer satisfaction.

 

Webelieve that wireless and mobile data solutions have helped organizationsincrease productivity and efficiency in transportation, logistics, mobileoffice, field service, government and Homeland Security.  We believe that companies and agenciesengaged in these activities are increasingly seeking to give their workforcesmobile and wireless access to corporate applications, company data, andinternal e-mail and groupware.  Remoteaccess can be achieved either through continuous real-time communications, orby periodically synchronizing data to a handheld device.

 

Wehave seen many corporate IT managers who explore wireless and mobile datasolutions quickly become overwhelmed with the complexity of the wireless worldand its frequently incompatible and changing protocols for carrier networks,devices and applications, as well as the issues surrounding support for suchdeployments.  As carrier networkscontinue to deploy newer technologies, we provide our customers with theability to migrate and upgrade to them due to the capabilities of our software.

 

Usingthe Aether Fusion(TM) technology foundation, we develop, deploy and managemobile and wireless solutions built on industry standard technology.  Businesses, systems integrators anddevelopers can also use elements of Aether Fusion(TM) on their own to quicklycreate, deploy and manage wireless solutions across multiple devices andcarrier networks.  We complement ourtechnology with services including wireless data engineering and applicationdevelopment, wireless data hosting, product fulfillment and customersupport.  These components can be usedseparately or in various combinations to extend existing and futureapplications and data to virtually any handheld device over virtually anywireless network.

 

OnJanuary 16, 2003, Aether announced two initiatives with EDS.  Under an alliance agreement with EDS, Aetherand EDS agreed to develop and deliver wireless and mobile solutions based onAether technologies and EDS services. In addition, under a managed services agreement, EDS will manage on afee basis, some of Aether’s internal information technology (IT) operations andcustomer care services.  This

 

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relationship will provideadditional flexibility for Aether to scale its services component morecost-effectively while allowing Aether access to EDS’s client relationships asa sales channel.

 

On February 5, 2003,Aether announced a global strategic alliance with Sun Microsystems.  The alliance will expand the companies’collaborative sales, marketing, and engineering efforts.  The companies will work together to developjoint solutions built on open standards using the Sun Open Net Environment andAether Fusion (TM).  The companies willalso work together to develop and market the joint solutions for field forcesin businesses and government agencies that perform functions such asmaintenance and service, distribution and delivery, public safety andhealthcare.

 

OnMarch 5, 2003, Aether announced the availability of Aether’s wireless datasolutions for public safety on Nextel’s i95cl JavaTMtechnology-enabled handsets and Nextel’s iM1100.  Focused principally on PocketBlueTM, a handheldapplication which can run on Nextel’s nationwide digital packet data network,this solution is part of a fully integrated mobile data system, providingwireless criminal database queries, secure messaging and alarm capabilities forall connected authorized mobile users. The handheld application integrates with Aether PacketClusterTM,which provides officers in vehicles with real-time silent communication throughtext messaging.

 

THEAETHER STRATEGY

 

We believe ourcapabilities and experience position Aether as a market leader in providingmobile and wireless data solutions to businesses and government agencies.  Our strategy is to extend our leadershipposition through our engineering expertise, our software products, our hostedservices and our partnerships with global technology leaders to move intogrowth opportunities.

 

Wewill continue to focus resources on core areas where we either have developed aleadership position or have recognized a clear market opportunity.  A number of our products have cross-sellingopportunities among the markets cited below. We are seeking to maximize these opportunities as we work with partnerslike EDS and Sun Microsystems.  Wecurrently focus on the following markets:

 

Transportation. Our mainproducts in this area are MobileMaxTM, a vehicle location and messaging solutionfor long-haul trucks, and a number of asset monitoring products, includingGeoLogicTM, TrailerMaxTM and 20/20vTM. MobileMAXTM allows transportation companies to increase their ROI throughthe least-cost-routing capability of multi-mode technology (terrestrial andsatellite connectivity) to deliver two-way data and dispatch messaging andautomatic, instantly communicated information on each vehicle - most typicallytrucks.  Least cost routing refers toMobileMax’s capability to utilize the less costly terrestrial-based wirelessconnectivity whenever possible. Otherwise, MobileMax is connected using satellite connectivity.  The optional enhancements for MobileMaxTMinclude a collection of geopositioning-driven features such as automaticstate-line crossing information, arrival/departure notifications, and certaingeo-fencing capabilities.  Geo-fencingis the ability to define geographic areas and boundaries upon which exceptionreporting, which is the ability to alert the appropriate personnel, can bebased.  Once a geo-fence is established,users can be automatically notified, as a result of exception reporting, if avehicle enters or leaves the defined area. This functionality can be used for territory management, route verification,arrival/departure notification and prohibited locations.  Exception reporting can also be applied to awide variety of additional events, such as arrivals, departures, deliveries,pick-ups, illegal entries, unauthorized movement, and more.

 

Aether markets GeoLogicTM,TrailerMaxTM and 20/20vTM, three asset monitoring products for trailers and othermobile assets, that incorporate a variety of geo-fencing and exceptionreporting features.  GeoLogicTM is amanagement and satellite-based tracking solution that allows fleet managers tomonitor thousands of trailers in the field by utilizing a unique,user-configurable event-driven and exception- based alert reportingsystem.  It incorporates the use ofgeo-fences and pre-determined events such as arrivals, departures, entry to thetrailer, and disconnection from the truck to help with mission critical andsecure load planning.  Its target marketis large trucking fleets.

 

TrailerMaxTMis an asset monitoring solution that is targeted towards for-hire truck fleetsand private truck fleets.  As comparedto GeoLogic, TrailerMax is a lower cost, terrestrial-based solution.

 

20/20vTMis a nationwide vehicle location and management solution targeting commercialfleets.  The product, which we believehas cross-selling potential, is often used to track private fleets such asthose used for field service, sales, and delivery organizations.  Location and status information is deliveredin real-time to an Internet-based host, providing anywhere, anytime managementof fleets.  Given 20/20vTM’sapplicability to large enterprises that have delivery and/or service fleetswhich support their businesses, Aether’s Enterprise Mobility Solutions divisionwill also market and sell Aether 20/20vTM to enterprise fleets operating inNorth America.

 

EnterpriseMobility Solutions (EMS).  We arefocused on providing integrated wireless data solutions to enterprises withproduct development emphasis on field service, sales force automation,distribution and delivery management, and mail and messaging access.  One of the primary tasks of EMS issupporting our relationships with EDS and Sun Microsystems.  EDS intends to add wireless and mobilecapabilities to its product offerings by adopting Aether’s technologies andexpertise.  The Sun Microsystemsalliance expands our collaborative sales, marketing, and engineeringefforts.  The EMS group will help EDSand Sun Microsystems as they market a wide variety of Aether’sapplications.  For example, in additionto marketing 20/20vTM, EMS will also market our supply chain management product,e-Mobile Delivery.  e-Mobile Deliveryprovides delivery confirmation through signature capture and allows for customeron-line order/delivery tracking. It limits paperwork, thus reducing lostdocuments and inaccurate information. e-Mobile Delivery also streamlines a customer’s payment cycle, whichreduces costs and increases the potential for profits.  e-Mobile Delivery is currently beingtransitioned to Aether Fusion (TM)TM, and will then benefit from Aether Fusion’simproved capabilities, enterprise class security, greater scalability, deviceand network independence, and ease of use. Another

 

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productwith cross-selling potential is Aether’s mobile office solution, AetherAttaché.  Recently released, Attaché isdesigned to address the needs of office workers who have a need for mobileaccess to corporate e-mail and groupware. Utilizing Aether Fusion (TM)TM, Attaché extends collaborativeapplications, such as email and calendaring, to the mobile user, virtuallyregardless of device and carrier network.

 

MobileGovernment. We are a service provider in the area of wireless data solutionsfor public safety.  We believe that ourexisting user base positions us to help agencies address their standardrequirements as well as their expanded Homeland Security needs.  We believe that Aether is well positionedfor certain aspects of Homeland Security in that we have products for both lawenforcement and asset tracking.  Thecombination of the two could allow us, for example, to integrate the exceptionreporting capabilities of our asset tracking products with law enforcementnotifications.  Our public safetysolutions are integrated into 47 different state databases as well as local andfederal databases to deliver real-time information in seconds without having toinvolve dispatch or other resources. Our products in this area are the PacketCluster family of products, the handheldversion of PacketCluster Patrol called PocketBlue, the FireRMS family ofproducts for fire and rescue companies, and the handheld application for thiscommunity, PocketRescue.

 

PRODUCTSAND SERVICES

 

Currently we provide ourproducts and services directly.  Throughour alliance with EDS, EDS will begin to assume responsibility for the deliveryof some of our products and services during 2003.  Specifically, as EDS sells our products, they will assist us, tovarying degrees, with integration services. Additionally, EDS will assume our hosted services and deployment supportcomponents for our EMS group.  Webelieve this arrangement will help us grow more cost-effectively.

 

Ourproducts and services include:

 

• Software applications targeted to specific vertical marketsectors  (transportation, mobilegovernment, and mobile workforce

enablementapplications) and for general wireless data management and infrastructure;

 

• Integration services to businesses and government agenciesseeking to develop and incorporate wireless data systems;

 

• Hosted services, including wireless integration andconnectivity, and Internet and messaging services, and

 

• Deployment support that includes product fulfillment andcustomer service.

 

Applicationsand Software

 

Wehave built on our experience in developing tailored applications for specificcustomers to develop an increasing number of products that are replicable andscalable for a range of customers. Rapid application development on Aether Fusion(TM) has become an area ofemphasis for us.  We currently marketover twenty applications and software products.  Approximately 65 percent of our engineers are devoted to thisactivity.  The application types are asfollows:

 

Automatic Vehicle Location (AVL)

• Aether 20/20VTM

• Aether TrailerMaxTM

 

Delivery Management

• Aether e-Mobile DeliveryTM

 

Device and Software Management

• Aether FusionITTM

 

E-Mail and Mobile Office

• Aether AttachéTM

• BlackberryTM by AetherTM

 

Field Service

• Aether 20/20VTM

• Tailored Solutions

 

Fleet Management

• Aether 20/20VTM

• Aether GeoLogicTM

• Aether MobileMaxTM and related sub-products

• Aether Platinum ServiceTM

• Aether TrailerMaxTM

 

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Logistics

• Aether e-Mobile DeliveryTM

 

Market Data

• Aether Energy Pager

• Aether FX Alert

• Aether MarketClip and MarketClip Plus

• Aether Scrappy Pager

 

Mobile Communications

• Aether MobileMaxTM and related sub-products

 

Public Safety and Homeland Security

• Aether FireRMSTM and FireRMS Web

• Aether PocketBlueTM

• Aether PocketFDTM

• Aether PacketCluster® PatrolTM

• Aether PacketCluster® RescueTM

• Aether PacketWriter®

• Aether StopTrackerTM* (trademark of PSComm)

 

Sales Force Automation

• Tailored Solutions

 

Supply Chain Management

• Aether e-Mobile DeliveryTM

 

Wireless and Mobile Platform

• Aether FusionTM

 

IntegrationServices

 

IntegrationServices includes consulting and engineering, and integration into the backendinfrastructure of businesses and government agencies for wireless datasolutions.  We provide engineeringservices to complement our software products and some of our hosted servicesand on a stand-alone basis.  We also mayaccept engineering assignments that might allow us to embrace technologicaladvances or expand into new industry sectors or services.  Our engineering staff includes wirelesssystems engineers, software engineers who specialize in developing applicationsfor handheld devices, and engineers who specialize in systems integration andtesting.  Approximately 15 percent ofour engineers are devoted to integration.

 

HostedServices

 

Weprovide secure, state-of-the-art hosting facilities for businesses andgovernment agencies that wish to outsource the operation and management oftheir wireless deployments.  Our hostedservices offerings include wireless integration into our Data Center describedbelow for application hosting and/or wireless connectivity, and Internet andmessaging services that augment vertical market applications.

 

Corporate managersrequire rigorous security standards when entrusting their data to thirdparties.  Our Data Center has numerousredundant elements and serves as a high-security physical link between datafeeds from our customers’ and others’ data systems and wireless carriernetworks.  We scramble digital messagesas they move along wireless networks using the latest encryptiontechnologies.  Our Data Center and theservices we offer through it relieve corporations from the burden ofconstructing similar facilities.  Webelieve our network operations center described below is capable of meeting thesecurity standards for services we developed or are developing for ourcustomers.

 

Webuilt a Network Operations Center (NOC), the monitoring center for operations,and a Data Center, the facility which holds the computing elements, that webelieve are unique to the industry in that they were built specifically forrobust wireless deployments.

 

Pursuantto our January 2003 agreement with EDS, EDS plans to install a network todeliver wireless solutions connecting us with suppliers and clients using anEDS facility as the management hub.  Asa result of this agreement, we will be transferring responsibility formonitoring our network operations to EDS. We are currently analyzing plans relating to our current NetworkOperations Center.

 

DeploymentServices

 

Ourdeployment services are currently headquartered in Owings Mills, Maryland andinclude product fulfillment and customer support, which help alleviate thecomplexities associated with implementing and supporting a solution. In today’senvironment in which IT departments have limited resources yet are tasked to domore dispersed work, we offer these services.

 

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Productfulfillment and provisioning facilitate the delivery of devices to thecustomer/employee base.  During thedevelopment process, device(s) are chosen based on the application’s use, andthese devices are delivered with the application(s) already on them.  For our customers**,** we have the ability toload and configure tailored software on mobile devices, activate wirelessmodems and perform quality assurance checks. We then pack, ship and track the product until the user receivesit.  For end users who already own adevice, we can provide the modem and software application only.  We handle all repair and warranty issues fordevices we provide to our customers.

 

Additionally, we offerpost-deployment customer support and customer billing.  Our customer care specialists can providesupport on virtually any issue that might arise from applicationtroubleshooting to wireless network and device issues.  We can also handle customer billing for ourcustomers’ user fees, device and modem purchases, and other charges.  Our billing system can support increases inour customers’ end user base.  Wealleviate the complexities that would otherwise be placed upon a customer’s ITdepartment.

 

Pursuantto our January 2003 agreement, EDS will assume responsibility for the callcenter and fulfillment operations for Aether’s EMS group**.**

 

SALESAND MARKETING

 

As of March 2002, we haveapproximately 50 salespeople, sales engineers for technical support during thesales cycle and marketing professionals. Our sales and marketing staff specialize in market sectors, but alsosell across the entire product and service line.  Our direct sales team covers all regions of the U.S., plus Europefrom offices in the United Kingdom.  Inaddition to having a vertical market focus, our salespeople focus on Fortune1000 companies that can benefit from field force automation applicationsincluding field service, sales force automation, and mobile collaboration toolssuch as cross-device messaging and personal information management.  Our business development personnel andsenior executives also assist in developing potential strategic relationships,such as the ones with EDS and Sun Microsystems, for selling and promoting ourproducts and services.

 

EUROPEANOPERATIONS THROUGH SILA

 

Weaddress the needs of business customers abroad through our European division,Sila Communications, Ltd (Sila).  In thefourth quarter of 2002, we acquired the remaining portion of Sila.  Sila currently targets major corporationsthroughout Europe **that**seek toextend their applications to handheld devices, as well as wireless carriersseeking to outsource wireless data services. Sila, headquartered in London, provides wireless system hosting and enduser support primarily to financial services customers via various wirelessnetworks from the European countries of the United Kingdom, Sweden and Spainand the region of Benelux.

 

STRATEGICRELATIONSHIPS

 

We believe thatpartnerships are critical to our success and vital to our growth.  The partnerships we have created includejoint development relationships in which we work together with firms to developproducts and/or next generation technologies to address specific verticalmarket opportunities.  We also work withvarious suppliers at the platform and application level in Original EquipmentManufacturer (OEM) relationships to embed technologies from suppliers in AetherFusionTM.  Finally, we have distributionpartnerships where we can gain the marketing capacity of other firms withgreater market presence in markets than we have today.

 

A significant focus ofours during 2002 was to secure relationships such as the ones we now have withEDS and Sun Microsystems.  Aether andEDS have formed an alliance to deliver wireless and mobile solutions based onAether technologies and EDS services. In addition, EDS will manage Aether’s internal IT operations andcustomer care services.  Thisrelationship with EDS will provide additional flexibility for Aether to scaleits services component of our offerings more cost effectively as we work toleverage EDS’ customer relationships. Aether and Sun Microsystems formed a global strategic alliance to expandcollaborative sales, marketing, and engineering efforts.  The companies will work together on jointsolutions built on open standards using the SunTM  Open Net Environment (Sun ONE) and Aether’s FusionTM for scalabilityand availability.  Aether and SunMicrosystems will market the joint solutions for field forces in businesses andgovernment agencies that perform functions such as maintenance and service,distribution and delivery, public safety and healthcare.  We believe the combination of thesecompanies’ products and services offer opportunities that were not previouslypresent to us.

 

WirelessNetwork Carriers

 

Asa relatively large purchaser of wireless data network capacity for many of thecarriers, we are able to negotiate favorable rates.  Typically, we have one-year contracts to buy data networkcapacity either for an agreed amount of kilobytes at a flat fee or on acents-per-kilobyte basis.

 

Wehave contracts with wireless carriers including Verizon Wireless, AT&TWireless, Cingular Wireless and Motient. As a result, we can give our customers a wide variety of wirelesscarrier choices.

 

COMPETITION

 

Themarket for our solutions is competitive. We believe we offer the broadest range of applications and services tobusinesses and government agencies necessary to enable the development,offering and ongoing support of wireless data communication systems for theiremployees and customers.  The widespreadadoption of industry standards may make it easier for new market entrants tooffer some or all of the services we

 

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offerand may make it easier for existing competitors to introduce some or all of theapplications and services they do not currently provide, or improve the qualityof their services.  We expect that wewill compete primarily on the basis of the functionality, breadth, quality andprice of our services.  Our current andpotential competitors include:

 

• wireless systems integrators and database vendors, includingIBM, EDS, and Oracle.

 

•mobile and/or wireless software companies, including Brience, Inc., ComverseTechnology, Inc., Extended Systems, Inc., Everypath, Inc., Openwave Systems,and Puma Technology, Inc.

 

• wireless data services providers, such as 724 Solutions Inc.and GoAmerica, Inc.

 

• wireless network carriers, such as, AT&T Wireless, CingularWireless, Nextel Communications, Inc., Sprint PCS Group, and Verizon Wireless.

 

Someof our existing and potential competitors have substantially greater financial,technical, marketing and distribution resources than we do. In the category ofwireless network carriers, some of these companies may also sell us airtime forour solutions.  Additionally, some ofthese companies have greater name recognition and more establishedrelationships with our target customers. Furthermore, these competitors may be able to adopt more aggressivepricing policies and offer customers more attractive terms than we can.

 

Notwithstandingthe competitiveness of our market, we believe that our potential competitorsface substantial barriers to market entry. Development of wireless data systems comparable to those we have alreadydeveloped is time consuming and costly.

 

**INTELLECTUAL PROPERTY RIGHTS**

 

We rely on a combination of trademark, patent,copyright, service mark, trade secret laws and contractual restrictions toestablish and protect proprietary rights in our products and services.  We have applied for various trademarks andpatents.

 

The following trademarks are registered with theUnited States Patent and Trademark Office. ScoutSync, Cerulean, Cerulean Design, PacketCluster, PacketClusterPatrol, PacketWriter, MobileMax2, Advantage, ScoutBuilder, Aether & Design,ScoutWeb, ScoutIT, Pro2000, e-Mobile, and Airbroker.  The following trademarks have been published or allowed by theUnited States Patent and Trademark Office: Aether, Aether Systems, AetherDesign, Unwired By Aether, Aether Attache, MobileFusion, PocketInvestigator,AIM Aether Intelligent Messaging, The Power Behind Mobile Workers, AerLead,Aether Fusion, PocketBlue, PocketEMS, PocketInspector, and PocketRescue.  There can be no assurances that ourapplications will be granted or that holders of other trademarks will not claimthat the published or allowed trademarks, or other Aether pending trademarkapplications, infringe their trademarks.

 

We have received notices of allowance for four of ourapplications while the remaining patent applications are pending.  There is no assurance that the patentapplications will result in patents being issued by the United States Patentand Trademark Office or other foreign patent offices, nor is there anyguarantee that any issued patent will be valid and enforceable.  Other companies may independently develop orotherwise acquire similar technology or gain access to our proprietarytechnology.  Despite our precautions,there can be no assurance that we will be able to adequately protect ourtechnology from competitors in the future. The enforcement of patent rights often requires the institution oflitigation against infringers.  Thislitigation is often costly and time consuming.

 

We may be subject to legal proceedings and claims fromtime to time relating to the intellectual property of others, even though wetake steps to assure that neither our employees nor our contractors knowinglyincorporates unlicensed copyrights or trade secrets into our products.  It is possible that third parties may claimthat our products and services may infringe upon their trademark, patent,copyright, or trade secret rights.  Anysuch claims, regardless of their merit, could be time consuming, expensive,cause delays in introducing new or improved products or services, require us toenter into royalty or licensing agreements or require us to stop using thechallenged intellectual property. Successful infringement claims against us may materially disrupt theconduct of our business or affect profitability. There are currently no legalproceedings or claims for infringement of intellectual property rights pendingagainst us.

 

**GOVERNMENT REGULATION**

 

Weare subject generally to government regulations that apply to publicly tradedDelaware corporations of similar size that are headquartered in Maryland.  Through sales and license agreements withfederal, state and local entities, we are sometimes subject to regulationsconcerning the acquisition of goods and services by such entities.

 

The wireless network carriers wecontract with to provide airtime and some of our hardware suppliers may besubject to regulation by the Federal Communications Commission. Changes in FCCregulations could affect the availability of wireless service these carriersare willing or able to sell to us.  Wecould also be adversely affected by developments in regulations that govern ormay in the future govern the Internet, data privacy, the allocation of radiofrequencies or the placement of cellular towers.  Regulations of the SEC governing online trading could reduce thelevel of online trading or the demand for wireless financial information.  Also, changes in these regulations couldcreate uncertainty in the marketplace that could reduce demand for our servicesor increase the cost of doing business as a result of costs of litigation orincreased service delivery cost or could in some other manner have a materialadverse effect on our business, financial condition or results of operations.

 

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Wecurrently do not collect sales or other taxes with respect to the sale ofservices or products in states and countries where we believe we are notrequired to do so.  We do collect salesand other taxes in the states in which we have offices and are required by lawto do so.  Some jurisdictions havesought to impose sales or other tax obligations on companies that engage inonline commerce within their jurisdictions. A successful assertion by one or more jurisdictions that we shouldcollect sales or other taxes on our products and services, or remit payment ofsales or other taxes for prior periods, could have a material adverse effect onour business, financial condition or results of operations.

 

Anynew legislation or regulation, or the application of laws or regulations fromjurisdictions whose laws do not currently apply to our business, could have anadverse effect on our business.

 

**EMPLOYEES**

 

As of December 31, 2002, we and our wholly-ownedsubsidiaries had a total of approximately 542 employees and of these employeesover 180 were engineers.  None of ouremployees is covered by a collective bargaining agreement.  We believe that our relations with ouremployees are good.

 

**ITEM 2.PROPERTIES**

 

Our principal offices arelocated in Owings Mills, Maryland in an 86,000 square foot facility under alease expiring in January 2005 with no renewal option. We also lease anaggregate of approximately 303,000 square feet for our offices in Larkspur,California; San Rafael, California; Boca Raton, Florida; Bethesda, Maryland;New York, New York (which is being sublet); McLean, Virginia; Richmond,Virginia; Vienna, Virginia; Tempe, Arizona; Marlborough, Massachusetts; Zillah,Washington; Richardson, Texas; Joplin, Missouri; London, England; and Monterey,Mexico. We share space among our segments and for corporate and other purposes.Sila has offices in different European locations. We are currently holdingapproximately 224,000 square feet of space for sublease, which we plan to exitor have exited in connection with our restructuring plans. 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.LEGAL PROCEEDINGS**

 

Aetheris among the hundreds of defendants named in nine class action lawsuits seekingdamages on account of alleged violations of securities law.  The case is being heard in the United StatesDistrict Court for the Southern District of New York.  The court has consolidated the actions by all of the nameddefendants that actually issued the securities in question.  Now there are approximately 310 consolidatedcases before Judge Scheindlin, including the Aether Systems action, under thecaption In Re Initial Public Offerings Litigation, Master File 21 MC 92(SAS).

 

Theseactions were filed on behalf of persons and entities that acquired our commonstock after our initial public offering in October 20, 1999.  Among other things, the complaints claimthat prospectuses, dated October 20, 1999 and September 27, 2000 and issued byAether in connection with the public offerings of common stock, allegedlycontained untrue statements of material fact or omissions of material fact inviolation of securities laws because the prospectuses allegedly failed todisclose that the offerings’ underwriters had solicited and received additionaland excessive fees, commissions and benefits beyond those listed in thearrangements with certain of their customers which were designed to maintain,distort and/or inflate the market price of the Company’s common stock in theaftermarket.  The actions seekunspecified monetary damages and rescission. Aether believes the claims are without merit and is vigorouslycontesting 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 courtissued an Opinion and Order on defendants’ motions to dismiss, which grantedthe motions in part and denied the motions in part.  As to Aether Systems,the motion to dismiss the claims against it was denied in its entirety. Discovery is now commencing.  Because the litigation is at a very earlystage, the Company is unable to assess the likelihood of an unfavorable outcomeand can make no determination as to the amount or range of potential loss, ifany.

 

Aether is also a party to other legal proceedings in the normal course ofbusiness.  Based on evaluation of thesematters and discussions with counsel, the Company believes that liabilitiesarising from these matters will not have a material adverse effect on theconsolidated results of its operations or financial position.

 

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matters were submitted to Aether’s stockholders forconsideration during the fiscal quarter ended December 31, 2002.

 

9

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**PART II**

 

**ITEM5. MARKET FOR THE COMPANY’S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS**

 

(1) PRICE RANGE OF COMMON STOCK

 

Our common stock has been quoted on the Nasdaq NationalMarket under the symbol AETH since our initial public offering on October 20,1999.  Prior to that time, there was nopublic market for the common stock.  Thefollowing table sets forth, for the periods indicated, the high and low pricesper share of the common stock as reported on the Nasdaq National Market.

 
| **QUARTER ENDED** |   | **2002** |   | **2001** |   |
|-------------------|--------|----------|--------|----------|--------|
|              |   | **HIGH** |   | **LOW**  |   | **HIGH** |   | **LOW** |   |
| March 31          |   | $        | 11.09  |     | $      | 4.10 |   | $ | 60.25 |   | $ | 12.19 |   |
| June 30           |   | $        | 4.77   |     | $      | 2.50 |   | $ | 18.95 |   | $ | 7.39 |   |
| September 30      |   | $        | 4.15   |     | $      | 2.52 |   | $ | 11.50 |   | $ | 5.60 |   |
| December 31       |   | $        | 4.18   |     | $      | 2.25 |   | $ | 9.74 |   | $ | 5.25 |   |

 

(2) APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS

 

The number of record holders of the Company’s commonstock as of December 31, 2002 was 638. The Company believes that in excess of 25,000 beneficial owners holdsuch shares of common stock in depository or nominee form.

 

(3) DIVIDENDS

 

We have never declared or paid any cash dividends onour capital stock nor, when we were organized as a limited liability company,did we make any distributions to our members. We currently intend to retain earnings, if any, to support thedevelopment of our business and do not anticipate paying cash dividends in theforeseeable future.  Payment of futuredividends, if any, will be at the discretion of our board of directors aftertaking into account factors such as our financial condition, operating resultsand current and anticipated cash needs.

 

**ITEM6. SELECTED FINANCIAL DATA**

 

The table that follows presents portions of ourconsolidated financial statements and is not a complete presentation inaccordance with accounting principles generally accepted in the United Statesof America.  You should read thefollowing selected consolidated financial data together with our consolidatedfinancial statements and related notes and with Management’s Discussion andAnalysis of Financial Condition and Results of Operations included elsewhere inthis Annual Report on Form 10-K.  Theconsolidated statement of operations data for the years ended December 31,2000, 2001 and 2002 and the consolidated balance sheet data as of December 31,2001 and 2002 are derived from our audited consolidated financial statements,which are included as exhibits to this report on Form 10-K.  The consolidated statement of operationsdata for the year ended December 31, 1998 and 1999 and the consolidated balancesheet data as of December 31, 1998, 1999 and 2000 are derived from auditedfinancial statements that do not appear in this annual report on Form10-K.  The historical results presentedbelow are not necessarily indicative of the results to be expected for anyfuture fiscal year. See Management’s Discussion and Analysis of FinancialCondition and Results of Operations in Item 7. The pro forma net loss per share information for the historical periodspresented gives effect to our conversion from a limited liability company to acorporation immediately prior to our initial public offering.

 

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|                                                                                                                        |   | **YEAR ENDED  DECEMBER 31,**                  |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                                                                        |   | **1998**                                      |   | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
|                                                                                                                        |   | **(IN  THOUSANDS, EXCEPT PER SHARE AMOUNTS)** |   |
| CONSOLIDATED  STATEMENT OF OPERATIONS DATA:                                                                                 |   |                                          |   |   |   |   |   |   |   |   |   |
| Revenue:                                                                                                                    |   |                                          |   |   |   |   |   |   |   |   |   |
| Subscriber  revenue                                                                                                         |   | $                                             | 549    |   | $ | 3,617 |   | $ | 24,802 |   | $ | 44,031 |   | $ | 69,582 |   |
| Engineering  services revenue                                                                                               |   | 963                                           |   | 2,594 |   | 9,444 |   | 7,860 |   | 3,192 |   |
| Software and  related services revenue                                                                                      |   | —                                        |   | — |   | 17,278 |   | 36,982 |   | 24,412 |   |
| Device sales                                                                                                                |   | —                                        |   | 115 |   | 6,630 |   | 24,007 |   | 19,345 |   |
| Total revenue                                                                                                               |   | 1,512                                         |   | 6,326 |   | 58,154 |   | 112,880 |   | 116,531 |   |
| Cost of  subscriber revenue                                                                                                 |   | 797                                           |   | 2,005 |   | 11,254 |   | 27,167 |   | 40,115 |   |
| Cost of  engineering services revenue                                                                                       |   | 304                                           |   | 1,366 |   | 5,693 |   | 3,644 |   | 1,533 |   |
| Cost of software  and related services revenue                                                                              |   | —                                        |   | — |   | 5,724 |   | 11,625 |   | 8,086 |   |
| Cost of device  sales                                                                                                       |   | —                                        |   | 105 |   | 7,345 |   | 38,318 |   | 17,486 |   |
| Total cost of revenue                                                                                                       |   | 1,101                                         |   | 3,476 |   | 30,016 |   | 80,754 |   | 67,220 |   |
| Gross profit                                                                                                                |   | 411                                           |   | 2,850 |   | 28,138 |   | 32,126 |   | 49,311 |   |
| Operating  expenses:                                                                                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| Research and  development(1)                                                                                                |   | 1,267                                         |   | 2,614 |   | 30,189 |   | 63,937 |   | 26,306 |   |
| General and  administrative(1)                                                                                              |   | 2,773                                         |   | 5,891 |   | 52,937 |   | 90,893 |   | 59,666 |   |
| Selling and  marketing (1)                                                                                                  |   | 840                                           |   | 2,095 |   | 54,151 |   | 66,757 |   | 28,767 |   |
| In process  research and development                                                                                        |   | —                                        |   | — |   | 7,860 |   | — |   | — |   |
| Depreciation and  amortization                                                                                              |   | 265                                           |   | 1,089 |   | 238,074 |   | 180,724 |   | 39,255 |   |
| Option and warrant  expense                                                                                                 |   | 33                                            |   | 19,198 |   | 14,345 |   | 14,408 |   | 6,542 |   |
| Impairment of  intangibles                                                                                                  |   | —                                        |   | — |   | —  |   | 1,121,001 |   | 69,534 |   |
| Restructuring  charge                                                                                                       |   | —                                        |   | — |   | — |   | 45,006 |   | 37,744 |   |
| Total operating  expenses                                                                                                   |   | 5,178                                         |   | 30,887 |   | 397,556  |   | 1,582,726 |   | 267,814 |   |
| Operating loss                                                                                                              |   | (4,767                                        | )      | (28,037 | ) | (369,418 | ) | (1,550,600 | ) | (218,503 | ) |
| Interest income  (expense), net                                                                                             |   | 74                                            |   | (229 | ) | 42,351 |   | 8,659 |   | (3,984 | ) |
| Equity in losses  of investments                                                                                            |   | —                                        |   | (2,425  | ) | (47,886 | ) | (57,523 | ) | (4,744 | ) |
| Investment loss,  including impairments, net                                                                                |   | —                                        |   | — |   | — |   | (143,382 | ) | (14,412 | ) |
| Minority  interest                                                                                                          |   | —                                        |   | — |   | 10,692 |   | 63,809 |   | (45 | ) |
| Other income —  escrow settlement                                                                                      |   | —                                        |   | — |   | — |   | — |   | 2,272 |   |
| Loss before  income taxes, extraordinary item and cumulative effect of change in  accounting principle                      |   | $                                             | (4,693 | ) | $ | (30,691 | ) | $ | (364,261 | ) | $ | (1,679,037 | ) | $ | (239,416 | ) |
| Income tax  benefit                                                                                                         |   | —                                        |   | — |   | 1,561 |   | 10,694 |   | 535 |   |
| Loss before  extraordinary item and cumulative effect of change in accounting principle                                     |   | (4,693                                        | )      | (30,691 | ) | (362,700 | ) | (1,668,343 | ) | (238,881 | ) |
| Extraordinary  item (early extinguishment Of debt)                                                                          |   | —                                        |   | — |   | — |   | 7,684 |   | 42,765 |   |
| Loss before  cumulative effect of change in accounting principle                                                            |   | (4,693                                        | )      | (30,691 | ) | (362,700 | ) | (1,660,659 | ) | (196,116 | ) |
| Cumulative  effect of change in accounting principle relating to adoption of SFAS No. 133  in 2001 and SFAS No. 142 in 2002 |   | —                                        |   | — |   | — |   | 6,564 |   | (129,306 | ) |
| Net loss                                                                                                                    |   | $                                             | (4,693 | ) | $ | (30,691 | ) | $ | (362,700 | ) | $ | (1,654,095 | ) | $ | (325,422 | ) |
| Net loss per  share - basic and diluted before extraordinary item and cumulative effect of  change in accounting principle  |   |                                          |   |   |   | $ | (9.99 | ) | $ | (40.96 | ) | $ | (5.67 | ) |
| Extraordinary  item                                                                                                         |   |                                          |   |   |   | — |   | 0.19 |   | 1.01 |   |
| Cumulative  effect of change in accounting principle relating to adoption of SFAS No. 133  in 2001 and SFAS No. 142 in 2002 |   |                                          |   |   |   | — |   | 0.16 |   | (3.07 | ) |
| Net loss per  share-basic and diluted                                                                                       |   |                                          |   |   |   | $ | (9.99 | ) | $ | (40.61 | ) | $ | (7.73 | ) |
| Weighted average  shares used in computing net loss per share — basic and diluted                                      |   |                                          |   |   |   | 36,310 |   | 40,732 |   | 42,117 |   |
| Pro forma net  loss per share — basic and diluted                                                                      |   | $                                             | (0.29  | ) | $ | (1.45 | ) |   |   |   |   |   |   |
| Pro forma  weighted average shares used in computing net loss per share — basic and  diluted                           |   | 15,916                                        |   | 21,207 |   |   |   |   |   |   |   |
|                                                                                                                        |   |                                          |   |   |   |   |   |   |   |   |   |
| CONSOLIDATED  BALANCE SHEET DATA:                                                                                           |   |                                          |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents (including restricted cash)                                                                      |   | $                                             | 1,755  |   | $ | 78,542 |   | $ | 872,747 |   | $ | 527,430 |   | $ | 68,593 |   |
| Short term  investments                                                                                                     |   | 6,191                                         |   | 2,092 |   | 2,648 |   | 2,490 |   | 255,825 |   |
| Working capital                                                                                                             |   | 7,519                                         |   | 83,128 |   | 819,624 |   | 503,873 |   | 335,159 |   |
| Total assets                                                                                                                |   | 8,765                                         |   | 102,534 |   | 2,677,375 |   | 949,420 |   | 473,409 |   |
| Total debt                                                                                                                  |   | —                                        |   | — |   | 334,942 |   | 306,138 |   | 154,946 |   |
| Members’ capital                                                                                                       |   | 8,030                                         |   | — |   | — |   | — |   | — |   |
| Stockholders’  equity                                                                                                  |   | —                                        |   | 98,342  |   | 2,167,698 |   | 542,527 |   | 227,400 |   |

 

----

(1) Exclusive of option and warrant expense - seeconsolidated financial statements.

 

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**ITEM 7. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(MD&A)**

 

You should read the following description of ourfinancial condition and results of operations in conjunction with ourConsolidated Financial Statements and Notes thereto and other financial dataappearing elsewhere in this Form 10-K.

 

**MD&A (1) OVERVIEW**

 

We provide the services, softwareand support necessary for businesses and government agencies to extend existingand future applications from the desktop to almost all currently availablepersonal digital assistant (PDA) operating systems and their respectivewireless devices.  Through the AetherFusionTM approach, we develop, deploy and manage wireless solutions built onindustry standard technology and backed by our expertise in wireless hosting,software and services.

 

We are focused on severalgrowth areas including enterprise services, mobile government, andtransportation.

 

During 2002, we expanded our products, services, andcustomer base in the transportation and logistics market through theacquisition of certain assets and licenses from @Track Communications, Inc.(“@Track”). @Track is a leading provider of wireless-based vehicle fleetmanagement and intelligent mobile-asset-tracking solutions.

 

**MD&A (2) FACTORS AFFECTINGCOMPARABILITY**

 

Our results of operations in 2000, 2001 and 2002 havebeen affected by acquisitions, investments and impairment charges.  The factors identified below have had asignificant impact on our operations and should be considered in comparing ourresults of operations in 2002 to those in 2001 and in comparing our results ofoperations in 2001 to those in 2000.

 

(a) ACQUISITIONS

 

We have acquired companies toexpand our product offerings and geographic markets and to acquire additionalengineering resources to develop products. Through December 31, 2001, we acquired 10 businesses (or parts ofbusinesses) for an aggregate consideration of $365.8 million in cash and equityvalued at the time of acquisition of $1.284 billion, consisting of 6,259,445shares of our common stock and 1,093,785 replacement options. In 2002, weexpanded our products, services, and customer base in the transportation andlogistics market through the acquisition of certain assets and licenses from@Track. @Track is a leading provider of wireless-based vehicle fleet managementand intelligent mobile-asset-tracking solutions.  The purchase consideration (excluding approximately $800,000 ofpurchase related expenses) was $15.0 million consisting of $3.0 million in cashand a $12.0 million note payable.  Thenote was interest bearing at 5.75% and was paid in equal monthly cashinstallments from May 2002 through July 2002.

 

During the fourth quarter of 2002, we purchased fromReuters, their 40% interest in Sila, a European joint venture we formed withReuters in 2000.  The results of Sila’soperation were consolidated with ours in 2002, 2001 and 2000.  As a result of this acquisition, allminority interests

 

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have been eliminated and all of our subsidiaries arenow wholly-owned.

 

Our acquisitions have increased our operating revenuesand expenses from the date of acquisition. In the discussion of results below,we quantify the effects of acquisitions on our revenues and expenses.  Generally, acquisitions also increased ourdepreciation and amortization expense as we amortize the value of acquisitionintangibles.  However during each of2001 and 2002, we wrote down the value of the intangible assets related toacquisitions significantly and as such, our amortization expense in 2001 and2002 respectively, decreased from the prior year.  See the section entitled “Impairment Charges” below for a moredetailed discussion of this write down. Also affecting amortization expense in 2002, was our adoption of SFASNo.142 on January 1, 2002 which required that we cease amortizing goodwill thusreducing our amortization expense in 2002. Finally, acquisitions affect non-cash compensation when we issue optionsto employees at the time of an acquisition.  See Note 4m in our consolidated financial statements for furtherdiscussion on the impact of the adoption of SFAS No. 142.

 

(b) INVESTMENTS

 

We have made investments through Aether Capital,L.L.C., our wholly-owned subsidiary, to promote the development of newtechnologies that are compatible with the services we offer or that we may wishto integrate into our services.  SinceAugust of 1999, we have invested approximately $196.8 million in 24companies.  We account for investmentsin which we exercise significant influence or have an ownership interestgreater than 20 percent under the equity method of accounting and record ourproportionate share of the investee’s net income or loss.

 

We currently have investments in severalpublicly-traded companies in which we do not exercise significant influence orhave an ownership interest greater than 20 percent.  We account for these investments at fair value based on quotedmarket prices.  Net unrealized gains andlosses on these available-for-sale securities are excluded from income andrecorded as a separate component of stockholders’ equity unless the decline isdeemed to be other than temporary. Subsequent to our investment, the market values of these investmentshave decreased significantly.  In somecases, we have determined the decline in market value of our investments inpublicly-traded companies to be other than temporary, and as such have recordedrealized losses on these investments, which are included in net loss.  See “Impairment Charges” below for a moredetailed discussion of these charges.

 

We also currently have investments in several privatecompanies in which we do not exercise significant control.  We account for these investments at costunless circumstances indicate the carrying amount of the investment may not berecoverable, at which time the carrying value of the investment is adjusted tofair value.  Subsequent to ourinvestment, we have written down the carrying value of our investments to fairvalue, which is approximately $2.2 million as of December 31, 2002.  See “Impairment Charges” below for a moredetailed discussion of these charges.

 

(c) IMPAIRMENT CHARGES

 

(i) Acquisitions

 

*SFAS No. 121 impairments*.  Through December 31, 2001, we recordedapproximately $1.718 billion in goodwill and other intangibles related to ouracquisitions.  During 2000 and 2001, weperformed on-going analysis of the recoverability of our goodwill and otherintangibles and the value of our investments in accordance with SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and For Long-Lived Assets tobe Disposed Of. Based on quantitative and qualitative measures, we assessed theneed to record impairment losses on long-lived assets used in operations whenimpairment indicators were present.

 

Based on a variety of indicators, we determined during2001 that the goodwill and other intangibles from our acquisitions may havebecome impaired. In accordance with SFAS No. 121, we performed undiscountedcash flow analyses of our acquisitions to determine whether any impairmentsexisted. When the undiscounted cash flows were less than the carrying value ofthe related assets, we determined a range of fair values using a combination ofvaluation methodologies including i.) discounted cash flow analysis, which isbased upon converting expected future cash flows to present value, and ii.)changes in market value since the date of acquisition relative to othercompanies and indices.

 

As a result of our review, we determined that thecarrying value of goodwill and certain other intangible assets related to ouracquisitions were not fully recoverable. Accordingly, during 2001, we recorded impairment charges ofapproximately $1.121 billion, which represents the difference between thecarrying value and fair value of the goodwill and other intangible assets.  Of the $1.121 billion, $775 million relatedto the Riverbed acquisition.

 

*Goodwill.*  We adopted the provisions of SFASNo. 142, "Goodwill and Other Intangible Assets," as ofJanuary 1, 2002.  Goodwill andintangible assets acquired in a purchase business combination and determined tohave an indefinite useful life are not amortized, but instead tested forimpairment at least annually in accordance with the provisions of SFASNo. 142. SFAS No. 142 also requires that intangible assets withestimable useful lives be amortized over their respective estimated usefullives to their estimated residual values, and reviewed for impairment inaccordance with SFAS No. 144, "Accounting for Impairment or Disposalof Long-Lived Assets."

 

In connection with SFASNo. 142’s transitional goodwill impairment evaluation, the Statementrequired us to perform an assessment of whether there was an indication thatgoodwill was impaired as of the date of adoption.  To accomplish this, we were required to identify our reportingunits and determine the carrying value of each reporting unit by assigning theassets and liabilities, including the existing goodwill and intangible assets,to those reporting units as of January 1, 2002.  We were required to determine the fair value of each reportingunit and

 

13

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compare it to thecarrying amount of the reporting unit within six months of January 1,2002.  To the extent the carrying amountof a reporting unit exceeded the fair value of the reporting unit, we would berequired to perform the second step of the transitional impairment test, asthis is an indication that the reporting unit goodwill may be impaired.  The second step was required for all threereporting units.  In this step, wecompared the implied fair value of each reporting units goodwill with thecarrying amount of the reporting units goodwill, both of which were measured asof the date of adoption.  The impliedfair value of goodwill was determined by allocating the fair value of thereporting unit to all of the assets (recognized and unrecognized) andliabilities of the reporting unit in a manner similar to a purchase priceallocation, in accordance with SFAS No. 141, "BusinessCombinations."  The residual fairvalue after this allocation was the implied fair value of the reporting unitgoodwill.  As a result of thisevaluation, we recorded an impairment charge of $129.3 million, which wasrecorded as cumulative effect of change in accounting principle in theaccompanying consolidated statements of operations.  Of this charge, $94.9 million, $32.0 million and $2.4 million wasin our Enterprise Mobility Solutions, Mobile Government and Transportationsegments, respectively.

 

SFAS No. 142 alsorequires that we repeat the two-step impairment analysis each year, beginningwith a recurring annual measurement date chosen by us in 2002.  We chose September 30, 2002 to be 2002’smeasurement date, and will continue to perform annual impairment reviews.  The September 30, 2002 review resulted in anadditional impairment charge of $26.8 million, which was recorded as impairmentof intangibles and other assets in the accompanying consolidated statements ofoperations.  Of this charge, $3.1million and $23.7 million was in our Mobile Government and Transportationsegments, respectively.

 

In both cases above, we,with the assistance of a third party appraiser, arrived at the implied fairvalue of goodwill using a discounted cash flow methodology.  Due to the continuing macro-economicslow-down and reduced spending on information technology (IT) in 2002 we do notexpect dramatic increases in cash flows in the near term which in turn resultedin discounted cash flows that did not support the value of the goodwill thathad been in our consolidated balance sheet.

 

*Intangiblesand Other Long-Lived Assets. *SFASNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”provides a single accounting model for long-lived assets to be disposed of.SFAS No. 144 also changes the criteria for classifying an asset as heldfor sale; and broadens the scope of businesses to be disposed of that qualifyfor reporting as discontinued operations and changes the timing of recognizinglosses on such operations.  We adoptedSFAS No. 144 on January 1, 2002.

 

In accordance with SFASNo. 144, long-lived assets, such as property, plant, and equipment, andpurchased intangibles subject to amortization, are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparisonof the carrying amount of an asset to estimated undiscounted future cash flowsexpected to be generated by the asset. 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 disposed of would be separatelypresented in the balance sheet and reported at the lower of the carrying amountor fair value less costs to sell, and are no longer depreciated.  The assets and liabilities of a disposedgroup classified as held for sale would be presented separately in theappropriate asset and liability sections of the balance sheet.

 

Goodwill and intangibleassets not subject to amortization are tested annually for impairment, and aretested for impairment more frequently if events and circumstances indicate thatthe asset might be impaired.  Animpairment loss is recognized to the extent that the carrying amount exceedsthe asset’s fair value.

 

During 2002, we assessedthe fair value of certain of our long-lived assets, including software,computer equipment, other tangible assets and identifiable intangible assetsobtained in connection with acquisitions. This assessment resulted in an impairment charge of $42.7 million in2002, which is recorded in impairment of intangibles and other assets in ourconsolidated statements of operations. Of this charge, $13.6 million, $125,000 and $9.3 million was in ourEnterprise Mobility Solutions, Mobile Government and Transportation segments,respectively.  The remaining impairmentcharge related to European operations and corporate and other assets.  We, with the assistance of third partyappraisers, determined the fair value of these assets based on a combination ofquoted market prices and a cost approach methodology.  A portion of the assets referred to above have been reclassifiedout of property, plant and equipment and are now being classified as assetsheld-for-sale in the accompanying consolidated balance sheet.

 

(ii) Investments

 

Through December 31, 2001, we made investments inother businesses totaling approximately $196.8 million.  We adjust the carrying value of ouravailable-for-sale investments and equity method investments in publiccompanies to market and record the change in market value to othercomprehensive income.  In accordancewith SAB 59, “Accounting for Noncurrent Marketable Equity Securities”, weassess the decline in market value in certain of our public company investmentsas other than temporary after reviewing the following factors: length of timeand extent to which the market value of the investment has been below cost, thefinancial position and the near-term prospects of the issuer, and our intentand ability to retain our investment in the investee for a period of timesufficient to allow for any anticipated recovery in market value.

 

With respect to investments in private companiesincluding those we account for using the equity method, we perform on-goingreviews based on quantitative and qualitative measures.  In evaluating our private companyinvestments, we determined a range of fair values based on a combination ofvaluation methods where applicable.  Wedetermine fair value from the range of possible values, after considering thestrength of the investee’s financial position, future prospects and riskprofile of the invested company.

 

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During 2001, we recorded a net charge of $143.4million, which included $136.7 million in impairment charges related to ourinvestments.  The remainder of the netcharge related to net gains (losses) from the sales of investments, and changesin the fair value of warrants.  During2002, we recorded a net charge of $14.4 million, which included $14.1 millionin impairment charges related to our investments.  The remainder of the charge related to net gains (losses) fromthe sales of investments, and changes in the fair value of warrants.

 

**MD&A (3) CRITICAL ACCOUNTING POLICIES**

 

Our critical accounting policies are as follows:

 

• Revenuerecognition;

• Estimatingthe valuation allowance for sales returns and doubtful accounts;

• Estimatingthe realizable value of our inventory;

• Valuation oflong-lived intangible assets and goodwill;

• Valuation ofinvestments; and

•Restructuring accruals

 

(a) REVENUE RECOGNITION

 

We derive our revenue from four sources: (i)subscriber revenue (ii) engineering services (iii) software and relatedservices, and (iv) device sales.  Asdescribed below, significant management judgments and estimates must be madeand used in connection with the revenue recognized in any accountingperiod.  If we made different judgmentsor utilized different estimates, the amount and timing of our revenue might havediffered materially from that reported.

 

i.) Subscriber revenue

 

We derive subscriber revenue from the provision ofreal-time access to business information integrated into existing wirelesscommunication platforms, and from the provision of comprehensive businesssolutions designed to meet the mobile management needs of truckload,less-than-load and private carriers. For all sales, we obtain signed binding contracts with our subscribers.  Contracts with our wireless data subscribersare generally for a one-year period and include a termination penalty ifcancelled by the subscriber before the one-year period expires.  These contracts are generally renewable atthe option of the subscriber for additional one-year periods or otherwisecontinue on a monthly basis until cancelled by the subscriber.

 

Contracts with our transportation and logisticssubscribers are generally for a three to five year period and include atermination penalty if cancelled by the subscriber before the term of thecontract expires.

 

Subscriber revenue is recognized monthly as theservice is provided.  Activation feesare deferred and recognized ratably over the expected life of the customerrelationship.

 

ii.) Engineering services revenue

 

Engineering services revenue is derived from theprovision of wireless integration consulting under time-and-materials andfixed-fee contracts.  Revenue ontime-and-materials contracts is recognized as time is spent at hourly rates,which are negotiated with the customer. Revenue on fixed-fee contracts is recognized on thepercentage-of-completion method based on costs incurred in relation to totalestimated costs.  Anticipated contractlosses are recognized as soon as they become known and estimable.  Considerable judgment may be required indetermining estimates to complete a project including the scope of work to becompleted and reliance on the customer or other vendors to fulfill sometasks.  If we made different judgmentsor utilized different estimates of the total amount of work we expect to berequired to complete the project, the timing of our revenue recognition fromperiod to period, and our margins on the project in the reporting period, mayhave differed materially from that reported.

 

iii.) Software and related services revenue

 

Software and related services revenues are generatedfrom licensing software and providing services, including maintenance andtechnical support, training and consulting. Software revenue consists of fees for licenses of our softwareproducts.  We recognize the revenue whenthe license agreement is signed, the license fee is fixed and determinable,delivery of the software has occurred, and when we estimate that thecollectibility of the fees is probable. At the time of the transaction, we assess whether the fee associatedwith our revenue transactions is fixed and determinable and whether or notcollection is reasonably assured.  If asignificant portion of a fee is due after our normal payment term, we accountfor the fee as not being fixed and determinable.  In these cases, we recognize revenue as the fees become due.  We assess collection based on a number offactors, including past transaction history with the customer and creditworthiness of the customer.  We do notrequest collateral from our customers.  Ifwe determine that collection of a fee is not reasonably assured, we defer thefee and recognize revenue at the time it becomes reasonably assured, which isgenerally upon receipt of cash.  If weassessed collectibility differently, the timing and amount of our revenuerecognition may have differed materially from that reported.

 

Revenue from licensing software that requiressignificant customization and modification is recognized using the percentageof completion

 

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method, based on the hours incurred in relation to thetotal estimated hours.  If we madedifferent judgments or utilized different estimates of the total amount of workwe expect to be required to customize or modify the software, the timing of ourrevenue recognition from period to period, and our margins on the project inthe reporting period, may have differed materially from that reported.  Service revenues consist principally ofmaintenance and technical support, which consists of unspecified when-and-ifavailable product updates and customer telephone support services and arerecognized ratably over the term of the service period.  If we allocated more or less value to thesewhen-and-if deliverables, the timing of our revenue recognition may havediffered materially from that reported. Other service revenues are recognized as the related services areprovided. In situations where we host the software and the customer has theoption to take possession of the software at any time during the hosting periodwithout significant penalty and we believe it is feasible for the customer toeither run the software on its own hardware or contract with another partyunrelated to us to host the software, the software element is accounted for asa seperate element, in accordance with SOP 97-2.  Otherwise, such amounts are recognized ratably over the hostingperiod. If our assessment of  thisfeasibility were different, the timing of our revenue recognition may havediffered materially from that reported.

 

iv.) Device revenue

 

We derive device revenue on the sale of wirelessdevices used to provide our services. Generally, revenue for device sales is recognized upon delivery.  In cases where, in our judgment, (1) theservice is essential to the functionality of the device and (2) only ourongoing service is available for the device, we recognize the device revenue asthe ongoing service is provided over the shorter of the life of the equipmentor the estimated term of the customer relationship.  If management were to judge differently about 1 or 2 above or onthe expected term of the customer relationship, the timing of our revenuerecognition may have differed materially from that reported.

 

v.) Revenue from multiple element arrangements

 

For arrangements with multiple elements, we allocaterevenue to each component of the arrangement using the residual valuemethod.  This means that we deferrevenue from the total fees associated with the arrangement equivalent to thefair value of the element(s) of the arrangement that has (have) not yet beendelivered.  The fair value of anyundelivered elements are established by using historical evidence specific toAether.  For instance, the fair valuesfor maintenance and technical support is based on separate sales of renewals toother customers or upon the renewal rates quoted in the contracts and the fairvalue of services, such as training, is based on separate sales by us of theseservices to other customers.  If weallocated the respective fair values of the elements differently, the timing ofour revenue recognition may have differed materially from that reported.

 

vi.) Revenue from related parties

 

Revenuefrom products and services sold to companies that we have also made strategicinvestments in (related parties) is allocated between the investment andrevenue recognized based on the relative fair value of the products andservices sold and the investment received. We have determined the fair value of the investments based on the factthat all of our investments were made in participation with other unrelatedfinancial investors at the same price per share as the other investors.  Our investment policy generally limits ourinvestments to companies that have completed at least two rounds of financingand generally requires that an unrelated investor lead the round of financingthat we participate in.  We haveestimated the fair value of products and services sold based on comparablesales transactions to other unrelated companies.  Sales to related parties were $10.5 million, $11.4 million, and$1.6 million for the years ended December 31, 2000, 2001, and 2002,respectively.  If we estimated fairvalues of the products and services differently, the amount of revenue recognizedmay have differed materially from that reported.  Please refer to the section below entitled “other related partyinformation” for more information on related parties.

 

(b) ALLOWANCE FOR SALES RETURNS AND DOUBTFUL ACCOUNTS

 

The preparation of financialstatements requires us to make estimates and assumptions that affect thereported amount of assets and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reported period. Specifically, we must make estimates of potential product returns andthe valuation of our accounts receivable. We analyze historical returns, current economic trends, and changes incustomer demand and acceptance of our products when evaluating the adequacy ofour allowance for sales returns.  Werecorded provisions for sales returns of $4.4 million and $517,000 during theyear ended December 31, 2001 and 2002, respectively.  We analyze historical bad debts, customer concentrations,customer credit-worthiness, and current economic trends when evaluating theadequacy of the allowance for doubtful accounts.  As a result, we recorded bad debt expense of $9.8 million and$3.6 million during the year s ended December 31, 2001 and 2002, respectively.As of December 31, 2002, our net accounts receivable balance was $22.5 million,net of allowance for sales returns and doubtful accounts of $7.7, million.  If we had used different estimates andassumptions related to the amount of sales returns we would receive, and aboutthe collectibility of our accounts receivable, our provisions for sales returnsand allowance for doubtful accounts may have differed materially from thatreported.

 

(c) VALUATION OF INVENTORY

 

Inventory, net of allowance for obsolete andslow-moving inventory, consists of finished goods such as handheld computers,pagers, wireless modems, and accessories and is stated at the lower of cost ormarket.  Cost is determined using astandard costing method, which approximates the first-in, first-outmethod.  Our inventory is subject torapid technological changes that could have an adverse impact on itsrealization in future periods.  Inaddition, there are a limited number of suppliers of our inventory.  During 2001 and 2002, we recorded impairmentcharges

 

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of approximately $14.4 million and $263,000,respectively, to reduce the carrying value of our inventory due to obsolescenceand excess inventory.  We estimated thereduction in inventory value based on our consideration of the following: (1)quantities and composition of inventory held; (2) sales prices of competingvendors; (3) projected unit sales and unit pricing over subsequent twelve monthperiod; and (4) evaluation of remaining inventory purchase commitments.  If our projections were different, ourmargins on device sales may have differed materially from that reported. If ourestimates of projected units sales and unit pricing are less than actualresults, we may be required to record additional impairment charges in thefuture.

 

(d) VALUATION OF LONG-LIVED ASSETS INCLUDINGINTANGIBLE ASSETS AND GOODWILL

 

During 2001, we recorded significant impairmentcharges on our goodwill and other intangible assets associated with ouracquisitions.  These charges and ouraccounting policies are described in detail under “Impairment Charges”above.  In 2002, we recorded significantimpairment charges on our goodwill and other intangible assets associated withour acquisitions pursuant to our adoption of SFAS No. 142, “Goodwill and OtherIntangible Assets” (including our annual impairment test in accordance withSFAS No. 142) and SFAS No. 144 “Accounting for the Impairment or Disposal ofLong-Lived Assets.”   See “ImpairmentCharges” above for further discussion.

 

(e) VALUATION OF INVESTMENTS

 

During 2001 and 2002, we recorded significantimpairment charges on our strategic investments.  These charges and our accounting policies are described under“Impairment Charges” above.

 

(f) ESTIMATION OF RESTRUCTURING ACCRUALS

 

During 2001, we implemented an expense reduction planas part of our integration strategy focused on improving operationalefficiencies and the implementation of other measures in order to reduceplanned expenses.  These efforts have resultedin the consolidation of excess facilities and a reduction in our workforce.  The charge related mainly to aworkforce reduction of over 480 positions and the closing or consolidation oftwelve facilities. During 2002, we continued our expense reduction plan focusedon improving operational efficiencies and the implementation of other measuresintended to reduce planned expenses. These efforts have resulted in further consolidation of excessfacilities and eliminations of positions. The charge related mainly to a work force reduction of over 353positions and the closing or consolidation of four facilities.  Employee separation benefits under therestructuring plans include severance, medical, and other benefits.  Facility closure costs and other costsincluded expected losses on subleases, brokerage commissions, asset impairmentcharges, contract termination costs and other costs.  As of December 31, 2002, the accrued liability related to therestructuring was $32.5 million.

 

Calculation of the restructuring accrual related toexpected losses on subleases requires us to make estimates concerning: (1) theexpected length of time to sublease the facility; (2) the expected rental rateson subleases; and (3) estimated brokerage expenses associated with executingthe sublease.  We used the assistance ofindependent real estate brokerage firms in the making these estimates, and ourestimates may be impacted by future economic trends.  The expected losses on subleases have not been discounted. If theactual results differ from our estimates, we may be required to adjust ourrestructuring accrual related to expected losses on subleases, includingrecording additional losses.

 

**MD&A (4) RECENT ACCOUNTINGPRONOUNCEMENTS**

 

(i) SFAS No. 145

 

In April 2002, the FASBissued SFAS No. 145, “ Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections.”  SFAS No. 145 rescinds FASB No. 4 and 64 inrelation to reporting gains and losses from extinguishment of debt.  SFAS No. 145 amends SFAS No. 4 and 64 andrequires gains and losses from extinguishment of debt to be classified asextraordinary items only if they meet the criteria in Opinion 30.  Applying the provisions of Opinion 30 willdifferentiate between normal recurring operations of a company and transactionsthat are unusual or infrequent in matter. SFAS No. 145 also amends Statement No. 13, to the effect thatsale-leaseback accounting for certain lease modifications should be accountedfor in the same manner as sale-leaseback transactions.  In connection with the adoption of thisStatement, we will be required to classify as operating income gains from theextinguishment of debt of $7.7 million and $42.8 million for the years endedDecember 31, 2001 and 2002, respectively. Such amounts are currently recorded as extraordinary items.

 

(ii) SFAS No. 146

 

In June 2002, the FASB issued SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities.”  SFAS No. 146 requires that a liability for acost associated with an exit or disposal activity be recognized when incurredat fair value.  SFAS No. 146 in turneliminates the definition and requirements of ETIF Issue 94-3.  SFAS No. 146 is effective for exit ordisposal activities that are initiated after December 31, 2002.  The adoption of SFAS No. 146 may have aneffect on the timing of future restructuring charges taken, if and when theyoccur.

 

(iii) SFAS No. 148

 

In December 2002, the FASB issued Statement No. 148“Accounting for Stock-Based Compensation – Transition and Disclosure – anamendment of FASB Statement No. 123. The Statement is effective for 2002. SFAS No. 148 requires new disclosures about the effect of stock-basedemployee compensation on reported results. The Statement requires that effects be disclosed more prominently byspecifying the

 

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form, content and location of those disclosures.  The Statement permits several ways oftransitioning to the Fair Value method of accounting for stock-basedcompensation, however the Statement does not require that Companies discontinuethe intrinsic value method of accounting for stock-based compensation.  We will continue to use the intrinsic valuemethod of accounting for stock-based compensation and have adopted thedisclosure requirements of Statement in this annual report filed on Form10-K.  See footnote 4 in ourconsolidated financial statements.

 

(iv) Financial Interpretation No. 45

 

In November 2002, the FASB issued FASB InterpretationNo. 45, “Guarantors Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others.”  Interpretation No. 45 discusses thenecessary disclosures to be made by a guarantor in its financial statementsabout its obligations under certain guarantees that it has issued.  It also requires the guarantor to recognizeas a liability, at fair value, at the inception of the guarantee, theobligation incurred in issuing the guarantee. The disclosure requirements are effective for 2002.  The reporting requirements are effective ona prospective basis for guarantees issued after December 31, 2002.  Please see section entitled “Liquidity andCapital Resources” below for a description of these guarantees.

 

(v) EITF 00-21

 

In November, 2002 the Emerging Issues Task Force issuedits final consensus on Revenue Arrangements with Multiple Deliverables.  This guidance is effective for revenuearrangements entered into in fiscal periods beginning after June 15, 2003 oralternatively, entities may elect to report the change in accounting as acumulative-effect adjustment.  EITF00-21 discusses criteria necessary to determine when an arrangement may beviewed to have separate units of accounting (and thus revenue) and when anarrangement should be viewed as a single unit of accounting.  We are currently performing an analysis ofhow this might affect revenue recognition for arrangements we routinely enterinto that have multiple deliverables.

 

(vi) Financial Interpretation No. 46

 

In January 2003, the FASB issued Interpretation No.46, "Consolidation of Variable Interest Entities, an interpretation of ARBNo. 51. "This interpretation addresses the consolidation by businessenterprises of variable interest entities as defined the Interpretation.  The interpretation applies immediately to variableinterests in variable interest entites created after January 31, 2003, and tovariable interests in variable interest entities obtained after January 31,2003.  The Interpretation is applied tothe enterprise no later than the end of the first annual reporting periodbeginning after June 15, 2003.  Theapplication of this Interpretation is not expected to have a material effect onour financial statements.  The Interpretationrequires certain disclosures in financial statements  issued after January 31, 2003 if it is reasonably possible thatwe will consolidate or disclose information about variable interest entitieswhen the Interpretation becomes effective.

 

**MD&A (5) COMPARISON OF RESULTSFOR YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000**

 

(a) SUBSCRIBER REVENUE

 

Subscriber revenueconsists of the amortization over the life of the expected customerrelationship of nonrefundable activation fees, monthly per-subscriber servicefees, monthly per subscriber exchange fees for access to financial informationfrom the securities exchanges and markets, and monthly fees for providingaccess to our network operations center. Subscriber revenue increased to $69.6 million for the year endedDecember 31, 2002 from $44.0 million for the year ended December 31, 2001 andfrom $ 24.8 million for the year ended December 31, 2000.  Subscribers increased to 108,519 at December31, 2002 from 62,403 at December 31, 2001 and from 47,273 at December 31, 2000.  Approximately $20.2 million of the increasein revenue and 22,306 of the increase in subscribers in 2002 was due toincreased subscribers for the Highway Master product line obtained inconnection with an acquisition made in the first quarter of 2002.  The remaining increase was primarily due tothe increase in subscribers for our Blackberry by Aether products, partiallyoffset by a decline in subscriber revenue from our domestic and European marketdata products.  Approximately $9.6million of the increase in 2001 over 2000 was due to sales to existing and newMobileMax customers and, approximately $9.6 million of the increase insubscriber revenue resulted from the increased number of subscribers thatsigned on to our existing and new product and service offerings such aswireless messaging and financial services products.  The MobileMax product line was obtained in connection with anacquisition made in the fourth quarter of 2000.

 

(b) COST OF SUBSCRIBER REVENUE

 

Cost of subscriber revenue consists primarily ofairtime costs, financial data costs, and securities exchange and marketfees.  Our airtime costs are determinedby agreements we have with several wireless carriers.  Typically, we have one-year contracts to buy data networkcapacity either for an agreed amount of kilobytes at a flat fee or on acents-per-kilobyte basis.  Cost ofsubscriber revenue excludes depreciation on, and operating costs of, ournetwork operations center and certain costs of customer fulfillment andcustomer care.  Cost of subscriberrevenue increased to $40.1 million for the year ended December 31, 2002, from$27.2 million for the year ended December 31, 2001, and from $11.3 million forthe year ended December 31, 2000.  Theincrease for 2002 was primarily due to the increase in subscriber revenue over 2001as discussed above.  Approximately $10.4million of the increase in 2002 was due to increased subscribers for theHighway Master product line obtained in connection with an acquisition made inthe first quarter of 2002.  We generallyexpect the cost of subscriber revenue to increase proportionately with anyincrease in subscriber revenue.  Theincrease for 2001 from 2000 relates primarily to the increase in subscriberrevenue between periods as discussed above. During 2001, the cost of subscriber revenue increased relative to volumeof sales as a result of several factors. These factors included the increased cost of airtime in Germany relatedto Sila and incremental costs associated with providing services to non-payingcustomers obtained in connection with our acquisition of Motient’s retailtransportation business unit. During 2001 we converted some of these non-payingcustomers into paying subscribers by repairing their non-workingequipment.  Due to these conversion andto the cessation of our operations in Germany, our margins improved in 2002.

 

(c) ENGINEERING SERVICES REVENUE

 

Revenue from engineering services consists of amounts billed to ourcustomers for engineering time on an hourly basis or fixed fees on a perproject basis.  Engineering servicesrevenue decreased to $3.2 million for the year ended December 31, 2002, from$7.9 million for the year ended December 31, 2001 and from $ 9.4 million forthe year ended December 31, 2000.  Thedecrease for 2002 over 2001 was primarily due to the

 

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general decrease in corporate IT (information technology) spending whichin turn has reduced spending on the custom solutions that our engineering groupprovides.  The decrease in 2001 over2000 was due to the completion of several large engineering projects in early2001 combined with a general decrease in corporate IT (information technology)spending.

 

(d) COST OF ENGINEERING SERVICES REVENUE

 

Cost of engineering services revenue consists of cashcompensation and related costs for engineers and other project-relatedcosts.  Cost of engineering servicesrevenue decreased to $1.5 million for the year December 31, 2002, from $3.6million for the year ended December 31, 2001, and from $5.7 million for the yearended December 31, 2000.  The decreasebetween periods was primarily due to the decrease in engineering servicesperformed as discussed above, combined with lower relative costs of revenue aswe gain engineering efficiencies.

 

(e) SOFTWARE AND RELATED SERVICES REVENUE

 

We derive revenue from the licensing of softwareproducts such as our PacketCluster, PocketBlue and FireRMS software suites mostoften used by our federal, state and local government customers.  We also derive revenue from the licensing ofother software products including elements of the Aether FusionTMplatform, formerly sold as AIM and the ScoutWare software suite, as well asfrom the e-Mobile software suite.  Inthe future, we may generate revenue from the licensing of newer versions of oursoftware foundation Aether FusionTM.  Software and related services revenue decreased to $24.4 millionfor the year ended December 31, 2002 from $37.0 million for the year endedDecember 31, 2001, which increased from $17.3 million for the year ended December31, 2000. Approximately $6.2 million of the decrease between 2002 and 2001 wasdue to the decrease in software sales for the ScoutWare software suite, andapproximately $3.0 million of the decrease was due to the decrease in softwaresales for the PacketCluster software suites. The decrease in ScoutWare sales was primarily related to the loss ofseveral high volume customers from 2001 to 2002.   Most of the remaining decrease was due to the elimination of theAdvantage software suite.  The decreasedsales of these products reflects the general decrease in corporate IT spendingduring 2001 and into 2002.  The increasein 2001 over 2000 was primarily due to sales to existing and new customers ofthe PacketCluster software suite and the FireRMS software suite, both of whichwere obtained in conjunction with acquisitions made late in 2000.

 

(f) COST OF SOFTWARE AND RELATED SERVICES REVENUE

 

Cost of software and related services revenue consistsof costs of licensing, including royalty payments and personnel costs.  Cost of software and related servicesrevenue was $8.1 million for the year ended December 31, 2002, $11.6 millionfor the year ended December 31, 2001, and $5.7 million for the year endedDecember 31, 2000, relating to royalty fees for third-party intellectualproperty used in the software that we sell and personnel costs incurred in thecustomization of software products and the support of those products.  The decrease for 2002 from 2001 relatesprimarily to the decrease in software revenue between periods as discussedabove.  The increase for 2001 over 2000relates primarily to the increase in software revenue between periods asdiscussed above.

 

(g) DEVICE SALES

 

We derive device revenue on the sale of wirelessdevices used to provide our services. Revenue from device sales decreased to $19.3 million for the year endedDecember 31, 2002 from $24.0 million for the year ended December 31, 2001 whichwas an increase from $6.6 million for the year ended December 31, 2000.  The decrease in device sales between 2002and 2001 relates to decreased device revenue from some of our governmentcontracts as these projects have moved from the hardware deployment phase in2001 to the latter stages of completion in 2002.  The decrease in device sales also relates to the reduction in theselling price of handheld devices, partially offset by the increase in devicesales of the Mobile messaging product line. The increase in device sales between 2001 and 2000 relates primarily tosales of products to new subscribers between periods and $3.4 million of bulksales of devices to other vendors.

 

(h) COST OF DEVICE SALES

 

Cost of device sales consists of the cost of thehardware from the hardware manufacturer or wholesaler.  Cost of devices decreased to $17.5 millionfor the year ended December 31, 2002 from $38.3 million for the year endedDecember 31, 2001, which was an increase from $7.3 million for the year endedDecember 31, 2000.  Approximately$263,000 and $14.4 million of the cost of device sales for 2002 and 2001,respectively, related to obsolescence and excess inventory charges.  The decrease in cost of device sales in 2002also relates to the movement of some of the government contracts into differentstages of completion as mentioned above in device sales.  The increase in the cost of device sales for2001 relates primarily to the increase in device sales between periods and thebulk sales of devices to other vendors. Included in the results for 2001 are bulk sales of hardware at or belowcost made primarily to reduce inventory.

 

(i) RESEARCH AND DEVELOPMENT EXPENSES

 

Research and development expenses consist primarily ofcash compensation and related costs for engineers engaged in research and

development activities and, to a lesser extent, costsof materials relating to these activities. We expense research and development costs as we incur them.  Research and development expenses, includingin-process research and development related to acquisitions, decreased to $26.3million for the year ended December 31, 2002, from $63.9 million for the yearended December 31, 2001, which was an increase from $38.0 million for the yearended December 31, 2000.  The decreasein 2002 from 2001 was primarily due to our reduction in work force betweenperiods and from significantly reduced spending on contractors andfacilities.  The increase in 2001 from2000 was due to the hiring of

 

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additional engineers and consultants for increasedresearch and development activities associated with the development of our softwareproducts, mobile computing platforms, including AetherFusionTM, andwireless data services and a full year of costs associated with engineersobtained in connection with acquisitions made during 2000.  In addition, we incurred charges of $7.9million for in-process research and development in connection with several ofour acquisitions in 2000.  We anticipatethat our research and development expenses will continue to decrease in 2003due to reductions in personnel that have occurred during 2002.  For more information on our restructuringefforts refer to the section entitled “Estimation of Restructuring Accrual”above.

 

(j) GENERAL AND ADMINISTRATIVE EXPENSES

 

General and administrative expenses consist primarilyof cash compensation and related costs for general corporate and businessdevelopment personnel, along with rent, network operations costs, and generalsupport costs.  General andadministrative expenses decreased to $59.7 million for the year ended December31, 2002, from $90.9 million for the year ended December 31, 2001 which was anincrease  from $52.9 million for theyear ended December 31, 2000.  Thedecrease in 2002 compared to 2001 was primarily due to reductions in personneland the reduced spending on professional fees. The increase in 2001 was primarily due to additional personnel andconsultants performing general corporate activities, additional facilities andthe full year of operations of our acquisitions since 2000.  In 2001, the increased scope of our businessrequired additional personnel and other expenses, such as consulting, traveland facilities, in all areas including: customer service, network operations,project management, legal and accounting. We will incur general administrative expenses in 2003 related to ouroutsourcing agreement with EDS, however these expenses will be offset by areduction in personnel and other cost of providing these same servicesinternally.  As such, we do notanticipate significant changes in our general and administrative expenses in2003.  For more information on ourrestructuring efforts refer to the section entitled “Estimation ofRestructuring Accrual” above.

 

(k) SELLING AND MARKETING EXPENSES

 

Selling and marketing expenses consist primarily ofadvertising and promotions, sales and marketing personnel, travel andentertainment, certain customer fulfillment and customer care costs.  Selling and marketing expenses decreased to$28.8 million for the year ended December 31, 2002, from $66.8 million for theyear ended December 31, 2001 which was an increase from $54.2 million for theyear ended December 31, 2000.  Thedecrease in selling and marketing expenses in 2002 compared to 2001 was dueprimarily to reductions in personnel, bad debt expense, and advertising.  The increase in selling and marketingexpenses in 2001 over 2000 was due primarily to the increased number of salespersons obtained in connection with acquisitions and the related salaries,commissions, and other costs incurred as a result of increased revenue for2001.  We anticipate that our sellingand marketing expenses will continue to decrease in 2003 due to a full year’sbenefit of the personnel reductions made in 2002 and continued focus onefficient spending of our selling and marketing dollars.

 

(l) DEPRECIATIONAND AMORTIZATION

 

Depreciation and amortization expenses consistprimarily of the amortization of intangible assets obtained in connection withour acquisitions. Depreciation and amortization expenses also includedepreciation expenses arising from equipment purchased for our data centers andother property and equipment purchases. Depreciation and amortization decreased to $39.3 million for the yearended December 31, 2002, from $180.7 million for the year ended December 31,2001 and from $238.1 million for the year ended December 31, 2000.  The decrease was primarily a result of theimpairment charges recorded during 2001 and 2002, which significantly reducedthe carrying value of the goodwill and other intangibles, and from the adoptionof SFAS No. 142 on January 1, 2002, requiring us to cease amortizingapproximately $171.0 million of goodwill and assembled workforce.  For more information on our adoption of SFASNo. 142, please refer to the section entitled “New Accounting Pronouncements”above.  Given the reduction of the netbook value of our assets as a result of impairment charges taken during theyear, we expect depreciation and amortization expense to decrease in the shortterm.

 

(m) OPTION AND WARRANT EXPENSE

 

Option and warrant expense consists of expensesrecorded to account for the difference, on the date of grant, between the fairmarket value of common stock and the exercise price of stock options issued toemployees, the fair value of restricted stock granted to employees and the fairvalue of equity-based awards to non-employees. We have in the past issued options and/or warrants at prices belowmarket value in connection with our acquisitions as replacements for existingoptions in the acquired company.  Weaccount for equity-based employee compensation arrangements in accordance withthe provisions of Accounting Principle Board (APB) Opinion No. 25, “Accountingfor Stock Issued to Employees”, and related interpretations including FIN 44,and comply with the disclosure provisions of Statement of Financial AccountingStandards (SFAS) No. 123, “Accounting for Stock-Based Compensation”. Under APBNo. 25, compensation expense is based upon the difference, if any, on the dateof grant, between the fair value of our stock and the exercise price.  All equity-based awards to non-employees areaccounted for at their fair value in accordance with SFAS No. 123.  Option and warrant expense decreased to $6.5 million for the year ended December 31, 2002, from $14.4 million for theyear ended December 31, 2001 which was a increase from $14.3 million for theyear ended December 31, 2000.  Thedecrease in 2002 compared to 2001 was primarily the result of the cancellationof options as we reduced our work force. The increase for 2001 was primarily due to the fact that in January2001, we canceled approximately 2.5 million options granted to employees andissued approximately 756,000 shares of restricted stock to a number ofemployees holding options with exercise prices higher than our then-currentmarket value.  We recognize option andwarrant expense as these shares vest. We expect to record an additional $2.8 million of expense over thevesting period of the restricted stock grants through 2004.  During 2001 and 2002, we recorded expense of$5.9 million and $2.7 million, respectively, related to these restrictedshares.  This increase was partiallyoffset by some restricted shares expiring as

 

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employees were terminated throughout the year pursuantto our cost containment efforts.  Givenour numerous acquisitions since our inception and the issuance of restrictedstock under our Acquisition Incentive Plan, we expect to continue to havesubstantial option and warrant expense.

 

(n) IMPAIRMENT OFINTANGIBLES AND OTHER ASSETS

 

Impairment of intangiblesand other assets consists of the amount of goodwill, intangibles and otherassets written down in the period. Impairment of intangibles decreased to $69.5 million in 2002 from $1.121billion in 2001.  See Factors Affecting Comparabilityabove for further discussion of the impairment of intangibles and other assetsin 2002 and 2001.  There was noimpairment of intangibles for 2000.

 

(o)  RESTRUCTURING CHARGE

 

During each of the last three quarters of 2001, we hadrestructuring charges.  We implementedan expense reduction plan as part of our integration strategy focused onimproving operational efficiencies and the implementation of other measuresintended to reduce planned expenses. These efforts have resulted in the consolidation of excess facilitiesand a reduction in our workforce.  Thecharge related mainly to a workforce reduction of over 480 positions and theclosing or consolidation of twelve facilities. Employee separation benefits under the restructuring plan includedseverance, medical, and other benefits. Facility closure costs included expected losses on subleases, brokeragecommissions, asset impairment charges, contract termination costs and othercosts.  During 2002, we continued ourexpense reduction plan focused on improving operational efficiencies and theimplementation of other measures in order to reduce planned expenses.  These efforts have resulted in the furtherconsolidation of excess facilities and elimination of positions.  As a result of this restructuring plan, werecorded charges to earnings of $37.7 million for the year ended December 31,2002 and $45.0 million for the year ended December 31, 2001.  There was no restructuring charge for 2000.  The charges related mainly to a workforcereduction of over 353 and 480 positions and the closing or consolidation offour and twelve facilities for the years ended December 31, 2002 and 2001,respectively.  Employee separationbenefits of approximately $5.6 million for the year ended December 31, 2002 and$10.2 million for the year ended December 31, 2001 include severance, medical,and other benefits.  Facility closureand other costs of $32.1 million for the year ended December 31, 2002 and $34.8million for the year ended December 31, 2001 include expected losses onsubleases, brokerage commissions, asset impairment charges, and othercosts.  As of December 31, 2002, theaccrued liability balance related to the restructuring was $32.5 million.

 

(p) INTEREST INCOME

 

Interestincome consists primarily of interest income from cash equivalents andshort-term investments.  Interest incomedecreased to $10.7 million for the year ended December 31, 2002 from $28.0million for the year ended December 31, 2001 which was a decrease from $57.1million for the year ended December 31, 2000. The decreases in 2002 and 2001were primarily the result of decreasing cash balances over the years combinedwith decreased interest rates.  Weexpect interest income to continue to decline as our cash balance declines.

 

(q) INTEREST EXPENSE

 

Interest expense consists primarily of debt service onour outstanding convertible subordinated notes payable.  Interest expense decreased to $14.7 millionfor the year ended December 31, 2002 from $19.3 million for the year endedDecember 31, 2001, which was an increase from $14.7 million for the year endedDecember 31, 2000. The decrease for 2002 as compared to 2001 was primarily dueto a decrease in interest expense as the result of the buy-back of debt in2002.  During 2002, we bought back $135.6million face value of our convertible subordinated notes payable, most of whichwas repurchased at the end of the second and fourth quarters, and as suchexpect reduced interest expense going forward. The increase for 2001 was primarily due to a full year of interest onour notes in 2001 and accrued interest on a $5.2 million forward salearrangement entered into during 2001.

 

(r) EQUITY IN LOSSES OF INVESTMENTS

 

Equity in losses of investments consists of ourproportionate share of the net losses in our investments over which we exercisesignificant influence and as such account for under the equity method ofaccounting.  Equity in losses ofinvestments decreased to $4.7 million for the year ended December 31, 2002 from$57.5 million for the year ended December 31, 2001 which was an increase from$47.9 million for the year ended December 31, 2000.  The decrease in 2002 compared to 2001 relates to continuedwrite-downs of certain of our investments coupled with a reduction of losseswithin the investees as they intentionally reduce spending or are short oncapital to spend.  The increase in 2001over 2002 relates to a full year of losses associated with investments made atvarious times during 2000.

 

(s) INVESTMENT LOSS, INCLUDING IMPAIRMENTS, NET

 

Investment loss, including impairments consists of theloss taken on investments where the decline in market value was deemed to beother than temporary.  Investment lossalso includes amounts related to the decline in the fair value of derivativeinstruments, offset by realized gains from the sales of investments.  Net investment loss, including impairmentsdecreased to $14.4 million for the year ended December 31, 2002 from $143.4million in December 31, 2001, which included $14.1 million and $136.7 million,respectively, in impairment charges related to our investments.  The remainder of the net charge related tonet gains (losses) from the sales of investments, and changes in the fair valueof warrants.  We had no investmentlosses in 2000.  The decrease in 2002was due to the fact that the carrying value of our investments had beensubstantially depleted by the losses taken on our investments in 2001.  The increase in 2001 was mainly due tooverall declining market conditions.

 

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(t) MINORITY INTEREST

 

Minority interest consists wholly of Reuters’ownership interest in Sila prior to 2002. During the fourth quarter of 2002, we purchased from Reuters their 40%interest in Sila. Reuters’ portion of Sila’s loss was approximately $(45,000),$63.8 million and $10.7 million for the years ended December 31, 2002, 2001 and2000 respectively.  Since we now whollyown Sila, we will no longer allocate any portion of Sila’s net income or lossto Reuters through minority interests and all of our subsidiaries are nowwholly owned.  Sila’s losses areincluded in the consolidated income statement for the years ended December 31,2002, 2001 and 2000.  Sila’s decreasedlosses in 2002 were due to our integration strategy focusing on improvingoperational efficiencies and the implementation of other measures in order toreduce planned expenses.  The increasedlosses in 2001 over 2000 were due to a full year of operations combined with aramp up of spending as Sila expanded.

 

(u) OTHER INCOME

 

Other income was $2.3 million for the year endedDecember 31, 2002.  There was no otherincome for the years ended December 31, 2001 and 2000.  Other income in 2002 consisted of an escrowsettlement of $2.5 million related to our purchase of RTS Wireless in Novemberof 2000, offset by other expenses related to the settlement.  This settlement was recorded as other incomedue to the previous write-off of assets acquired in the RTS Wirelessacquisition.

 

(v) INCOME TAX BENEFIT

 

The income tax benefit ofapproximately $535,000 for 2002 relates to refunds received from the carrybackof federal net operating losses to prior tax years for one of oursubsidiaries.  The income tax benefit of$10.7 million and $1.6 million for 2001and 2000, respectively, consists of aforeign deferred tax benefit associated with the impairment of identifiableintangibles by Sila.  We do not expectto record additional tax benefits for the foreseeable future.

 

(w) EXTRAORDINARY ITEM

 

The extraordinary item for 2002 consists entirely ofthe gain realized from the early extinguishment of $135.6 million inconvertible subordinated notes payable. Extraordinary item was $42.8 million for the year ended December 31,2002 and $7.7 million for the year ended December 31, 2001.  The 2001 extraordinary item related to theearly extinguishment of $20.0 million in convertible subordinated notespayable.  There were no extraordinaryitems in 2000.

 

(x) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTINGPRINCIPLE

 

Cumulative effect of change in accounting principlewas ($129.3) million for the year ended December 31, 2002 and $6.6 million forthe year ended December 31, 2001.  The2002 charge related to the adoption of SFAS No. 142, “Goodwill and OtherIntangible Assets.”  The $129.3 millionimpairment charge represented a decrease in the value of certain intangibleassets obtained in connection with acquisitions made in 2000 as discussed inthe section entitled “Impairment Charges” above.  The 2001 amount related to the adoption of SFAS No.133, “Accountingfor Derivatives and Hedging Activities”. The $6.6 million represented the fair value of warrants we hold in twoof our investees, which met the criteria for a derivative under SFAS No. 133.  There was no cumulative effect of change inaccounting principle in 2000.

 

**MD&A (6) SEGMENT RESULTS**

 

Aether’s operating segments include EnterpriseMobility Solutions, Transportation, and Mobile Government.

 

The Enterprise Mobility Solutions (EMS) Segment is focused onproviding integrated wireless data solutions to enterprises with productdevelopment emphasis on field service, sales force automation, distribution anddelivery management, and mail and messaging access.

 

In ourTransportation Segment our main products are MobileMaxTM, a vehicle location andmessaging solution for long-haul trucks, and a number of asset monitoringproducts, including GeoLogicTM, TrailerMaxTM and 20/20vTM.  Our MobileMAXTM product hasleast-cost-routing capability made possible by multi-mode technology(terrestrial and satellite connectivity) to deliver two-way data and dispatchmessaging and automatic, instantly communicated information on each vehicle -typically trucks.

 

Inour Mobile Government Segment we are a service provider in the area ofwireless  data solutions for publicsafety.  We have products for both lawenforcement and asset tracking.  Ourpublic safety solutions are integrated into 47 different state databases aswell as local and federal databases to deliver real-time information in secondswithout having to involve dispatch or other resources.  Our products in this area are thePacketCluster family of products, the handheld version of PacketCluster Patrolcalled PocketBlue, the FireRMS family of products for fire and rescue companies,and the handheld application for this community, PocketRescue.

 

Corporate and Other consists mainly of corporateassets.  We do not allocate corporateassets to the Segments for internal reporting purposes.

 

Aether began to report its financial results bysegment as of the first quarter of 2000. During 2000, 2001 and 2002, Aether’sreportable segments have changed — and Aether expects them to continue tochange – as its operating structure, business and the market in which it

 

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operates evolves. As we did not report based on our current segments for 2001, it isimpracticable for us to compare 2002’s results to the results of 2001.

 

Segment detail is summarized as follows:

 
| **YEAR ENDED  DECEMBER 31, 2002** |   | **Enterprise  Mobilility  Solutions** |   | **Transportation** |   | **Mobile  Government** |   | **Corporate  & Other** |   | **Total** |   |
|-----------------------------------|--------|---------------------------------------|--------|--------------------|--------|------------------------|--------|----------------------------|--------|-----------|--------|
| Revenue                           |   | $                                     | 54,894 |               | $      | 41,147                 |   | $                          | 20,490 |      | $      | — |   | $ | 116,531 |   |
| Gross Profit  (loss)              |   | $                                     | 18,300 |               | $      | 17,478                 |   | $                          | 13,533 |      | $      | — |   | $ | 49,311 |   |
| Total Assets                      |   | $                                     | — |               | $      | —                 |   | $                          | — |      | $      | 473,409 |   | $ | 473,409 |   |

 

**MD&A(7) OTHER RELATED PARTY INFORMATION**

 

(a) AOL

 

Weentered into a series of agreements (the “Agreements”) with AmericaOnline, Inc. (“AOL”) in November of 2001. On November 4, 2002, the Company, AOL and AOL Time Warner Inc.(“AOLTW” and, collectively with AOL, the “AOL Parties”) entered into aSettlement Agreement and Mutual Release (the “Settlement Agreement”) pursuantto which Aether and the AOL Parties agreed to terminate all of the Agreementswith the exception of a Stock Purchase Agreement. The Stock Purchase Agreement(filed by Aether on April 1, 2002 as Exhibit 10.25 to Form 10-K)will remain in effect to govern the 737,790 shares of our stock purchased byAOL on December 3, 2001 but was modified by the Settlement Agreement so asnot to require future investment in Aether by AOL. In connection with thetermination of the other Agreements, the Settlement Agreement also provides forthe release to us of approximately $5.3 million that we had previouslydeposited in an escrow account under the terms of the Agreements. Subsequent tosigning the Settlement Agreement, $5.3 million was released and is no longershown as restricted cash on our balance sheet. The parties have agreed that no other amounts are due or owing to anyparty.  Pursuant to this settlement, wetook a charge of approximately $6.5 million to write off certain AOL relatedintangible assets.

 

(b) ADDITIONAL RELATEDPARTY INFORMATION

 

During the years 2000, 2001, and 2002, the Company received services fromstockholders and other related entities including Reuters (financial dataservices), Huber Oros (benefit coordination services) and AOL Time Warner(advertising services).  These companiesare considered related parties due to the fact that they are significantstockholders or entities with familial relationships with members of the seniormanagement of the Company or with significant shareholders of the Company. Forthe year ended December 31, 2002, related party expense was $5.3 million, themajority of which related to advertising services purchased.  For the years ended December 31, 2000 and2001, related party expenses were $5.7 million and $2.2 million respectively.Please refer to the section above entitled “Critical Accounting Policies” formore information on related party revenue.

 

**MD&A (8) LIQUIDITY AND CAPITALRESOURCES**

 

Since 1999, we have financed ouroperations primarily through private and public placements of our equity anddebt securities.  Through December 31,2002, we have raised aggregate net proceeds of approximately $1.5 billion, netof underwriters discounts, including the issuance of $310.5 million of 6%convertible subordinated notes.  As ofDecember 31, 2002, we had approximately $324.4 million in cash and short-terminvestments and working capital of approximately $335.2 million.

 

Net cash used in operating activities was $63.8 million,$220.7 million and $90.5 million for the years ended December 31, 2000,2001 and 2002, respectively. The principal use of cash in each of these periodswas to fund our losses from operations.

 

Net cash used in investing activities was $512.2 million, $120.0 millionand $270.7 million for the years ended December 31, 2000, 2001 and 2002,respectively.  For the year endedDecember 31, 2001, we used $38.5 million for the purchase of property and equipment,$41.5 million for investments in companies and $33.8 million for payments on2000 acquisitions.  For the year endedDecember 31, 2002, we used $5.0 million for the purchase of property andequipment, $16.3 million for acquisition-related costs, and $252.7 million forthe net purchases of short-term investment instruments (primarily United StatesGovernment sponsored securities).

 

Net cash provided by financing activities was $1.4 billion and $6.5million for the years ended December 31, 2000 and 2001 respectively and net

 

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cash used in financing activities was $92.3 million for the year endedDecember 31, 2002.  For the year endedDecember 31, 2001, cash used in financing activities related primarily to therepurchase of convertible subordinated notes payable.  For the year ended December 31, 2002, we used $92.9 million torepurchase convertible subordinated notes. Even given our recent repurchase of debt, we believe we have sufficientresources to cover our operating expenses and material commitments for at leastthe next 12 months.

 

(a) LETTERS OF CREDIT

 

During the normal course of operations, we have entered into variousletter of credit agreements.  As ofDecember 31, 2002, we had outstanding $7.8 million in letters of credit whichexpire at various times over the next eight years.

 

(b) GUARANTEES

 

We have certain guaranteesdisclosable under FIN 45 as follows:

 

•                  We have guaranteed the payment to our Landlord onseveral properties we have sublet.  Themaximum guarantee on these properties is $2.7 million.

•                  In our Mobile Government segment, we may have to payliquidated damages in some cases if our subcontractors do not perform ontime.  In addition, we sometimesindemnify certain of our customers against damages, if any, they might incur asa result of a claim brought against them related to third party softwareimbedded in our products.  We are unableto estimate the maximum exposure of such indemnifications due to the inherentuncertainty and the varying nature of contractual terms.

•                  We generally warrant our products against certainmanufacturing and other defects.  Theseproduct warranties are provided for specific periods of time and/or usage ofthe product depending on the nature of the product and other factors.  As of December 31, 2001 and 2002, we haveaccrued $1.9 million and approximately $788,000, respectively, for estimatedproduct warranty claims.  The accruedproduct warranty costs are based primarily on historical experience of actualwarranty claims as well as current information on repair cost.

 

The following table provides thechanges in our product warranties:

 
|                                                                          |   | **2002** |   |
|-------------------------------------------------------------------------------|--------|----------|--------|
| Warranty  liability balance at January 1, 2002                                |   | $        | 1,943  |   |
| Liabilities  accrued for warranties issued during the period                  |   | 493      |   |
| Warranty  claims paid during the period                                       |   | (490     | )      |
| Changes  in liability for warranties during the period, including expirations |   | (1,158   | )      |
| Warranty  liability balance at December 31, 2002                              |   | $        | 788    |   |

 

(c) CONTRACTUAL OBLIGATIONS

 

The following table describes all of our contractualcommitments including our future minimum lease payments.

 
|                                                                                     |   | **Payments  due by period** |    |
|------------------------------------------------------------------------------------------|--------|-----------------------------|---------|
| **Contractual Obligations**                                                              |   | **Total**                   |    | **Less than  1 year** |   | **1-3 years** |   | **3-5 years** |   | **More than  5 years** |   |
|                                                                                     |   |                        |    |   |   |   |   |   |   |   |   |
| Long-Term Debt  Obligations                                                              |   | 178,149                     |    | 9,295 | (1) | 168,854 | (1) | — |   | — |   |
| Capital Lease  Obligations                                                               |   | —                      |    | — |   | — |   | — |   | — |   |
| Operating Lease  Obligations                                                             |   | 71,393                      | (2)     | 12,021 |   | 27,738 |   | 22,807 |   | 8,827 |   |
| Purchase  Obligations                                                                    |   | 45,900                      |    | 43,665 | (4)  | 2,235 | (4) | — | (4) | — | (4) |
| Other Long-Term  Liabilities Reflected on the Registrant’s Balance Sheet under GAAP |   | —                      | (3)     | — |   | — |   | — |   | — |   |
|                                                                                     |   |                        |    |   |   |   |   |   |   |   |   |
| **Total**                                                                                |   | $                           | 295,442 |   | $ | 64,981 |   | $ | 198,827 |   | $ | 22,807 |   | $ | 8,827 |   |
|                                                                                          |        |                             |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1) Long-term debt obligations includes interest ofapproximately $23.2 million through March 2005.

 

(2) Facilities representing $61.3 million of ourminimum lease payments have been subleased or are available for sublease.  Although there can be no assurance, weexpect actual expenditures related to the above commitments will be less thanindicated above due to reductions we are in the process of negotiating.

 

(3) The Company does not have any other Long-Termliabilities requiring cash payment (deferred rent and deferred revenue do notrequire a cash outlay) that are not already included in the categoriesabove.  For instance, the entire longterm portion of our restructuring reserve relates to our operating leaseobligations which are already quantified in the third line of the above table.

 

(4) Our commitments to EDS include fees for year oneand implementation fees.  Contractualcommitments for years 2 through 7 are not included here as they will bedetermined based on variable pricing and are cancelable for fees ranging fromapproximately $1 million to $2 million over the term of the arrangement

 

 

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**MD&A (9) RISK FACTORS**

 

Our results of operations are affected by a variety offactors, including those described below.

 

(a) WE HAVE HISTORICALLY INCURRED LOSSES AND WE EXPECTTHESE LOSSES TO CONTINUE IN THE FUTURE.

 

We reported net losses of $362.7 million, $1.7 billionand $325.4 million for the years ended December 31, 2000, 2001, and 2002,respectively.  We expect to continue toincur significant sales and marketing, systems development and administrativeexpenses.  Therefore, we will need togenerate significant revenue to become profitable and sustain profitability ona quarterly or annual basis.  We expectto continue to incur significant losses for the foreseeable future.  As a result, we may not be able to achieveprofitability on a quarterly or annual basis. In particular, there can be no assurance that we will achieveprofitability before our cash resources have been depleted.

 

(b) THERE IS NO ESTABLISHED MARKET FOR OUR SERVICES;WE MAY NOT BE ABLE TO SELL ENOUGH OF OUR SERVICES TO BECOME PROFITABLE.

 

The markets for wireless data and transaction servicesare still emerging.  Continued growth indemand for, and acceptance of, these services

remains uncertain. Current barriers to market acceptance of these services include cost,reliability, functionality and ease of use. We cannot be certain that these barriers will be overcome.  Our competitors may develop alternativewireless data communications systems that gain broader market acceptance thanour systems.  If the market for ourservices does not grow, or grows more slowly than we currently anticipate, wemay not be able to attract customers for our services and our revenues would beadversely affected.

 

(c) OUR ACQUISITIONS, INVESTMENTS AND STRATEGICALLIANCES MAY NOT DELIVER THE VALUE WE PAID OR WILL PAY FOR THEM.

 

Excessive expenses may result if we do notsuccessfully integrate our acquisitions, investments and strategic alliances,or if the costs and management resources we expend in connection with theintegrations exceed our expectations. We expect that our acquisitions, investments and strategic alliances andany acquisitions, investments or strategic alliances we may pursue in thefuture will have a continuing, significant impact on our business, financialcondition and operating results.  Thevalue of the companies that we acquired or invested in may be less than theamount we paid, and our financial results may be adversely affected if:

 

• we fail toassimilate the acquired assets with our pre-existing business;

 

• we lose keyemployees of these companies or of Aether as a result of the acquisitions;

 

• ourmanagement’s attention is diverted by other business concerns; or

 

• we assumeunanticipated liabilities related to the acquired assets.

 

In addition, the companies we have acquired orinvested in or may acquire or invest in are subject to each of the businessrisks we describe in this section, and if they incur any of these risks thebusinesses may not be as valuable as the amount we paid.  Further, we cannot guarantee that we willrealize the benefits or strategic objectives we were seeking to obtain byacquiring or investing in these companies.

 

We have already reduced the carrying value of ouracquired companies and investments in other companies by an aggregate of $1.3billion due to our evaluation of the fair value of those businesses, and wecannot assure you that additional reductions will not be necessary.

 

(d) WE MAY NOT ACHIEVE PROFITABILITY IF WE ARE UNABLETO MAINTAIN, IMPROVE AND DEVELOP THE WIRELESS DATA SERVICES WE OFFER.

 

We believe that our future business prospects dependin part on our ability to maintain and improve our current services and todevelop new ones on a timely basis.  Ourservices will have to achieve market acceptance, maintain technologicalcompetitiveness and meet an expanding range of customer requirements.  As a result of the complexities inherent inour service offerings, major new wireless data services and serviceenhancements require long development and testing periods.  We may experience difficulties that coulddelay or prevent the successful development, introduction or marketing of newservices and service enhancements. Additionally, our new services and service enhancements may not achievemarket acceptance.  If we cannoteffectively develop and improve services, we may not be able to recover ourfixed costs or

 

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otherwise become profitable.

 

(e) IF WE DO NOT RESPOND EFFECTIVELY AND ON A TIMELYBASIS TO RAPID TECHNOLOGICAL CHANGE, OUR SERVICES MAY BECOME OBSOLETE AND WEMAY LOSE SALES.

 

The wireless and data communications industries arecharacterized by rapidly changing technologies, industry standards, customerneeds and competition, as well as by frequent new product and serviceintroductions.  Our services areintegrated with wireless handheld devices and the computer systems of ourcorporate customers.  Our services mustalso be compatible with the data networks of wireless carriers.  We must respond to technological changesaffecting both our customers and suppliers. We may not be successful in developing and marketing, on a timely andcost-effective basis, new services that respond to technological changes,evolving industry standards or changing customer requirements.  Our ability to grow and achieveprofitability will depend, in part, on our ability to accomplish all of thefollowing in a timely and cost-effective manner:

 

• effectivelyuse and integrate new wireless and data technologies;

 

• continue todevelop our technical expertise;

 

• enhance ourwireless data, engineering and system design services;

 

• developapplications for new wireless networks; and

 

• influenceand respond to emerging industry standards and other changes.

 

(f) WE DEPEND UPON WIRELESS NETWORKS OWNED ANDCONTROLLED BY OTHERS.

 

If we do not have continued access to sufficientcapacity on reliable networks, we may be unable to deliver services and oursales could decrease.  Our ability togrow and achieve profitability partly depends on our ability to buy sufficientcapacity on the networks of wireless carriers such as Verizon Wireless,Cingular, Metrocall, Motient and AT&T Wireless and on the reliability andsecurity of their systems.  All of ourservices are delivered using airtime purchased from third parties.  We depend on these companies to provideuninterrupted and bug free service and would not be able to satisfy ourcustomers’ needs if they failed to provide the required capacity or neededlevel of service.  In addition, ourexpenses would increase and our profitability could be materially adverselyaffected if wireless carriers were to increase the prices of theirservices.  Our existing agreements withthe wireless carriers generally have one-year terms.  Some of these wireless carriers are, or could become, ourcompetitors, and if they compete with us, they may refuse to provide us withtheir services.

 

(g) ONE OF OUR SUPPLIERSOF WIRELESS SERVICES HAS BEEN SUED FOR PATENT INFRINGMENT WHICH RAISES UNCERTAINTYREGARDING ITS ABILITY TO CONTINUE TO SUPPLY US WITH THESE SERVICES.

 

Research In MotionLimited (RIM) which supplies us with hardware and wireless services that we inturn package with other services and resell, is engaged in legal proceedingswith NTP Inc. which alleges that certain RIM products infringed on patents heldby NTP Inc..  This creates uncertaintyregarding RIM’s ability to continue to supply us with services.  RIM’s inability to supply services to uscould cause a loss of revenue and increase our net losses.

 

(h) OUR FAILURE TO DEVELOP RECOGNITION FOR THE AETHERBRAND COULD PREVENT US FROM ACHIEVING A PROFITABLE LEVEL OF SALES.

 

Our expenses related to sales and marketing activities(excluding option and warrant expense) were $54.2 million, $66.8 million and$28.8 million for the years ended December 31, 2000, 2001 and 2002,respectively.  However, in connectionwith our efforts to reduce operating expenses, we began to reduce our sales andmarketing expenses in 2002 and intend to reduce those expenses significantly in2003.  Although we believe we caneffectively market Aether’s brand with reduced costs, our efforts may be lesssuccessful than if our expenses remained at historic levels.  There can be no assurances that holders ofother trademarks will not claim that the published or allowed trademarks, orother Aether pending trademark applications, infringe their trademarks.  We may not be able to use these nameseffectively or at all if we fail to obtain such registrations due to conflictingmarks or otherwise.  As a result of ourrecent acquisitions, we expect to market our acquired products and servicesunder their existing brands.  We maylose existing customers or fail to attract new customers if these brands arenot well received by our customers, if our marketing efforts are notproductive, if we are otherwise unsuccessful in increasing our brand awarenessor if our competition has greater brand recognition.

 

(i) AS WE IMPLEMENT OUR PLAN TO REDUCE OUR OPERATINGEXPENSES, WE MAY FAIL TO SUPPORT OUR OPERATIONS, WHICH COULD REDUCE DEMAND FOROUR SERVICES AND MATERIALLY ADVERSELY AFFECT OUR REVENUE.

 

Our business strategy is based on the assumption thatthe number of subscribers to our services, the amount of information they wantto receive and the number of services we offer will all increase.  We must continue to develop and expand oursystems and operations to accommodate this growth.  The expansion and/or maintenance and adaptation of our customerservice and network operations center require substantial financial,operational and management resources. At the same time, we have implemented plans to reduce our operatingexpenses, which entail

 

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a reduction in operational and managementresources.  While we believe that ourcost reductions are targeted at areas that are not necessary to maintain anddevelop our ability to serve customers, there can be no assurance that we willsucceed in lowering costs while maintaining our ability to provideservice.  If we fail to maintain orimprove service levels, we may lose customers and/or the opportunity to providemore services and products.

 

(j) WE DEPEND ON RECRUITING AND RETAINING KEYMANAGEMENT AND TECHNICAL PERSONNEL WITH WIRELESS DATA AND SOFTWARE EXPERIENCE.WE MAY NOT BE ABLE TO DEVELOP NEW PRODUCTS OR SUPPORT EXISTING PRODUCTS IF WECANNOT HIRE OR RETAIN QUALIFIED EMPLOYEES.

 

Because of the technical nature of our products andthe dynamic market in which we compete, our performance depends on attractingand retaining key employees. Competition for qualified personnel in the wireless data and softwareindustries is intense and finding qualified personnel with experience in bothindustries is even more difficult.  Webelieve there are only a limited number of individuals with the requisiteskills in the field of wireless data communication, and it is becomingincreasingly difficult to hire and retain these persons.  Competitors and others have in the pastattempted, and may in the future attempt, to recruit our employees.  Each of our engineers has entered into anon-competition agreement with us for a period of ten months after they leaveAether.  These agreements will notprevent our engineers from leaving or working for competitors relatively soonafter they leave us.

 

We currently maintain a key person life insurancepolicy for David S. Oros, our chairman and chief executive officer.  We do not maintain insurance policies forany of our other executive officers.

 

(k) WE MAY NOT HAVE ADEQUATELY PROTECTED OURINTELLECTUAL PROPERTY RIGHTS, WHICH COULD ALLOW COMPETITORS TO DEVELOP SIMILARPRODUCTS USING SIMILAR TECHNOLOGY, THUS REDUCING OUR SALES AND REVENUE.

 

We have attempted to protect our technology, includingthe technology we have obtained or will obtain in our acquisitions, throughpatent, trademark and copyright protection, as well as through trade secretlaws and non-competition and non-disclosure agreements with all employees.  Our technology may infringe on valid patentsheld by third parties, or patents held by third parties may limit the scope ofany patents we receive.  In particular,the patent we acquired in our acquisition of Riverbed covers a technology thatis similar to other patented technologies. If we are not adequately protected, other companies with sufficientengineering expertise could develop competing products based on ourintellectual property and reduce our sales and revenue.

 

(l) WE MAY BE SUED BY THIRD PARTIES FOR INFRINGEMENTOF THEIR INTELLECTUAL PROPERTY RIGHTS AND INCUR COSTS OF DEFENSE AND POSSIBLYROYALTIES OR LOSE THE RIGHT TO USE TECHNOLOGY IMPORTANT TO PROVIDING OURSERVICES.

 

The telecommunications and software industries arecharacterized by the existence of a large number of patents and frequent litigationbased on allegations of patent infringement or other violations of intellectualproperty rights.  As the number ofparticipants in our market increases, the possibility of an intellectualproperty claim against us could increase. Intellectual property claims, with or without merit, could betime-consuming and expensive to litigate or settle, could require us to enterinto costly royalty arrangements, could divert management attention fromadministering our business and could hinder us from conducting our business.

 

(m) WE MAY BE SUBJECT TO LIABILITY FOR TRANSMITTINGINFORMATION, AND OUR INSURANCE COVERAGE MAY BE INADEQUATE TO PROTECT US FROMTHIS LIABILITY.

 

We may be subject to claims relating to informationtransmitted over systems we develop or operate.  These claims could take the form of lawsuits for defamation,negligence, copyright or trademark infringement or other actions based on thenature and content of the materials. Although we carry general liability insurance, our insurance may not coverpotential claims of this type or may not be adequate to cover all costsincurred in defense of potential claims or to indemnify us for all liabilitythat may be imposed.

 

(n) DISRUPTION OF OUR SERVICES DUE TO ACCIDENTAL ORINTENTIONAL SECURITY BREACHES MAY HARM OUR REPUTATION, POTENTIALLY CAUSING ALOSS OF SALES AND AN INCREASE IN OUR EXPENSES.

 

A significant barrier to the growth of wireless dataservices or transactions on the Internet or by other electronic means has beenthe need for secure transmission of confidential information.  Our systems could be disrupted byunauthorized access, computer viruses and other accidental or intentionalactions.  We may incur significant coststo protect against the threat of security breaches or to alleviate problemscaused by such breaches.  If a thirdparty were able to misappropriate our users’ personal or proprietaryinformation or credit card information, we could be subject to claims,litigation or other potential liabilities that could materially adversely impactour revenue and may result in the loss of customers.

 

(o) ANY TYPE OF SYSTEMS FAILURE COULD REDUCE SALES,INCREASE COSTS OR RESULT IN CLAIMS OF LIABILITY.

 

Certain of our existing wireless data services aredependent on real-time, continuous feeds from Reuters Selectfeed Plus andothers.  The ability of our subscribersto make securities trades, receive sales leads and receive critical businessinformation requires timely and uninterrupted

 

27

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connections with our wireless network carriers.  Any disruption from our satellite feeds orbackup landline feeds could result in delays in our subscribers’ ability toreceive information or execute trades. We cannot be sure that our systems will operate appropriately if weexperience a hardware or software failure or if there is an earthquake, fire orother natural disaster, a power or telecommunications failure, intentionaldisruptions of service by third parties, an act of God or an act of war.  A failure in our systems could cause delaysin transmitting data, and as a result we may lose customers or face litigationthat could involve material costs and distract management from operating ourbusiness.

 

(p) OUR ABILITY TO SELL NEW AND EXISTING SERVICES AT APROFIT COULD BE IMPAIRED BY COMPETITORS.

 

Intense competition could developin the market for services we offer.  Wedeveloped our software using standard industry development tools.  Many of our agreements with wirelesscarriers, wireless handheld device manufacturers and data providers arenon-exclusive.  Our competitors coulddevelop and use the same products and services in competition with us.  With time and capital, it would be possiblefor competitors to replicate our services. Our potential competitors could include wireless network carriers suchas AT&T Wireless, Cingular Wireless, Nextel Communications, Inc., SprintPCS Group, and Verizon Wireless; mobile and/or wireless software companiesincluding Brience, Inc., Comverse Technology, Inc., Extended Systems, Inc.,Everypath, Inc., Openwave Systems, and Puma Technology, Inc.; wireless dataservices providers such as 724 Solutions Inc. and GoAmerica, Inc. and; wirelesssystems integrators and database vendors, including IBM and Oracle.  Many of our potential competitors havesignificantly greater resources than we do. Furthermore, competitors maydevelop a different approach to marketing the services we provide in whichsubscribers may not be required to pay for the information provided by ourservices. Competition could reduce our market share or force us to lower pricesto unprofitable levels.

 

(q) AN INTERRUPTION IN THE SUPPLY OF PRODUCTS ANDSERVICES THAT WE OBTAIN FROM THIRD PARTIES COULD CAUSE A DECLINE IN SALES OFOUR SERVICES, AND PRODUCTS WE PURCHASE TO AVOID SHORTAGES MAY BECOME OBSOLETEBEFORE WE CAN USE THEM.

 

In designing, developing and supporting our wirelessdata services, we rely on wireless carriers, wireless handheld devicemanufacturers, content providers, software providers and companies that managesome of our other services such as our internal IT operations and customer careservices.  These suppliers mayexperience difficulty in supplying us products or services sufficient to meetour needs or they may terminate or fail to renew contracts for supplying usthese products or services on terms we find acceptable.  Any significant interruption in the supplyof any of these products or services could cause a decline in sales of ourservices unless and until we are able to replace the functionality provided bythese products and services.  We alsodepend on third parties to deliver and support reliable products, enhance ourcurrent products, develop new products on a timely and cost-effective basis andrespond to emerging industry standards and other technological changes.  In addition, we rely on the ability of ourcontent providers — including Reuters, the New York Stock Exchange, Inc., theChicago Board of Trade, the Nasdaq Stock Market, Inc. and the Options PriceReporting Authority — to continue to provide us with uninterrupted access tothe news and financial information we provide to our customers.  The failure of third parties to meet thesecriteria, or their refusal or failure to deliver the information for whateverreason, could materially harm our business.

 

(r) OUR SALES CYCLE IS LONG, AND OUR STOCK PRICE COULDDECLINE IF SALES ARE DELAYED OR CANCELLED.

 

Quarterly fluctuations in our operating performanceare exacerbated by the length of time between our first contact with a businesscustomer and the first revenue from sales of services to that customer or endusers.  Because our services represent asignificant investment for our business customers, we spend a substantialamount of time educating them regarding the use and benefits of our servicesand they, in turn, spend a substantial amount of time performing internalreviews and obtaining capital expenditure approvals before purchasing ourservices.  As much as a year may elapsebetween the time we approach a business customer and the time we begin todeliver services to a customer or end user. Any delay in sales of our services could cause our quarterly operatingresults to vary significantly from projected results, which could cause our stockprice to decline. In addition, we may spend a significant amount of time andmoney on a potential customer that ultimately does not purchase our services.

 

(s) OUR SOFTWARE MAY CONTAIN DEFECTS OR ERRORS, ANDOUR SALES COULD DECREASE IF THIS INJURES OUR REPUTATION OR DELAYS SHIPMENTS OFOUR SOFTWARE.

 

Our software products and platforms are complex andmust meet the stringent technical requirements of our customers.  We must develop our services quickly to keeppace with the rapidly changing software and telecommunications markets.  Software as complex as ours is likely tocontain undetected errors or defects, especially when first introduced or whennew versions are released.  Our softwaremay not be free from errors or defects after delivery to customers has begun,which could result in the rejection of our software or services, damage to ourreputation, lost revenue, diverted development resources and increased serviceand warranty costs.

 

(t) NEW LAWS AND REGULATIONS THAT IMPACT OUR INDUSTRYCOULD INCREASE OUR COSTS OR REDUCE OUR OPPORTUNITIES TO EARN REVENUE.

 

We are not currently subject to direct regulation bythe Federal Communications Commission or any other governmental agency, otherthan regulations applicable to publicly traded Delaware corporations of similarsize that are headquartered in Maryland. However, in the future, we may become subject to regulation by the FCCor another regulatory agency.  Inaddition, the wireless carriers that supply us airtime and certain of ourhardware suppliers are subject to regulation by the FCC and regulations thataffect them could increase our costs or reduce our ability to continue sellingand supporting our services.

 

28

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(u) WE CONDUCT OPERATIONS IN A NUMBER OF COUNTRIESTHROUGH SILA AND ARE SUBJECT TO RISKS OF INTERNATIONAL OPERATIONS.

 

We currently operate outside the U.S. through Sila,which has operations throughout Europe.

 

Any failure by Sila to successfully implement ormaintain services could result in negative publicity and have an unfavorableimpact on our ability to expand our products and services to Europe.  We face various risks in expanding outsidethe U.S., including:

 

• difficultyand cost of monitoring our international operations;

 

• culturaldifferences in the conduct of business;

 

• unexpectedchanges in regulatory requirements, including U.S. export restrictions onencryption technologies; and

 

• recessionaryor inflationary environments in foreign economies, particularly in thefinancial services sector.

 

We cannot ensure that our international operationswill contribute positively to our business, financial condition or result ofoperations. Our failure to manage international growth could result in higheroperating costs than anticipated or could delay or preclude altogether ourability to generate revenues in international markets. In addition, ourexpanding operations outside the U.S. are, in some instances, conducted incurrencies other than the U.S. dollar and fluctuations in the value of foreigncurrencies relative to the U.S. dollar could cause currency exchangelosses.  We cannot predict the effect ofexchange rate fluctuations on our future operating results.

 

(v) DEBT SERVICE OBLIGATIONS MAY ADVERSELY AFFECT OURCASH FLOW.

 

As a result of the $154.9 million of 6% convertiblesubordinated notes due 2005 currently outstanding, we have a substantial amountof indebtedness, primarily consisting of the notes.  As a result of this indebtedness, we are obligated to makeprincipal and interest payments.  Thereis a possibility that we may be unable to generate cash sufficient to pay theprincipal of, interest on and other amounts due in respect of our indebtednesswhen due.  We may also obtain additionallong-term debt and working capital lines of credit to meet future financingneeds.  We cannot assure you thatadditional financing arrangements will be available on commercially reasonableterms or at all.

 

(w) WE MAY NOT BE ABLE TO RECOVER THE FULL VALUE OFGOODWILL RECORDED ON SOME OF OUR ACQUISITIONS AND INVESTMENTS.

 

During 2002, 2001, and 2000, we recorded approximately$1.7 billion in goodwill and other intangibles related to our acquisitions andmade investments in other companies of approximately $196.8 million.  Consideration for some of our acquisitionswas partially or fully funded through the issuance of shares of our commonstock at a time when our stock price was at historically high prices.  Most of the companies we acquired orinvested in were start-up or newly formed entities.  Most of these companies were privately held and their fair valuesare highly subjective and not readily determinable.  Our policy is to review the value of all our acquisitions andinvestments for impairment whenever events or circumstances indicate that thecarrying amount may not be recoverable. At the time of our acquisitions and investments, market valuations andthe availability of capital for such companies were at historically highlevels.  During the year ended December31, 2001, stock prices and market valuations in our industry and similarindustries have fallen substantially in response to a variety of factors,including a general downturn in the economy, a curtailment in the availabilityof capital and a general reduction in technology expenditures.  The market valuations of those publiclytraded companies in which we have invested and of other companies similar tothose we have acquired or invested in have declined substantially.  For the year ended December 31, 2002, werecorded impairment charges aggregating $170.5 million on these acquisitionsand investments.  If similar adversemarket conditions develop in the future, we may be required to take additionalimpairment charges.

 

**ITEM7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The following discussion about our market riskdisclosures involves forward-looking statements.  Actual results could differ materially from those projected inforward-looking statements.  We maintaininstruments subject to interest rate and foreign currency exchange raterisk.  We categorize all of our marketrisk sensitive instruments as non-trading or other instruments.

 

(1) INTEREST RATE SENSITIVITY

 

We are exposed to interest rate risk related to ourcash and cash equivalents and short-term investments.  Our investment policy calls for investment in short-term low riskinstruments.  All investments insecurities with maturities greater than one year are held asavailable-for-sale, in compliance with our investment policy.  At December 31, 2002, we had $68.6 million(including restricted cash) invested in money market, commercial paper andcertificates of deposit.  At December31, 2002, we had $255.8 million invested in U.S. Government Agency-sponsoredsecurities with maturities that range from less than one year to threeyears.  We believe that a 10% increaseor decline in interest rates would not be material to our investment income orcash flows.

 

29

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We are exposed to interest rate risk on our fixed ratesubordinated convertible notes payable. The fair value of this fixed rate debt is sensitive to changes ininterest rates.  If market ratesdecline, the required payments will exceed those based on current marketrates.  Under our current policy, we donot use interest rate derivative instruments to manage our risk of interestrate fluctuations.  As our long-termdebt obligations bear fixed interest rates, we have minimal cash flow exposuredue to general interest rate changes associated with our long-term debtobligations.

 

(2) FOREIGN RATE SENSITIVITY

 

We are exposed to foreign currency exchange riskthrough our European subsidiary, Sila. All sales from the U.S. to foreign countries have been denominated inU.S. dollars. Since the revenue and expenses of Sila generally are denominatedin local currencies, exchange rate fluctuations between such local currenciesand the U.S. dollar will subject us to currency translation risk with respectto the reported results of Sila as well as risks sometimes associated withinternational operations.  The countriesin which Sila has operations have traditionally had relatively stablecurrencies.  We do not hedge our foreigncurrency exposure. We believe that a 10% increase or decline in the BritishPound exchange ratio would not be material to cash and cash equivalentbalances, interest income, or cash flows from consolidated operations.

 

**ITEM8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**REPORTOF INDEPENDENT AUDITORS**

 

The financial statement and supplementary data ofAether required by this item are filed as exhibits hereto, are listed underItem 5(a)(1) and (2), and are incorporated herein by reference.

 

**ITEM9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

None.

 

### **PARTIII**

 

**ITEM10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

The information required by this Item will be includedin Aether’s Proxy Statement for the 2003 Annual Meeting of Shareholders underthe caption Directors and Executive Officers which will be filed with theSecurities and Exchange Commission no later than 120 days after the close ofthe fiscal year ended December 31, 2002, and is incorporated herein byreference.

 

**ITEM11. EXECUTIVE COMPENSATION**

 

The information required by this Item will be includedin Aether’s Proxy Statement for the 2003 Annual Meeting of Shareholders underthe caption Executive Compensation which will be filed with the Securities andExchange Commission no later than 120 days after the close of the fiscal yearended December 31, 2002, and is incorporated herein by reference.

 

**ITEM12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The information required by this Item will be includedin Aether’s Proxy Statement for the 2003 Annual Meeting of Shareholders underthe caption Security Ownership of Certain Beneficial Owners and Managementwhich will be filed with the Securities and Exchange Commission no later than120 days after the close of the fiscal year ended December 31, 2002, and isincorporated herein by reference.

 

30

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| **Plan Category**                                           |   | **Plan Name**               |   | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights** |   | **Number of  securities remaining  available for future  issuance under   equity  compensation plans** |   |
|-------------------------------------------------------------|--------|-----------------------------|--------|----------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------|--------|
|                                                        |   |                        |   |                                                                                               |   |                                                                               |   |                                                                                                   |   |
| Equity  compensation plans approved by security holders     |   | 1999 Equity  Incentive Plan |   | 6,567,901                                                                                          |   | 10.69                                                                              |   | 1,881,955                                                                                              |   |
|                                                        |   |                        |   |                                                                                               |   |                                                                               |   |                                                                                                   |   |
| Equity  compensation plans not approved by security holders |   | Acquisition  Incentive Plan |   | 511,755                                                                                            |   | —(1                                                                           | )      | 1,388,245                                                                                              |   |
|                                                        |   |                        |   |                                                                                               |   |                                                                               |   |                                                                                                   |   |
| Total                                                       |   |                        |   | 7,079,656                                                                                          |   | 9.91                                                                               |   | 3,270,200                                                                                              |   |

 

----

(1) All of the securitiesissued to date under this plan have been shares of restricted stock that vestover various periods.

 

**ITEM13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

The information required by this Item will be includedin Aether’s Proxy Statement for the 2003 Annual Meeting of Shareholders underthe caption Certain Relationships and Related Transactions which will be filedwith the Securities and Exchange Commission no later than 120 days after theclose of the fiscal year ended December 31, 2002, and is incorporated herein byreference.

 

**ITEM 14. CONTROLS & PROCEDURES**

 

Quarterly evaluation of the company’s DisclosureControls and Internal Controls.

 

Within 90 days prior to the date of this report, wecarried out an evaluation, under the supervision of our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures.  In designing and evaluating the disclosure controls and procedures,Aether and its management recognized that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives. Based upon our evaluation, our CEO and CFO concluded that our disclosurecontrols and procedures are effective in bringing to their attention on atimely basis, material information relating to Aether required to be includedin the Company’s periodic filings.  Itshould be noted that the design of any system of controls is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions regardless of how remote.

 

The CEOand CFO note that, since our last evaluation of internal controls, there havebeen no significant changes in internal controls or in other factors that couldsignificantly affect internal controls, including any corrective actions withregard to significant deficiencies and material weaknesses.  Internal controls are procedures which aredesigned with the objective of providing reasonable assurance that (1) ourtransactions are properly authorized; (2) our assets are safeguarded againstunauthorized or improper use; and (3) our transactions are properly recordedand reported, all to permit the preparation of our financial statements inconformity with generally accepted accounting principles.

 

**PART IV**

 

**ITE****M 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES ANDREPORTS ON FORM 8-K**

 

(a)(1) FINANCIAL STATEMENTS

 

The following financial statementsrequired by this item are submitted in a separate section beginning on page 39of this report.

 
| Independent Auditors’  Report                                                                                   |
|----------------------------------------------------------------------------------------------------------------------|
| Report  of Other Independent Auditors                                                                                |
| Consolidated Balance Sheets  as of December 31, 2001 and  2002                                                  |
| Consolidated  Statements of Operations and Comprehensive Loss for the years ended December  31, 2000, 2001, and 2002 |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31, 2000,  2001 and 2002          |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2000, 2001 and 2002                          |
| Notes to  Consolidated Financial Statements                                                                          |

 

31

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(a)(2) FINANCIAL STATEMENT SCHEDULES

 

The following financial statement schedules requiredby this item are submitted on page S-1 of this Report.

 
| Schedule II — Valuation  and Qualifying Accounts |
|-------------------------------------------------------|

 

All other schedules are omitted because they are notapplicable or the required information is shown in the Consolidated FinancialStatements or the notes thereto.

 

(a)(3) EXHIBITS

 

The exhibit index is incorporated herein by reference.

 

(b) REPORTS ON FORM 8-K

 

•                      Acurrent report on Form 8-K was dated and filed on October 15, 2002 pursuant toItem 5 (Other Events) and Item 7 (Financial Statements and Exhibits).

 

•        A current report on Form 8-K dated November4, 2002 was filed on November 6, 2002 pursuant to Item 5 (Other Events).

 

•                        Acurrent report on Form 8-K dated November 6, 2002 was filed on November 7, 2002pursuant to Item 5 (Other Events) and Item 7 (Financial Statements andExhibits).

 

(c) EXHIBITS

 

The exhibits required by this Item are listed in theIndex of Exhibits.

 

(d) FINANCIAL STATEMENTS SCHEDULES

 

The financial statement schedules required by thisItem are listed under Item 14(a)(2).

 

32

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### **SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report on Form 10-K to be signed on its behalfby the undersigned, thereunto duly authorized on March 31**,** 2003.

 

**AETHERSYSTEMS, INC.**

 

 
|   | *By:*  | */s/*                                   | *DAVID  S. OROS* |   |
|--------|--------|-----------------------------------------|------------------|--------|
|   |   |                                    | *DAVID  S. OROS* |
|   |   | *Chairman  and Chief Executive Officer* |
|        |        |                                         |                  |        |  |

 

33

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**POWEROF ATTORNEY**

 

Each person whose signature appears below under theheading Signature constitutes and appoints David S. Oros and David C. Reymannas his or her true and lawful attorneys-in-fact each acting alone, with fullpower of substitution and resubstitution, for him or her and in his or hername, place and stead, in any and all capacities to sign any or all amendmentsto this Report on Form 10-K, and to file the same, with all exhibits thereto,and other documents in connection therewith, with the Securities and ExchangeCommission, granting unto said attorneys-in-fact full power and authority to doand perform each and every act and thing requisite and necessary to be done inand about the premises, as fully for all intents and purposes as he or shemight or could do in person, hereby ratifying and confirming all that saidattorneys-in-fact, or their substitutes, each acting alone, may lawfully do orcause to be done by virtue hereof.

 

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 31, 2003 |
| DAVID S. OROS            |   | Executive Officer                             |   |           |
|                     |   |                                          |   |           |
| /s/ GEORGE M. DAVIS      |   | Vice Chairman and                             |   | March 31, 2003 |
| GEORGE M. DAVIS          |   | President                                     |   |           |
|                     |   |                                          |   |           |
| /s/ DAVID C. REYMANN     |   | Chief Financial Officer                       |   | March 31, 2003 |
| DAVID C. REYMANN         |   | (Principal Financial and  Accounting Officer) |   |           |
|                     |   |                                          |   |           |
| /s/ J. CARTER BEESE, JR. |   | Director                                      |   | March 31, 2003 |
| J. CARTER BEESE, JR.     |   |                                          |   |           |
|                     |   |                                          |   |           |
| /s/ JAMES T. BRADY       |   | Director                                      |   | March 31, 2003 |
| JAMES T. BRADY           |   |                                          |   |           |
|                     |   |                                          |   |           |
| /s/ GEORGE P. STAMAS     |   | Director                                      |   | March 31, 2003 |
| GEORGE P. STAMAS         |   |                                          |   |           |
|                     |   |                                          |   |           |
| /s/ JACK B. DUNN, IV     |   | Director                                      |   | March 31, 2003 |
| JACK B. DUNN, IV         |   |                                          |   |           |
|                     |   |                                          |   |           |
| /s/ EDWARD J. MATHIAS    |   | Director                                      |   | March 31, 2003 |
| EDWARD J. MATHIAS        |   |                                          |   |           |
|                     |   |                                          |   |           |
| /s/ TRUMAN T. SEMANS     |   | Director                                      |   | March 31, 2003 |
| TRUMAN T. SEMANS         |   |                                          |   |           |
|                     |   |                                          |   |           |
| /s/ KENDRA VANDERMEULEN  |   | Director                                      |   | March 31, 2003 |
| KENDRA  VANDERMEULEN     |   |                                          |   |           |

 

34

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### **SECTION 302 CERTIFICATIONS**

 

I, David S. Oros, certify that:

 

1. I have reviewed this annual reporton Form 10-K of Aether Systems, Inc.;

 

2. Based on my knowledge, this annualreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report;

 

3. Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

 

4. The registrant’s other certifyingofficers and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

 

a) designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

c) presented in this annual report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5. The registrant’s other certifyingofficers and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a) all significant deficiencies in the design or operationof internal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6. The registrant’s other certifyingofficers and I have indicated in this annual report whether there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
|                      | March 31, 2003 |
|---------------------------|----------------|
| *David S. Oros*           |
| *Chief Executive Officer* |

 

35

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### **SECTION 302CERTIFICATIONS**

 

I, David C. Reymann, certify that:

 

1. I have reviewed this annual reporton Form 10-K of Aether Systems, Inc.;

 

2. Based on my knowledge, this annualreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this annual report.

 

3. Based on my knowledge, thefinancial statements, and other financial information included in this annualreport, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, theperiods presented in this annual report;

 

4. The registrant’s other certifyingofficers and I are responsible for establishing and maintaining disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and we have:

 

a) designed such disclosure controls and procedures toensure that material information relating to the registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularlyduring the period in which this annual report is being prepared;

 

b) evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this annual report (the “Evaluation Date”); and

 

c) presented in this annual report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5. The registrant’s other certifyingofficers and I have disclosed, based on our most recent evaluation, to theregistrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a) all significant deficiencies in the design or operationof internal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and

 

b) any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6. The registrant’s other certifyingofficers and I have indicated in this annual report whether there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
|                      | March 31, 2003 |
|---------------------------|----------------|
| *David C. Reymann*        |
| *Chief Financial Officer* |

 

36

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EXHIBITINDEX

 
| **EXHIBIT  NUMBER** |   | **DOCUMENT AND DESCRIPTION**                                                                                                                                                |
|---------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                        |
| 2.1                 |   | Agreement of  Merger, dated October 18, 1999, between Aether  Systems LLC, and Aether Systems, Inc. (1)                                                                |
|                |   |                                                                                                                                                                        |
| 2.2                 |   | Agreement and  Plan of Merger dated February 9, 2000 by and among Aether Systems, Inc., RTS  Acquisition, Inc. and Riverbed Technologies, Inc.(3)                           |
|                |   |                                                                                                                                                                        |
| 2.3                 |   | Share Purchase  Agreement relating to IFX Group Limited (4)                                                                                                                 |
|                |   |                                                                                                                                                                        |
| 3.1                 |   | Amended and  Restated Certificate of Incorporation of Aether Systems, Inc. (as amended)(3)                                                                                  |
|                |   |                                                                                                                                                                        |
| 3.2                 |   | Bylaws of Aether  Systems, Inc.(1)                                                                                                                                          |
|                |   |                                                                                                                                                                        |
| 4.1                 |   | Specimen  Certificate for Aether Systems Common Stock.(1)                                                                                                                   |
|                |   |                                                                                                                                                                        |
| 4.2                 |   | Form of Indenture  for Convertible Debt(2)                                                                                                                                  |
|                |   |                                                                                                                                                                        |
| 10.1                |   | Amended and  Restated License, Marketing and Distribution Agreement between Reuters  America, Inc. and Aether Technologies International, L.L.C. dated August 11,  1998.(1) |
|                |   |                                                                                                                                                                        |
| 10.2                |   | Contract Between  Morgan Stanley Dean Witter Online Direct, Inc. and Aether Technologies  International, L.L.C. dated August 5, 1999.(1)                                    |
|                |   |                                                                                                                                                                        |
| 10.3                |   | Options Price  Reporting Authority Vendor Agreement between Aether Technologies and the  American Stock Exchange, Inc. dated June 3, 1997.(1)                               |
|                |   |                                                                                                                                                                        |
| 10.4                |   | Agreement between  Aether Technologies International, L.L.C. and New York Stock Exchange dated  July 19, 1999.(1)                                                           |
|                |   |                                                                                                                                                                        |
| 10.5                |   | Vendor Agreement  by and between Aether Technologies International, L.L.C. and the Nasdaq Stock  Market, Inc. dated October 4, 1996.(1)                                     |
|                |   |                                                                                                                                                                        |
| 10.6                |   | Dow Jones Indexes  Enterprise Distribution Agreement dated April 23, 1999.(1)                                                                                               |
|                |   |                                                                                                                                                                        |
| 10.7                |   | Employment  Agreement between Aether Technologies International, L.L.C. and David Oros  dated July 7, 1999.(1)                                                              |
|                |   |                                                                                                                                                                        |
| 10.8                |   | Employment Agreement  between Aether Systems, Inc. and David C. Reymann dated June 8, 2001.(5)                                                                              |
|                |   |                                                                                                                                                                        |
| 10.9                |   | Series A  Preferred Stock Purchase Agreement dated August 9, 1999.(1)                                                                                                       |
|                |   |                                                                                                                                                                        |
| 10.10               |   | Software License  Agreement by and between Aether Technologies International, L.L.C. and AirWeb  Corporation dated August 9, 1999(1)                                        |

 

37

----

 
| 10.11  |   | Strategic License  Agreement between Aether Technologies International, L.L.C. and Riverbed  Technologies, Inc. dated June 15, 1999.(1) |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                    |
| 10.12  |   | Credit Agreement  dated September 28, 1999 among Merrill Lynch & Co. and the leaders named  therein.(1)                             |
|   |   |                                                                                                                                    |
| 10.13  |   | Aether Systems,  Inc. 1999 Equity Incentive Plan as amended June 22, 2001.                                                              |
|   |   |                                                                                                                                    |
| 10.14  |   | Aether Systems,  Inc. Senior Bonus Plan effective as of September 29, 1999.(1)                                                          |
|   |   |                                                                                                                                    |
| 10.15  |   | Aether Systems,  Inc. Acquisitions Incentive Plan effective as of December 15, 2000.(4)                                                 |
|   |   |                                                                                                                                    |
| 10.16  |   | Amended and  Restated Registration Rights Agreement dated March 3, 2000.(1)                                                             |
|   |   |                                                                                                                                    |
| 10.17  |   | Form of  Subscription Agreement between Aether Systems, Inc. and National Discount  Brokers.(1)                                         |
|   |   |                                                                                                                                    |
| 10.18  |   | Series B  Preferred Stock Purchase Agreement dated January 18, 2000.(2)                                                                 |
|   |   |                                                                                                                                    |
| 10.19  |   | Inciscent, Inc.  Series A Stock Purchase Agreement(2)                                                                                   |
|   |   |                                                                                                                                    |
| 10.20  |   | Agreement between  National Discount Brokers Corporation and Aether Systems, Inc., dated  November 4, 1999.(2)                          |
|   |   |                                                                                                                                    |
| 10.21  |   | Common Stock  Purchase Agreement by and among Aether Systems, Inc. and America Online, Inc.  dated as of November 5, 2001.              |
|   |   |                                                                                                                                    |
| 21.1   |   | Subsidiaries of  Aether Systems.                                                                                                        |
|   |   |                                                                                                                                    |
| 23.1   |   | Consent of KPMG  LLP.                                                                                                                   |
|   |   |                                                                                                                                    |
| 23.2   |   | Consent of Ernst  & Young LLP.                                                                                                      |

 

----

(1) Incorporated by reference to the RegistrationStatement (File No. 333-85697) on Form S-1 filed with the Commission on October20, 1999, as amended.

 

(2) Incorporated by reference to the RegistrationStatement (File No. 333-30852) or Form S-1 filed with the Commission onFebruary 22, 2000, as amended.

 

(3) Incorporated by reference to the Form 10-Q filedwith the Commission on August 14, 2000.

 

(4) Incorporated by reference to the RegistrationStatement (File No. 333-52222) on Form S-8 filed with the Commission onDecember 20, 2000.

 

(5) Incorporated by reference to the Form 10-Q filedwith the Commission on June 30, 2001.

 

38

----

 

**INDEPENDENT AUDITORS’ REPORT**

 

The Board of Directors and Stockholders

Aether Systems, Inc.:

 

We have auditedthe accompanying consolidated balance sheets of Aether Systems, Inc. andsubsidiaries as of December 31, 2001 and 2002, and the related consolidatedstatements of operations and comprehensive loss, stockholders’ equity and cashflows for each of the years in the three-year period ended December 31,2002.  These consolidated financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.  We did not audit the consolidated financialstatements of Sila Communications Limited, a majority-owned subsidiary, whichstatements reflect total assets constituting 2.2% of the related consolidatedtotal in 2001 and total revenues constituting 21.7% and 11.5% of the relatedconsolidated totals in 2000 and 2001, respectively.  Those statements were audited by other auditors whose report hasbeen furnished to us, and our opinion insofar as it relates to the amountsincluded for Sila Communications Limited, is based solely on the report of theother auditors.

 

We conducted ouraudits in accordance with auditing standards generally accepted in the UnitedStates of America.  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonablebasis for our opinion.

 

In our opinion,based on our audits and the report of the other auditors, the consolidatedfinancial statements referred to above present fairly, in all materialrespects, the financial position of Aether Systems, Inc. and subsidiaries as ofDecember 31, 2001 and 2002, and the results of their operations and their cashflows for each of the years in the three-year period ended December 31, 2002,in conformity with accounting principles generally accepted in the United Statesof America.

 

As discussed innote 4 to the financial statements, the Company changed its method foraccounting for derivatives with the adoption of SFAS No. 133 “Accounting forDerivative Instruments and Hedging Activities” in 2001, and changed its method ofaccounting for intangible assets with the adoption of SFAS No. 142, “Goodwilland Other Intangible Assets” in 2002.

 
| /s/ KPMG LLP |   |
|--------------|--------|

 

*McLean, Virginia*

*February 4, 2003*

 

**REPORTOF INDEPENDENT AUDITORS**

 

To The Board of Directors and Shareholders

Sila Communications Limited

 

We have audited the consolidated balance sheet of SilaCommunications Limited as of December 31, 2001 and 2000 and the relatedconsolidated statement of operations, shareholders' equity and cash flows forthe year ended December 31, 2001 and for period from May 5, 2000 (inception) toDecember 31, 2000 (not seperately presented herein).  These financial statements are the responsibility of theCompany's management.  Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audit in accordance with auditingstandards generally accepted in the United States.  Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. And audit aslo includes assessing the accounting principles used andsignifigant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statementsreffered to above present fairly, in all material respects, the consolidatedfinancial position of Sila Communications Limited at December 31, 2001 and 2000and the consolidated results of their operations and their consolidated cashflows for the year ended December 31, 2001 and for the period from May 5, 2000(inception) to December 31, 2000, in conformity with accounting principlesgenerally accepted in the United States.

 

ERNST & YOUNG LLP

 

London, England

Febuary 5, 2002

39

----

 

**AETHERSYSTEMS, INC.**

**CONSOLIDATED BALANCE SHEETS**

(IN THOUSANDS, EXCEPTSHARE DATA)

 
|                                                                                                                                                                 |   | **DECEMBER 31,** |         |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------|--------------|
|                                                                                                                                                                 |   | **2001**         |         | **2002** |   |
| ASSETS                                                                                                                                                               |   |             |         |   |   |
| Current assets:                                                                                                                                                      |   |             |         |   |   |
| Cash and cash equivalents                                                                                                                                            |   | $                | 522,177      |   | $ | 68,593 |   |
| Restricted cash                                                                                                                                                      |   | 5,253            |         | — |   |
| Short-term investments                                                                                                                                               |   | 2,490            |         | 255,825 |   |
| Trade accounts receivable, net of allowance for doubtful  accounts of $10,561 and $7,689 at December 31, 2001 and 2002, respectively                                 |   | 24,802           |         | 22,514 |   |
| Inventory                                                                                                                                                            |   | 27,178           |         | 19,664 |   |
| Assets held for sale                                                                                                                                                 |   | —           |         | 5,250 |   |
| Net investment in sales-type leases (current)                                                                                                                        |   | —           |         | 1,656 |   |
| Prepaid expenses and other assets (current)                                                                                                                          |   | 19,521           |         | 16,276 |   |
| Total current assets                                                                                                                                                 |   | 601,421          |         | 389,778 |   |
| Property and equipment, net                                                                                                                                          |   | 61,304           |         | 19,301 |   |
| Investments                                                                                                                                                          |   | 32,350           |         | 2,228 |   |
| Intangibles, net                                                                                                                                                     |   | 226,774          |         | 40,396 |   |
| Net investment in sales-type leases (non-current)                                                                                                                    |   | —           |         | 6,691 |   |
| Other assets (noncurrent), net                                                                                                                                       |   | 27,571           |         | 15,015 |   |
|                                                                                                                                                                 |   | $                | 949,420      |   | $ | 473,409 |   |
| LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY                                                                                                         |   |             |         |   |   |
| Current liabilities:                                                                                                                                                 |   |             |         |   |   |
| Current portion of notes payable                                                                                                                                     |   | $                | 15,493  |   | $ | 4 |   |
| Accounts payable                                                                                                                                                     |   | 8,560            |         | 1,902 |   |
| Accrued expenses                                                                                                                                                     |   | 27,666           |         | 19,963 |   |
| Accrued employee compensation and benefits                                                                                                                           |   | 9,983            |         | 7,336 |   |
| Deferred revenue                                                                                                                                                     |   | 15,145           |         | 14,234 |   |
| Restructuring reserve (current portion)                                                                                                                              |   | 15,452           |         | 8,651 |   |
| Accrued interest payable                                                                                                                                             |   | 5,249            |         | 2,529 |   |
| Total current liabilities                                                                                                                                            |   | 97,548           |         | 54,619 |   |
| Convertible subordinated notes payable and other notes   Payable (less current portion)                                                                              |   | 290,645          |         | 154,942 |   |
| Deferred revenue (less current portion)                                                                                                                              |   | 6,380            |         | 11,789 |   |
| Restructuring reserve (less current portion)                                                                                                                         |   | 12,365           |         | 23,801 |   |
| Deferred rent                                                                                                                                                        |   | —           |         | 858 |   |
| Total liabilities                                                                                                                                                    |   | 406,938          |         | 246,009 |   |
|                                                                                                                                                                 |   |             |         |   |   |
| Minority interest in net assets of a subsidiary                                                                                                                      |   | (45              | )            | — |   |
|                                                                                                                                                                 |   |             |         |   |   |
| Stockholders’ equity:                                                                                                                                           |   |             |         |   |   |
| Preferred stock, $0.01 par value; 1,000,000 shares authorized;  0 shares issued and outstanding at December 31, 2001 and 2002                                        |   | —           |         | — |   |
| Common stock, $0.01 par value;1,000,000,000 shares authorized;  41,864,646 and 42,249,280 shares issued and outstanding at December 31, 2001  and 2002, respectively |   | 419              |         | 422 |   |
| Additional paid-in capital                                                                                                                                           |   | 2,579,445        |         | 2,586,613 |   |
| Accumulated deficit                                                                                                                                                  |   | (2,039,409  | )            | (2,364,831 | ) |
| Foreign currency translation adjustment                                                                                                                              |   | 487              |         | 3,722 |   |
| Unrealized gain on investments available for sale                                                                                                                    |   | 1,585            |         | 1,474 |   |
| Total stockholders’ equity                                                                                                                                      |   | 542,527          |         | 227,400 |   |
| Commitments and Contingencies                                                                                                                                        |   |             |         |   |   |
|                                                                                                                                                                 |   |             |         |   |   |
| Total liabilities and stockholders’ equity                                                                                                                      |   | $                | 949,420      |   | $ | 473,409 |   |

 

See accompanying notes to consolidated financialstatements.

 

40

----

 

**AETHERSYSTEMS, INC.**

### **CONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE LOSS**

(IN THOUSANDS, EXCEPT PERSHARE DATA)

 
|                                                                                                                           |   | **YEAR ENDED DECEMBER 31,** |     |
|--------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|----------|
|                                                                                                                           |   | **2000**                    |     | **2001** |   | **2002** |   |
| Subscriber revenue                                                                                                             |   | $                           | 24,802   |   | $ | 44,031 |   | $ | 69,582 |   |
| Engineering services revenue                                                                                                   |   | 9,444                       |     | 7,860 |   | 3,192 |   |
| Software and related services revenue                                                                                          |   | 17,278                      |     | 36,982 |   | 24,412 |   |
| Device sales                                                                                                                   |   | 6,630                       |     | 24,007 |   | 19,345 |   |
| Total revenue                                                                                                                  |   | 58,154                      |     | 112,880 |   | 116,531 |   |
| Cost of subscriber revenue                                                                                                     |   | 11,254                      |     | 27,167 |   | 40,115 |   |
| Cost of engineering services revenue                                                                                           |   | 5,693                       |     | 3,644 |   | 1,533 |   |
| Cost of software and related services revenue                                                                                  |   | 5,724                       |     | 11,625 |   | 8,086 |   |
| Cost of device sales                                                                                                           |   | 7,345                       |     | 38,318 |   | 17,486 |   |
| Total cost of revenue                                                                                                          |   | 30,016                      |     | 80,754 |   | 67,220 |   |
| Gross profit                                                                                                                   |   | 28,138                      |     | 32,126 |   | 49,311 |   |
| Operating expenses:                                                                                                            |   |                        |     |   |   |   |   |
| Research and development (exclusive of option and warrant  expense)                                                            |   | 30,189                      |     | 63,937 |   | 26,306 |   |
| General and administrative (exclusive of option and warrant  expense)                                                          |   | 52,937                      |     | 90,893 |   | 59,666 |   |
| Selling and marketing (exclusive of option and warrant  expense)                                                               |   | 54,151                      |     | 66,757 |   | 28,767 |   |
| In-process research and development related to acquisitions                                                                    |   | 7,860                       |     | — |   | — |   |
| Depreciation and amortization                                                                                                  |   | 238,074                     |     | 180,724 |   | 39,255 |   |
| Option and warrant expense:                                                                                                    |   |                        |     |   |   |   |   |
| Research and development                                                                                                       |   | 6,233                       |     | 6,767 |   | 3,469 |   |
| General and administrative                                                                                                     |   | 6,246                       |     | 4,511 |   | 1,928 |   |
| Selling and marketing                                                                                                          |   | 1,866                       |     | 3,130 |   | 1,145 |   |
| Impairment of intangibles and other assets                                                                                     |   | —                      |     | 1,121,001 |   | 69,534 |   |
| Restructuring charge                                                                                                           |   | —                      |     | 45,006 |   | 37,744 |   |
|                                                                                                                           |   | 397,556                     |     | 1,582,726 |   | 267,814 |   |
| Operating loss                                                                                                                 |   | (369,418                    | )        | (1,550,600 | ) | (218,503 | ) |
| Other income (expense):                                                                                                        |   |                        |     |   |   |   |   |
| Interest income                                                                                                                |   | 57,075                      |     | 28,013 |   | 10,684 |   |
| Interest expense                                                                                                               |   | (14,724                     | )        | (19,354 | ) | (14,668 | ) |
| Equity in losses of investments                                                                                                |   | (47,886                     | )        | (57,523 | ) | (4,744 | ) |
| Investment loss, including impairments, net                                                                                    |   | —                      |     | (143,382 | ) | (14,412 | ) |
| Minority interest                                                                                                              |   | 10,692                      |     | 63,809 |   | (45 | ) |
| Other income – escrow settlement                                                                                          |   | —                      |     | — |   | 2,272 |   |
| Loss before income taxes, extraordinary item and cumulative  effect of change in accounting principle                          |   | (364,261                    | )        | (1,679,037 | ) | (239,416 | ) |
| Income tax benefit                                                                                                             |   | 1,561                       |     | 10,694 |   | 535 |   |
| Loss before extraordinary item and cumulative effect of change  in accounting principle                                        |   | (362,700                    | )        | (1,668,343 | ) | (238,881 | ) |
| Extraordinary item (early extinguishment of debt)                                                                              |   | —                      |     | 7,684 |   | 42,765 |   |
| Loss before cumulative effect of change in accounting  principle                                                               |   | (362,700                    | )        | (1,660,659 | ) | (196,116 | ) |
| Cumulative effect of change in accounting principle relating  to adoption of SFAS No. 133 in 2001 and SFAS No. 142 in 2002     |   | —                      |     | 6,564 |   | (129,306 | ) |
| Net Loss                                                                                                                       |   | $                           | (362,700 | ) | $ | (1,654,095 | ) | $ | (325,422 | ) |
| Other comprehensive loss:                                                                                                      |   |                        |     |   |   |   |   |
| Unrealized holding gain (loss) on investments available for  sale                                                              |   | 775                         |     | 880 |   | (111 | ) |
| Foreign currency translation adjustment                                                                                        |   | (113                        | )        | 600 |   | 3,235 |   |
| Comprehensive loss                                                                                                             |   | $                           | (362,038 | ) | $ | (1,652,615 | ) | $ | (322,298 | ) |
| Net loss per share – basic and diluted before extraordinary  item and cumulative effect of change in accounting principle |   | $                           | (9.99    | ) | $ | (40.96 | ) | $ | (5.67 | ) |
| Extraordinary item (early extinguishment of debt)                                                                              |   | —                      |     | 0.19 |   | 1.01 |   |
| Cumulative effect of change in accounting principle relating  to adoption of SFAS No. 133 in 2001 and SFAS No. 142 in 2002     |   | —                      |     | 0.16 |   | (3.07 | ) |
| Net loss per share-basic and diluted                                                                                           |   | $                           | (9.99    | ) | $ | (40.61 | ) | $ | (7.73 | ) |
| Weighted average shares outstanding-basic and diluted                                                                          |   | 36,310                      |     | 40,732 |   | 42,117 |   |

 

See accompanying notes to consolidated financialstatements.

 

41

----

 

**AETHERSYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY**

(DOLLARS IN THOUSANDS)

 
|                                                               |   | **PREFERRED  STOCK** |   | **COMMON  STOCK** |   | **ADDITIONAL  PAID-IN  CAPITAL** |   | **ACCUMULATED  DEFICIT** |       | **NOTES  RECEIVABLE  FROM  STOCKHOLDER** |   | **FOREIGN  CURRENCY  TRANSLATION  ADJUSTMENT** |   | **UNREALIZED  GAIN (LOSS) ON  INVESTMENTS** |   |
|--------------------------------------------------------------------|--------|----------------------|--------|-------------------|--------|----------------------------------|--------|--------------------------|------------|------------------------------------------|--------|------------------------------------------------|--------|---------------------------------------------|--------|
| Balance at December 31, 1999                                       |   | $                    | — |              | $      | 271                              |   | $                        | 120,892    |                                     | $      | (22,614                                        | )      | $                                           | (137   | ) | $ | — |   | $ | (70 | ) |
| Repayment on note receivable from stockholder                      |   | —               |   | —            |   | —                           |   | —                   |       | 137                                      |   | —                                         |   | —                                      |   |
| Gain on sales of stock by equity method investee                   |   | —               |   | —            |   | 73,349                           |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Proceeds from secondary offering                                   |   | —               |   | 54                |   | 1,056,872                        |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Issuance of stock and replacement options in Riverbed  acquisition |   | —               |   | 45                |   | 1,136,038                        |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Issuance of stock and replacement options in Cerulean  acquisition |   | —               |   | 5                 |   | 69,944                           |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Issuance of stock and replacement options in RTS acquisition       |   | —               |   | 13                |   | 77,941                           |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Exercise of options and warrants                                   |   | —               |   | 16                |   | 2,635                            |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Option and warrant expense                                         |   | —               |   | —            |   | 14,345                           |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Unrealized gain on investments available for sale                  |   | —               |   | —            |   | —                           |   | —                   |       | —                                   |   | —                                         |   | 775                                         |   |
| Foreign currency translation                                       |   | —               |   | —            |   | —                           |   | —                   |       | —                                   |   | (113                                           | )      | —                                      |   |
| Net loss                                                           |   | —               |   | —            |   | —                           |   | $                        | (362,700   | )                                        | — |                                           | — |                                        | — |   |
| Balance at December 31, 2000                                       |   | $                    | — |              | $      | 404                              |   | $                        | 2,552,016  |                                     | $      | (385,314                                       | )      | $                                           | — |   | $ | (113 | ) | $ | 705 |   |
| Gain on sales of stock by equity method investee                   |   | —               |   | —            |   | 6,071                            |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Proceeds from sale of stock                                        |   | —               |   | 7                 |   | 4,868                            |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Issuance of stock for acquisition                                  |   | —               |   | 1                 |   | 999                              |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Exercise of options and warrants                                   |   | —               |   | 7                 |   | 1,083                            |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Option and warrant expense                                         |   | —               |   | —            |   | 14,408                           |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Unrealized gain on investments available for sale                  |   | —               |   | —            |   | —                           |   | —                   |       | —                                   |   | —                                         |   | 880                                         |   |
| Foreign currency translation                                       |   | —               |   | —            |   | —                           |   | —                   |       | —                                   |   | 600                                            |   | —                                      |   |
| Net loss                                                           |   | —               |   | —            |   | —                           |   | $                        | (1,654,095 | )                                        | — |                                           | — |                                        | — |   |
| Balance at December 31, 2001                                       |   | $                    | — |              | $      | 419                              |   | $                        | 2,579,445  |                                     | $      | (2,039,409                                     | )      | $                                           | — |   | $ | 487 |   | $ | 1,585 |   |
| Exercise of options and warrants                                   |   | —               |   | 3                 |   | 626                              |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Option and warrant expense                                         |   | —               |   | —            |   | 6,542                            |   | —                   |       | —                                   |   | —                                         |   | —                                      |   |
| Unrealized gain on investments available for sale                  |   | —               |   | —            |   | —                           |   | —                   |       | —                                   |   | —                                         |   | (111                                        | )      |
| Foreign currency translation                                       |   | —               |   | —            |   | —                           |   | —                   |       | —                                   |   | 3,235                                          |   | —                                      |   |
| Net loss                                                           |   | —               |   | —            |   | —                           |   | $                        | (325,422   | )                                        | — |                                           | — |                                        | — |   |
| Balance at December 31, 2002                                       |   | $                    | — |              | $      | 422                              |   | $                        | 2,586,613  |                                     | $      | (2,364,831                                     | )      | $                                           | — |   | $ | 3,722 |   | $ | 1,474 |   |

 

 

42

----

 

|                                                               |   | **TOTAL**  |      |
|--------------------------------------------------------------------|--------|------------|-----------|
| Balance at December 31, 1999                                       |   | $          | 98,342    |   |
|                                                               |   |       |      |
| Repayment on note receivable from stockholder                      |   | 137        |      |
| Gain on sales of stock by equity method investee                   |   | 73,349     |      |
| Proceeds from secondary offering                                   |   | 1,056,926  |      |
| Issuance of stock and replacement options in Riverbed  acquisition |   | 1,136,083  |      |
| Issuance of stock and replacement options in Cerulean  acquisition |   | 69,949     |      |
| Issuance of stock and replacement options in RTS acquisition       |   | 77,954     |      |
| Exercise of options and warrants                                   |   | 2,651      |      |
| Option and warrant expense                                         |   | 14,345     |      |
| Unrealized gain on investments available for sale                  |   | 775        |      |
| Foreign currency translation                                       |   | (113       | )         |
| Net loss                                                           |   | (362,700   | )         |
| Balance at December 31, 2000                                       |   | $          | 2,167,698 |   |
| Gain on sales of stock by equity method investee                   |   | 6,071      |      |
| Proceeds from sale of stock                                        |   | 4,875      |      |
| Issuance of stock for acquisition                                  |   | 1,000      |      |
| Exercise of options and warrants                                   |   | 1,090      |      |
| Option and warrant expense                                         |   | 14,408     |      |
| Unrealized gain on investments available for sale                  |   | 880        |      |
| Foreign currency translation                                       |   | 600        |      |
| Net loss                                                           |   | (1,654,095 | )         |
| Balance at December 31, 2001                                       |   | $          | 542,527   |   |
| Exercise of options and warrants                                   |   | 629        |      |
| Option and warrant expense                                         |   | 6,542      |      |
| Unrealized gain on investments available for sale                  |   | (111       | )         |
| Foreign currency translation                                       |   | 3,235      |      |
| Net loss                                                           |   | (325,422   | )         |
| Balance at December 31, 2002                                       |   | $          | 227,400   |   |

 

43

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**AETHERSYSTEMS, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(DOLLARS IN THOUSANDS)

 
|                                                                                                                             |   | **YEAR  ENDED DECEMBER 31,** |     |
|----------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|----------|
|                                                                                                                             |   | **2000**                     |     | **2001** |   | **2002** |   |
| Cash flows from operating activities:                                                                                            |   |                         |     |   |   |   |   |
| Net loss                                                                                                                         |   | $                            | (362,700 | ) | $ | (1,654,095 | ) | $ | (325,422 | ) |
| Adjustments to reconcile net loss to net  cash used by operating activities:                                                     |   |                         |     |   |   |   |   |
| Depreciation and amortization                                                                                                    |   | 238,074                      |     | 180,724 |   | 39,255 |   |
| Provision for doubtful accounts                                                                                                  |   | 1,391                        |     | 9,801 |   | 3,578 |   |
| Provision for inventory obsolescence                                                                                             |   | 83                           |     | 14,381 |   | 263 |   |
| Equity in losses of investments                                                                                                  |   | 47,886                       |     | 57,523 |   | 4,744 |   |
| Option and warrant expense                                                                                                       |   | 14,345                       |     | 14,408 |   | 6,542 |   |
| Minority interest                                                                                                                |   | (10,692                      | )        | (63,809 | ) | 45 |   |
| Deferred income tax benefit                                                                                                      |   | (1,561                       | )        | (10,694 | ) | — |   |
| In process research and development  related to acquisitions                                                                     |   | 7,860                        |     | — |   | — |   |
| Extraordinary item                                                                                                               |   | —                       |     | (7,684 | ) | (42,765 | ) |
| Cumulative effect of change in accounting  principle                                                                             |   | —                       |     | (6,564 | ) | 129,306 |   |
| Impairment of intangibles and other  assets                                                                                      |   | —                       |     | 1,121,001 |   | 69,534 |   |
| Realized losses on long-term investments,  including impairments                                                                 |   | —                       |     | 143,382 |   | 14,412 |   |
| Changes in assets and liabilities, net of  acquired assets and liabilities:                                                      |   |                         |     |   |   |   |   |
| Increase in trade accounts receivable                                                                                            |   | (17,177                      | )        | (5,540 | ) | (1,291 | ) |
| (Increase) decrease in inventory                                                                                                 |   | (10,019                      | )        | (25,286 | ) | 8,404 |   |
| (Increase) decrease in prepaid expenses  and other assets                                                                   |   | (9,186                       | )        | (3,955 | ) | 4,530 |   |
| Decrease in accounts payable                                                                                                     |   | (3,479                       | )        | (1,187 | ) | (6,657 | ) |
| Increase (decrease) in accrued expenses,  accrued employee compensation and benefits, interest payable and acquisitions  payable |   | 36,180                       |     | (15,189 | ) | (11,116 | ) |
| Increase in restructuring reserve and  other long term liabilities                                                               |   | —                       |     | 27,817 |   | 11,610 |   |
| Increase in deferred revenue                                                                                                     |   | 5,156                        |     | 4,273 |   | 4,498 |   |
| Net cash used by operating activities                                                                                            |   | (63,839                      | )        | (220,693 | ) | (90,530 | ) |
| Cash flows used by investing activities:                                                                                         |   |                         |     |   |   |   |   |
| Sales and maturities of short-term  investments                                                                                  |   | 7,731                        |     | 3,286 |   | 352,675 |   |
| Purchases of short-term investments                                                                                              |   | (5,618                       | )        | (3,411 | ) | (605,367 | ) |
| Acquisitions, net of cash acquired                                                                                               |   | (303,741                     | )        | (33,835 | ) | (16,277 | ) |
| Purchases of property and equipment                                                                                              |   | (48,346                      | )        | (38,468 | ) | (5,040 | ) |
| Investments                                                                                                                      |   | (158,412                     | )        | (41,504 | ) | (535 | ) |
| Sale of long-term investments                                                                                                    |   | —                       |     | 5,689 |   | 3,991 |   |
| Increase in other intangible assets                                                                                              |   | (1,800                       | )        | (4,653 | ) | (178 | ) |
| Increase in other assets                                                                                                         |   | (2,053                       | )        | (7,078 | ) | — |   |
| Net cash used in investing activities                                                                                            |   | (512,239                     | )        | (119,974 | ) | (270,731 | ) |
| Cash flows provided by financing  activities:                                                                                    |   |                         |     |   |   |   |   |
| Proceeds from issuance of common stock                                                                                           |   | 1,056,926                    |     | 4,875 |   | 629 |   |
| Proceeds from issuance of convertible  debt                                                                                      |   | 300,294                      |     | — |   | — |   |
| Repayment of notes payable including  buyback of convertible debt                                                                |   | —                       |     | (12,316 | ) | (92,888 | ) |
| Proceeds from note payable/credit  facility                                                                                      |   | —                       |     | 5,160 |   | — |   |
| Repayments on notes payable/credit  facility                                                                                     |   | —                       |     | (583 | ) | (64 | ) |
| Repayment of notes receivable from  stockholder                                                                                  |   | 137                          |     | — |   | — |   |
| (Increase) decrease in restricted cash                                                                                           |   | (26,899                      | )        | — |   | — |   |
| Contributions from minority shareholder  of a subsidiary                                                                         |   | 20,818                       |     | 8,227 |   | — |   |
| Exercise of options and warrants                                                                                                 |   | 2,651                        |     | 1,090 |   | — |   |
| Net cash provided by (used in) financing  activities                                                                             |   | 1,353,927                    |     | 6,453 |   | (92,323 | ) |
| Net increase (decrease) in cash and cash  equivalents                                                                            |   | 777,849                      |     | (334,214 | ) | (453,584 | ) |
| Cash and cash equivalents, at beginning  of period                                                                               |   | 78,542                       |     | 856,391 |   | 522,177 |   |
| Cash and cash equivalents, at end of  period                                                                                     |   | $                            | 856,391  |   | $ | 522,177  |   | $ | 68,593 |   |
| Supplemental disclosure of cash flow  information:                                                                               |   |                         |     |   |   |   |   |
| Cash paid during the year for interest                                                                                           |   | $                            | 9,327    |   | $ | 18,030 |   | $ | 16,061 |   |

 

See accompanying notes to consolidated financialstatements.

 

44

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Supplemental disclosure of non-cash investing andfinancing activities:

 

In 2000, 2001 and 2002, the Company incurredunrealized holding gains (losses) associated with its investments available forsale totaling $775, $880 and ($111), respectively. These amounts have beenreported as increases (decreases) in members’ capital and stockholders’ equity.

 

In January 2000, approximately $600 of tradereceivables owed to the Company by OmniSky, Corp. were offset by the Company’sadditional investment made in OmniSky, Corp.

 

In March 2000, the Company acquired RiverbedTechnologies, Inc. for 4,537,281 shares of the Company’s common stock andconverted existing options held by Riverbed employees into options to acquire862,480 shares of the Company’s common stock. The value of the common stock and replacement options of $1,136,083 wasallocated to the fair value of the assets purchased and liabilities assumedwith a corresponding increase in stockholders’ equity.

 

In connection with the acquisition of IFX and therelated formation of Sila and the acquisitions made by Sila, the Companyestablished a deferred tax liability of $12,255. Such amount was offset by anequal increase in goodwill.

 

In September 2000, the Company acquired Cerulean forcash of $75,000, 462,412 shares of the Company’s common stock and convertedexisting options held by Cerulean employees into options to acquire 94,275shares of the Company’s common stock. The value of the common stock and vested replacement options of $69,949was allocated to the fair value of the assets purchased and the liabilitiesassumed with a corresponding increase in stockholders’ equity.

 

In December 2000, the Company acquired RTS Wirelessfor cash of $34,000, 1,259,752 shares of the Company’s common stock andconverted existing options held by RTS employees into options to acquire 90,248shares of the Company’s common stock. The value of the common stock and vested replacement options of $77,954was allocated to the fair value of the assets purchased and liabilities assumedwith a corresponding increase in stockholders’ equity.

 

In connection with the acquisitions of Cerulean,Sinope, RTS and Motient, the Company has accrued $29,800 as of December 31,2000 for the remaining portion of the purchase price.  Such amount was allocated to the fair value of the assetspurchased and the liabilities assumed.

 

In 2000 and 2001, the Company recorded gains throughstockholders’ equity of $73,349 and $6,071, respectively, from the sale ofstock by OmniSky, Inc. to third parties at per share amounts in excess of thebook value per share.

 

In June 2001, the Company acquired certain completedtechnology from SmartPoint, Inc. in exchange for 70,852 shares of the Company’scommon stock.  The value of the commonstock of $1,000 was allocated to the fair value of the assets purchased with acorresponding increase in stockholders’ equity.

 

In July 2001, approximately $1,200 of tradereceivables owed to the Company by Spring Wireless,Ltd. was offset by theCompany’s additional investment in Spring Wireless.

 

In connection with the agreement with America OnlineInc. (“AOL”), the Company accrued $2,500 as of December 31, 2001 for theremaining portion of a license payment due to AOL. Such amount was allocated tothe fair value of the assets purchased. In 2002, this liability was written off in connection with thetermination of the agreement with AOL.

 

See accompanying notes to consolidated financialstatements.

 

45

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**AETHERSYSTEMS, INC.**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE (1) ORGANIZATION AND DESCRIPTIONOF THE BUSINESS**

 

Aether Systems, Inc. (the Company) was originallyformed as Aeros, L.L.C. in January 1996. The Company changed its name to Aether Technologies International,L.L.C. effective August 1996 and to Aether Systems L.L.C. effective September1999.  Immediately prior to thecompletion of its initial public offering of common stock on October 26, 1999,the limited liability company was converted into a Delaware corporation and theCompany’s name was changed to Aether Systems, Inc.

 

The Company provides the services,software and support necessary for businesses to extend existing and futureapplications from the desktop to almost all currently available personaldigital assistant (PDA) operating systems and their respective wirelessdevices.  Through the Aether FusionTMapproach, the Company develops, deploys and manages wireless solutions built onindustry standard technology and backed by its expertise in wireless hosting,software and services.

 

The Company operates inthree business segments: enterprise services, mobile government, andtransportation and logistics.

 

In 2002, the Company expanded itsproducts, services, and customer base in the transportation and logisticsmarket through the acquisition of certain assets and licenses from @TrackCommunications, Inc. (“@Track”).  @Trackis a leading provider of wireless-based vehicle fleet management andintelligent mobile-asset-tracking solutions.

 

**NOTE (2) MERGER AND INITIAL PUBLICOFFERING**

 

The Company is the successor to the business formerlyconducted by Aether Systems, L.L.C. (Aether) (previously Aether TechnologiesInternational, L.L.C.), which was formed in January 1996.  Effective October 26, 1999, in connectionwith the Company’s initial public offering of common stock, Aether merged withand into Aether Systems, Inc. The Company is the surviving company in themerger, and the Company and its stockholders own all of the assets and rightsand the Company is subject to all of the obligations and liabilities of Aether.Immediately prior to the merger, each member contributed its membership unitsin Aether Systems, L.L.C. to Aether Systems, Inc., a newly formed Delawarecorporation, in exchange for two and one-half shares of common stock of AetherSystems, Inc.  Effective with themerger, the Company converted to a Subchapter C Corporation under the InternalRevenue Code of 1986, as amended.

 

On October 26, 1999, the Company completed its initialpublic offering, which involved the sale of 6,900,000 shares of common stock at$16.00 per share, including 900,000 shares from the exercise of theunderwriters’ over-allotment option. Net proceeds to the Company after deducting underwriting discounts,commissions and other expenses of the offering were approximately $101.1million.

 

**NOTE (3) SECONDARY PUBLIC OFFERINGS**

 

On March 17, 2000, the Company completed a secondaryoffering for the sale of 5,411,949 shares of common stock, including the saleof 825,000 shares from the exercise of the underwriters’ over-allotment option,at $205.00 per share.  The net proceedsafter deduction of underwriting discounts and offering expenses wereapproximately $1.06 billion. Concurrently with this offering, the Company completed an offering forthe sale of an aggregate $310.5 million of 6% convertible subordinated notes(the Notes) due in 2005, including $40.5 million in principal amounts from theexercise of the underwriters’ over-allotment. The net proceeds after deduction of underwriting discounts and offeringexpenses were approximately $300.6 million. The underwriting discounts and expenses of the Notes offering of $9.8million have been included in other assets as deferred financing fees.  The Notes are convertible, at the option ofthe holder, at any time prior to maturity, into shares of common stock ofAether at a conversion price of $243.95 per share, which is equal to aconversion rate of

4.0992 shares per $1,000 principal amount of notes,subject to adjustment.

 

On September 27, 2000, certain of the Company’sstockholders sold 5,000,000 shares of common stock, in an underwritten offeringat $105.00 per share. No new shares were issued in the offering and, as such,the Company received no proceeds from the sale.

 

**NOTE (4) SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

(a) PRINCIPLES OF CONSOLIDATION

 

The consolidated financial statements include theaccounts of the Company and its wholly-owned subsidiaries.  All significant intercompany transactionsand balances have been eliminated in consolidation. Minority interest consistsof Reuters PLC’s ownership interest in Sila Communications Limited (“Sila”).

 

In December 2002, the Company purchased from Reuters,their 40% interest in Sila, a European joint venture the Company formed withReuters in 2000.  As a result of thisacquisition, all minority interests have been eliminated and all of theCompany’s subsidiaries are now wholly owned. The results of Sila’s operations have been consolidated with theCompany’s results in 2000, 2001 and 2002.

 

46

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(b) REVENUE RECOGNITION

 

The Company derives revenue from four sources (i)subscriber revenue (ii) engineering services (iii) software and relatedservices, and (iv) device sales.  Asdescribed below, significant management judgments and estimates must be madeand used in connection with the revenue recognized in any accounting period.

 

i.) Subscriber revenue

 

The Company derives subscriber revenue from theprovision of real-time access to business information integrated into existingwireless communication platforms, and from the provision of comprehensivebusiness solutions designed to meet the mobile management needs of truckload,less-than-load, and private carriers. For all sales, the Company obtains signed binding contracts with itssubscribers.  The Company’s contractswith wireless data subscribers are generally for a one-year period and includea termination penalty if cancelled by the subscriber before the initial periodexpires.  These contracts are generallyrenewable at the option of the subscriber for additional periods or otherwisecontinue on a monthly basis until cancelled by the subscriber.  Contracts with the transportation subscribersare generally for a three to five year period and include a termination penaltyif cancelled by the subscriber before the term of the contract expires.

 

The Company recognizes subscriber revenue on a monthlybasis as the service is provided. Activation fees are deferred and recognized ratably over the expectedlife of the customer relationship.

 

ii.) Engineering services revenue

 

Engineering services revenue is derived from theprovision of wireless integration consulting under time-and-materials andfixed-fee contracts.  Revenue ontime-and-materials contracts is recognized as time is spent at hourly rates,which are negotiated with the customer. Revenue on fixed-fee contracts is recognized on thepercentage-of-completion method based on costs incurred in relation to totalestimated costs.  Anticipated contractlosses are recognized as soon as they become known and estimable.

 

iii.) Software and related services revenue

 

Software and related services revenues are generatedfrom licensing software and providing services, including maintenance andtechnical support, training and consulting. Software revenue consists of fees for licenses of the Company’s softwareproducts.  The Company recognizesrevenue when the license agreement is signed, the license fee is fixed anddeterminable, delivery of the software has occurred, and collectibility of thefees is considered probable.  At thetime of the transaction, the Company assesses whether the fee associated withits revenue transactions is fixed and determinable and whether or notcollection is reasonably assured.  If asignificant portion of a fee is due after the normal payment term, the Companyaccounts for the fee as not being fixed and determinable.  In these cases, the Company recognizesrevenue as the fees become due.  TheCompany assesses collection based on a number of factors, including pasttransaction history with the customer and credit worthiness of thecustomer.  The Company does not requestcollateral from its customers.  If theCompany determines that collection of a fee is not reasonably assured, itdefers the fee and recognizes revenue at the time it becomes reasonablyassured, which is generally upon receipt of cash.

 

Revenue from licensing software that requiressignificant customization and modification is recognized using the percentageof completion method, based on the hours incurred in relation to the totalestimated hours.  Service revenuesconsist principally of maintenance and technical support, which consists ofunspecified when-and-if available product updates and customer telephonesupport services and are recognized ratably over the term of the serviceperiod.  Other service revenues arerecognized as the related services are provided.  In situations where the Company hosts the software and thecustomer has the option to take possession of the software at any time duringthe hosting period without significant penalty and it believes it is feasiblefor the customer to either run the software on its own hardware or contractwith another party unrelated to the Company to host the software, the softwareelement is accounted for in accordance with SOP 97-2.  Otherwise, such amounts are recognized ratably over the hostingperiod.

 

iv.) Device revenue

 

The Company derives device revenue from the sale ofwireless devices used to provide its services. Generally, revenue for device sales is recognized upon delivery.  In cases where in management’s judgment, i.)the service is essential to the functionality of the device and ii.) theCompany’s ongoing service is the only service available for the device, theCompany recognizes the device revenue as the ongoing service is provided overthe shorter of the life of the equipment or the estimated life of the customerrelationship.

 

v.) Revenue from multiple element arrangements

 

For arrangements with multiple elements, the Companyallocates revenue to each component of the arrangement using the residual valuemethod.  This means that the Companydefers revenue from the total fees associated with the arrangement equivalentto the fair value of the element(s) of the arrangement that has not yet beendelivered.  The fair value of anyundelivered elements is established by using historical evidence specific tothe Company.

 

47

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vi.) Revenue from related parties

 

Revenue from products and services sold to companiesthat the Company has also made strategic investments in (related parties) isallocated between the investment and revenue recognized based on the relativefair value of the products and services sold and the investment received.  The Company has determined the fair value ofthe investments based on the fact that all of its investments were made inparticipation with other unrelated financial investors at the same price pershare as the other investors.  TheCompany’s investment policy generally limits its investments to companies thathave completed at least two rounds of financing and generally requires that anunrelated investor lead the round of financing that the Company participatesin.  The Company has estimated the fairvalue of products and services sold based on comparable sales transactions toother unrelated companies.  Sales torelated parties were $10.5 million, $11.4 million, and $1.6 million for theyears ended December 31, 2000, 2001, and 2002, respectively.

 

(c) COST OF REVENUES

 

Cost of subscriber revenue consistsprimarily of airtime costs, financial data costs, and securities and marketexchange fees and excludes depreciation on and operating costs of the Company’snetwork operations centers and certain costs of customer fulfillment andcustomer care.  When the subscribers’monthly fee includes the use of a wireless device, the Company depreciates thecost of the device over its expected useful life or the expected term of thecustomer relationship.  Cost ofengineering services revenue consists of cash compensation and related costsfor engineering personnel and materials. Cost of software and related services revenue consists of third partyroyalties and personnel costs related to the cost of maintenance, consultingand support.  Cost of device salesconsists primarily of the cost of the device and is expensed when deliveryoccurs.  When the service is consideredessential to the functionality of the device, the cost of the device isexpensed over the shorter of the expected term of the customer relationship orthe life of the equipment.

 

(d) CASH AND CASH EQUIVALENTS

 

Cash equivalents include all highly liquid investmentspurchased with original maturities of three months or less. Cash and cashequivalents consisted of the following:

 
|                    |   | **DECEMBER 31,  2001** |    | **DECEMBER 31,  2002** |   |
|-------------------------|--------|------------------------|---------|------------------------|--------|
| Cash                    |   | $                      | 33,586  |                   | $      | 15,540 |   |
| Money market accounts   |   | 469,868                |    | 43,053                 |   |
| Municipal Bonds         |   | 5,285                  |    | —                 |   |
| Commercial paper        |   | 998                    |    | —                 |   |
| Certificates of deposit |   | 12,440                 |    | 10,000                 |   |
| Total                   |   | $                      | 522,177 |                   | $      | 68,593 |   |

 

At December 31, 2001 there was a restriction on $5.3million of the Company’s cash relating to the Company’s agreement withAOL.  The escrow was available to AOL inthe event of the Company’s non-payment of short-term advertising liabilities toAOL.  This restriction was removedduring 2002 in connection with the termination of the AOL agreement.

 

(e) SHORT-TERM INVESTMENTS

 

Short-term investments consist of highly liquidinvestments with original maturities greater than three months and less thanone year and those longer-term investments that the Company expects toliquidate within twelve months.  TheCompany has classified its short-term investments as available for sale andcarries such investments at fair value. Unrealized gains (losses) are excluded from earnings (loss) and arereported as a separate component of other comprehensive income (loss) untilrealized.  Realized gains and lossesfrom the sale of these investments are determined on a specific identificationbasis.

 

 

48

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Asof December 31, 2001, short-term available for sale securities consists of (inthousands):

 

 
|                                         |   | **Amortized   Cost** |   | **Gross  Unrealized  Holding Gains** |   | **Gross  Unrealized  Holding Losses** |   | **Fair  Value** |   |
|----------------------------------------------|--------|----------------------|--------|--------------------------------------|--------|---------------------------------------|--------|-----------------|--------|
|                                         |   |                 |   |                                 |   |                                  |   |            |   |
| U.S.  Treasury securities                    |   | $                    | 663    |                                 | $      | 12                                    |   | $               | — |   | $ | 675 |   |
| U.S.  Government Agency-sponsored securities |   | 1,270                |   | 36                                   |   | —                                |   | 1,306           |   |
| Corporate  debt securities                   |   | 495                  |   | 14                                   |   | —                                |   | 509             |   |
|                                         |   | $                    | 2,428  |                                 | $      | 62                                    |   | $               | — |   | $ | 2,490 |   |

 

Maturitiesof debt securities classified as available for sale were as follows at December31, 2001 (in thousands):

 
|                                    |   | **Amortized  Cost** |   | **Fair  Value** |   |
|-----------------------------------------|--------|---------------------|--------|-----------------|--------|
|                                    |   |                |   |            |   |
| Due  within one year                    |   | $                   | 188    |            | $      | 191 |   |
| Due  after one year through five years  |   | 1,797               |   | 1,848           |   |
| Due  after five years through ten years |   | 443                 |   | 451             |   |
| Due  after ten years                    |   | —              |   | —          |   |
|                                    |   | $                   | 2,428  |            | $      | 2,490 |   |

 

Asof December 31, 2002, short-term available for sale securities consists of (inthousands):

 
|                                         |   | **Amortized   Cost** |    | **Gross  Unrealized  Holding Gains** |   | **Gross  Unrealized  Holding Losses** |   | **Fair  Value** |   |
|----------------------------------------------|--------|----------------------|---------|--------------------------------------|--------|---------------------------------------|--------|-----------------|--------|
|                                         |   |                 |    |                                 |   |                                  |   |            |   |
| U.S.  Government Agency-sponsored securities |   | 254,449              |    | 1,376                                |   | —                                |   | 255,825         |   |
|                                         |   |                 |    |                                 |   |                                  |   |            |   |
|                                         |   | $                    | 254,449 |                                 | $      | 1,376                                 |   | $               | — |   | $ | 255,825 |   |
|                                              |        |                      |         |                                      |        |                                       |        |                 |        |  |  |  |  |

 

Maturitiesof debt securities classified as available for sale were as follows at December31, 2002 (in thousands):

 
|                                    |   | **Amortized  Cost** |    | **Fair  Value** |   |
|-----------------------------------------|--------|---------------------|---------|-----------------|--------|
|                                    |   |                |    |            |   |
| Due  within one year                    |   | $                   | 33,761  |            | $      | 34,039 |   |
| Due  after one year through five years  |   | 220,688             |    | 221,786         |   |
| Due  after five years through ten years |   | —              |    | —          |   |
| Due  after ten years                    |   | —              |    | —          |   |
|                                    |   | $                   | 254,449 |            | $      | 255,825 |   |

 

(f)FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The carrying amounts of theCompany’s financial instruments, which include cash equivalents, short-terminvestments, accounts receivable, accounts payable, accrued expenses and notespayable (excluding the Notes) approximate their fair value due to therelatively short duration of the instruments.

 

The fair value of the Notes at December 31, 2001 and2002 was $170.3 million and $119.3 million, respectively, based on quotedmarket prices, as compared to the carrying value of the Notes of $290.5 millionand $154.9 million, respectively.

 

(g) CONCENTRATION OF CREDIT RISK

 

Financial instruments which potentially subject theCompany to credit risk consist primarily of cash, cash equivalents and tradereceivables.

 

The company invests cash not immediately needed foroperations in money market securities and high-grade U.S. GovernmentAgency-sponsored securities.  The moneymarket securities represented underlying investments in commercial paper issuedby financial institutions and other companies with high credit ratings andsecurities issued or backed by the U.S. Government.  The amounts invested generally exceed the F.D.I.C. limits.  The Company has not experienced any materiallosses in its cash and cash equivalents or short-term investments and believesit is not exposed to any significant credit risk on these amounts.

 

Trade accounts receivable and short and long termlease receivables subject the Company to the potential for credit risk.  The Company extends

 

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credit to customers on an unsecured basis in thenormal course of business (lease receivables are secured by the leasedhardware).  A portion of the Company’scustomer base includes small companies with limited resources and cashflow.  The Company’s policy is toperform an analysis of the recoverability of its trade accounts receivable atthe end of each reporting period and to establish allowances for those accountsconsidered uncollectible.  The Companyanalyzes historical bad debts, customer concentrations, customercredit-worthiness, and current economic trends when evaluating the adequacy ofthe allowance for doubtful accounts.  Asa result, the Company recorded bad debt expense of $1.4 million, $9.8 millionand $3.6 million during the years ended December 31, 2000, 2001 and 2002,respectively.

 

(h) NET INVESTMENT IN SALES-TYPE LEASES

 

The Company leases devices to certain of its customersand accounts for these transactions as sales-type leases.  The Company records as its gross investmentin the sales-type leases at the present value of the minimum leasepayments.  There is no unguaranteedresidual value associated with the leased devices.  The receivables generally have terms of five years and arecollateralized by a security interest in the related equipment.  The Company records revenue on these leaseddevices as the ongoing service is provided over the shorter of the life of theequipment or the estimated life of the customer relationship.

 

(i) INVENTORY

 

Inventory, net of allowance for obsolete andslow-moving inventory, consists of finished goods such as handheld computers,pagers, wireless modems, and accessories and is stated at the lower of cost ormarket.  Cost is determined using a standardcosting method, which approximates the first-in, first-out method.  The Company’s inventory is subject to rapidtechnological changes that could have an adverse impact on its realization infuture periods.  In addition, there area limited number of suppliers of the Company’s inventory. During 2001 and 2002,the Company recorded an impairment charge of approximately $14.4 million and$263,000 to reduce the carrying value of its inventory due to obsolescence andexcess inventory.  The Company estimatedthe reduction in inventory value based on consideration of the following: (1)quantities and composition of inventory held; (2) sales prices of competingvendors; (3) projected unit sales and unit pricing over subsequent periods;and, (4) evaluation of remaining inventory purchase commitments.  If the Company’s estimates of projectedunits sales and unit pricing differ from actual results, the Company may berequired to record additional impairment charges in the future.

 

(j) PROPERTY AND EQUIPMENT

 

Property and equipment are stated at cost.Depreciation is calculated using the straight-line method over the estimateduseful lives of the assets, which range from three to ten 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.  For constructed assets, all costs that arenecessary to bring such assets to the condition and location necessary fortheir intended use are initially capitalized as construction-in-progress andare subsequently transferred to equipment.

 

(k) INVESTMENTS

 

The Company accounts for those investments in which itexercises significant influence or has an ownership interest greater thantwenty percent under the equity method. For equity method investments, the Company records its proportionateshare of the investee’s net income or loss. Generally, the Company accounts forits investments in which the Company has an ownership interest of less thantwenty percent under the cost method for its private investments. Investmentsin marketable equity securities, if not considered equity method investments,are considered available-for-sale securities.

 

Investments carried at cost or on the equity methodare written down if circumstances indicate the carrying amount of theinvestment may not be recoverable. Investments in marketable equity securities are carried at fair valuebased on quoted market prices.  Netunrealized holding gains and losses are excluded from income and are reportedas a separate component of stockholders’ equity unless a decline in marketvalue is considered other than temporary. Realized gains and losses are included in income.

 

(l) DERIVATIVES

 

The Company adopted SFAS No. 133,“Accounting for Derivatives Instruments and Hedging Activities”, as amended, onJanuary 1, 2001.  SFAS No. 133 requiresthe Company to recognize all derivatives on the balance sheet at fair value.Derivatives that are not hedges must be adjusted to fair value through the statementof operations. If the derivative is a hedge, depending on the nature of thehedge, changes in fair value of derivatives will either be offset against thechange in fair value of the hedged assets, liabilities or firm commitmentsthrough earnings, or recognized in other comprehensive income (loss) until thehedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value will beimmediately recognized in earnings.  TheCompany recognized a $6.6 million gain on the adoption of SFAS No. 133 ascumulative effect in change in accounting principle in 2001.

 

(m) GOODWILL

 

Goodwill represents theexcess of costs over the fair value of assets of businesses acquired.  The Company adopted the provisions of SFASNo. 142, “Goodwill and Other Intangible Assets*”,* as of January 1, 2002.  Goodwill and intangible assets acquired in a purchase businesscombination and determined to have an indefinite useful life are not amortized,but instead tested for impairment at least annually in

 

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accordance with theprovisions of SFAS No. 142. 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, “Accounting forImpairment or Disposal of Long-Lived Assets*”*.

 

In connection with SFASNo. 142’s transitional goodwill impairment evaluation, the Statementrequired the Company to perform an assessment of whether there was anindication that goodwill is impaired as of the date of adoption.  To accomplish this, the Company was requiredto identify its reporting units and determine the carrying value of eachreporting unit by assigning the assets and liabilities, including the existinggoodwill and intangible assets, to those reporting units as of January 1,2002.  The Company was required todetermine the fair value of each reporting unit and compare it to the carryingamount of the reporting unit within six months of January 1, 2002.  To the extent the carrying amount of areporting unit exceeded the fair value of the reporting unit, the Company wouldbe required to perform the second step of the transitional impairment test, asthis is an indication that the reporting unit goodwill may be impaired.  The second step was required for all threereporting units.  In this step, theCompany compared the implied fair value of each reporting units goodwill withthe carrying amount of the reporting units goodwill, both of which weremeasured as of the date of adoption. The implied fair value of goodwill was determined by allocating the fairvalue of the reporting unit to all of the assets (recognized and unrecognized)and liabilities of the reporting unit in a manner similar to a purchase priceallocation, in accordance with SFAS No. 141, “Business Combinations”.  The residual fair value after thisallocation was the implied fair value of the reporting unit goodwill.  As a result of this evaluation, the Companyrecorded an impairment charge of $129.3 million, which was recorded ascumulative effect of change in accounting principle in the accompanyingconsolidated statements of operations. Of this charge, $94.9 million, $32.0 million and $2.4 million was in theCompany’s Enterprise Mobility Solutions, Mobile Government and Transportationsegments, respectively.

 

SFAS No. 142 alsorequires that the Company repeat the two-step impairment analysis each year,beginning with a recurring annual measurement date chosen by the Company in2002.  The Company chose September 30,2002 to be 2002’s measurement date, and will continue to perform annualimpairment reviews on this date.  TheSeptember 30, 2002 review resulted in an additional impairment charge of $26.8million, which was recorded as impairment of intangibles in the accompanyingconsolidated statements of operations. Of this charge, $3.1 million and $23.7 million was in the Company’sMobile Government and Transportation segments, respectively.

 

In both cases above, theCompany, with the assistance of a third party appraiser, arrived at the impliedfair value of goodwill using a discounted cash flow methodology.  Due to the continuing macro-economic slow-downand reduced spending on information technology (IT) in 2002 the Company doesnot expect dramatic increases in cash flows in the near term which in turnresulted in discounted cash flows that did not support the value of thegoodwill that had been in the Company’s consolidated balance sheet.

 

Prior to the adoption ofSFAS No. 142, goodwill was amortized on a straight-line basis over theexpected periods to be benefited, which ranged from three to seven years, andassessed for recoverability by determining whether the amortization of the goodwillbalance over its remaining life could be recovered through undiscounted futureoperating cash flows of the acquired operation. All other intangible assetswere amortized on a straight-line basis from two to seven years.  The amount of goodwill and other intangibleasset impairment, if any, was measured in accordance with SFAS No. 121,“Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assetsto be Disposed of.”  The measurement wasbased on projected discounted future operating cash flows using a discount ratereflecting the Company’s average cost of funds.

 

The following table showswhat net income would have been in all periods presented exclusive ofamortization expense recognized in those periods related to goodwill andassembled workforce (both of which are no longer amortized under the provisionsof SFAS No. 142):

 
|                                              |   | **Year Ended December 31,** |      |
|---------------------------------------------------|--------|-----------------------------|-----------|
| **(amounts in thousands except per  share data)** |   | **2000**                    |      | **2001** |   |
| Net  loss as reported                             |   | $                           | (362,700) |   |   | (1,654,095 | ) |
| Add  back:                                        |   |                        |      |   |   |
| Amortization  of goodwill                         |   | 216,180                     |      | 130,403 |   |
| Amortization  of assembled work force             |   | 2,776                       |      | 6,237 |   |
| Adjusted  net loss                                |   | $                           | (143,744) |   |   | (1,517,455 | ) |
|                                              |   |                        |      |   |   |
| ***Per share amounts***                           |   |                        |      |   |   |
| Adjusted  net loss per share                      |   | $                           | (3.96)    |   |   | (37.25 | ) |

 

The above table does notconsider the effects of recording any additional impairments of goodwill thatmay have been required as a result of the non amortization of goodwill approachprescribed by SFAS No. 142.

 

The Company expects torecord approximately $5.5 million in 2003, $5.3 million in 2004, $3.6 millionin 2005, $1.3 million in 2006 and $705,000 in 2007 in amortization expense oncurrently held identifiable intangibles.

 

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(n) INTANGIBLES AND RECOVERY OF LONG-LIVED ASSETS

 

Identifiable intangible assets consist of completedtechnology, trademarks, and acquired subscribers and are amortized on astraight-line basis over two to seven years.

 

SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” provides asingle accounting model for long-lived assets to be disposed of. SFASNo. 144 also changes the criteria for classifying an asset as held forsale; and broadens the scope of businesses to be disposed of that qualify forreporting as discontinued operations and changes the timing of recognizinglosses on such operations.  The Companyadopted SFAS No. 144 on January 1, 2002.

 

In accordance with SFASNo. 144, long-lived assets, such as property, plant, and equipment, andpurchased intangibles subject to amortization, are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparisonof the carrying amount of an asset to estimated undiscounted future cash flowsexpected to be generated by the asset. 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 disposed of would be separatelypresented in the balance sheet and reported at the lower of the carrying amountor fair value less costs to sell, and are no longer depreciated.  The assets and liabilities of a disposed groupclassified as held for sale would be presented separately in the appropriateasset and liability sections of the balance sheet.

 

Goodwill and intangibleassets not subject to amortization are tested annually for impairment, and aretested for impairment more frequently if events and circumstances indicate thatthe asset might be impaired.  Animpairment loss is recognized to the extent that the carrying amount exceedsthe asset’s fair value.

 

During 2002, the Companyassessed the fair value of certain of its long-lived assets, includingsoftware, computer equipment, other tangible assets and identifiable intangibleassets obtained in connection with acquisitions.  This assessment resulted in an impairment charge of $42.7 millionin 2002, which is recorded in impairment of intangibles and other assets in theaccompanying consolidated statements of operations.  Of this charge, $13.6 million, $125,000 and $9.3 million was inthe Company’s Enterprise Mobility Solutions, Mobile Government andTransportation segments, respectively. The remaining impairment charge related to European operations andcorporate and other assets.  TheCompany, with the assistance of third party appraisers, determined the fairvalue of these assets based on a combination of quoted market prices and a costapproach methodology.  A portion of theassets referred to above have been reclassified from property, plant andequipment and are now being classified as assets held-for-sale in the accompanyingconsolidated balance sheet.

 

Prior to the adoption ofSFAS No. 144, the Company accounted for long-lived assets in accordancewith SFAS No. 121, "Accounting for Impairment of Long-Lived Assetsand for Long-Lived Assets to be Disposed Of."

 

(o) STOCK OPTIONS AND WARRANTS

 

The Company accounts for equity-based employeecompensation arrangements in accordance with the provisions of AccountingPrinciple Board (APB) Opinion No. 25, “Accounting for Stock Issued toEmployees”, and related interpretations including FIN 44. Under APB No. 25,compensation expense is based upon the difference, if any, on the date ofgrant, between the fair value of the Company’s stock and the exercise price.All equity-based awards to non-employees are accounted for at their fair valuein accordance with SFAS No. 123.  SFASNo. 123 established accounting and disclosure requirements using afair-value-based method of accounting for stock-based employee compensationplans.  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.  The following tableillustrates the effect on net income if the fair-value-based method had beenapplied to all outstanding and unvested awards in each period:

 
|                                                                                                              |   | **Year Ended December 31,** |     |
|-------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|----------|
|                                                                                                              |   | **2000**                    |     | **2001** |   | **2002** |   |
| Net  loss as reported                                                                                             |   | $                           | (362,700 | ) | $ | (1,654,095 | ) | $ | (325,422 | ) |
| Add  stock-based employee compensation expense included Included in reported net  income                          |   | 14,345                      |     | 14,408 |   | 6,542 |   |
| Deduct  total stock-based employee compensation expense determined under  fair-value-based method for all rewards |   | (53,200                     | )        | (81,400 | ) | (62,900 | ) |
|                                                                                                              |   |                        |     |   |   |   |   |
| Pro forma net loss                                                                                                |   | $                           | (401,555 | ) | $ | (1,721,087 | ) | $ | (381,780 | ) |

 

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(p) RESEARCH AND DEVELOPMENT

 

Research and development costs are expensed asincurred.

 

(q) ADVERTISING EXPENSE

 

Advertising costs are expensed as incurred. Productioncosts for advertising are expensed the first time the related advertisementtakes place.  Advertising expense wasapproximately $23.1 million, $8.1 million and $6.4 million for the years endedDecember 31, 2000, 2001 and 2002 respectively.

 

(r) INCOME TAXES

 

The Company recognizes income taxes using the assetand liability method, in accordance with SFAS No. 109.  Under the asset and liability method,deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases.  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 atax rate change on deferred tax assets and liabilities is recognized in incomein the period that includes the enactment date.

 

(s) USE OF ESTIMATES

 

The preparation of consolidated financial statementsin conformity with generally accepted accounting principles requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at thedates of the consolidated financial statements and the reported amounts ofrevenue and expenses during the reporting period.  Actual results could differ from those estimates.  Estimates are used in accounting for, amongother things, long-term contracts, allowances for uncollectible receivables,inventory obsolescence, recoverability of long-lived assets and investments,depreciation and amortization, employee benefits, restructuring accruals, taxesand contingencies.  Estimates andassumptions are reviewed periodically and the effects of revisions arereflected in the consolidated financial statements in the period they aredetermined to be necessary.

 

(t) OTHER COMPREHENSIVE LOSS

 

Comprehensive income, as defined, includes changes inequity of a business during a period from transactions and other events andcircumstances from non-owner sources. Other comprehensive income refers to revenue, expenses, gains and lossesthat under generally accepted accounting principles are included incomprehensive income, but excluded from net income.

 

For the years ended December 31, 2000, 2001 and 2002, othercomprehensive income (loss) consists of unrealized gains (losses) oninvestments available for sale and foreign currency translation gains (losses).

 

(u) FOREIGN CURRENCY TRANSLATION

 

For operations outside the U.S. that prepare financialstatements in currencies other than the U.S. dollar, results of operations andcash flows are translated at average exchange rates during the period, andassets and liabilities are translated at end-of-period exchange rates.  Translation adjustments are included as aseparate component of accumulated other comprehensive income (loss) instockholders’ equity.

 

(v) EARNINGS PER SHARE

 

The Company computes net income (loss) per share inaccordance with SFAS No. 128, “Earnings Per Share,” and SEC Staff AccountingBulletin No. 98 (SAB 98).  Under theprovisions of SFAS No. 128 and SAB 98, basic net income (loss) per share iscomputed by dividing net income (loss) available to common stockholders for theperiod by the weighted average number of common shares outstanding during theperiod.  Diluted net income (loss) pershare is computed by dividing the net income (loss) for the period by theweighted average number of common and dilutive common equivalent sharesoutstanding during the period.  As theCompany has had a net loss in each of the periods presented, basic and dilutednet loss per share are the same.

 

(w) RECENT ACCOUNTING PRONOUNCEMENTS

 

(i) SFAS No. 145

 

In April of 2002, theFASB issued SFAS No. 145, “ Rescission of FASB Statements No. 4, 44, and 64,Amendment of FASB Statement No. 13, and Technical Corrections.”  SFAS No. 145 rescinds FASB No. 4 and 64 inrelation to reporting gains and losses from extinguishment of debt.  The Statement amends SFAS No. 4 and 64 andrequires gains and losses from extinguishment of debt to be classified asextraordinary items only if they meet the criteria in Opinion 30.  Applying the provisions of Opinion 30 willdifferentiate between normal recurring operations of a company and transactionsthat are unusual or infrequent in nature. SFAS No. 145 also amends Statement No. 13, to the effect thatsale-leaseback accounting for certain lease modifications should be accountedfor in the same manner as sale-leaseback transactions.  In connection with the adoption of thisstatement, the Company will be required to classify as operating income gainsfrom the extinguishment of debt of $7.7 million and $42.8 million

 

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for the years endedDecember 31, 2001 and 2002, respectively. Such amounts are currently recorded as extraordinary items in theaccompanying consolidated statements of operations.

 

(ii) SFAS No. 146

 

In June of 2002, the FASB issued SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities.”  SFAS No. 146 requires that a liability for acost associated with an exit or disposal activity be recognized when incurredat fair value.  The Statement in turneliminates the definition and requirements of EITF Issue 94-3.  SFAS No. 146 is effective for exit ordisposal activities that are initiated after December 31, 2002.  The adoption of SFAS No. 146 may have aneffect on the timing of future restructuring charges taken, if and when theyoccur.

 

(iii) SFAS No. 148

 

In December 2002, the FASB issued Statement No. 148 “Accountingfor Stock-Based Compensation – Transition and Disclosure – an amendment of FASBStatement No. 123”.  The Statement iseffective for fiscal years ended after December 15, 2002.  SFAS No. 148 requires new disclosures aboutthe effect of stock-based employee compensation on reported results.  The Statement requires that effects bedisclosed more prominently by specifying the form, content and location ofthose disclosures.  SFAS No. 148 permitsseveral ways of transitioning to the Fair Value method of accounting forstock-based compensation, however the Statement does not require that companiesdiscontinue the intrinsic value method of accounting for stock-basedcompensation.  The Company will continueto use the intrinsic value method of accounting for stock-based compensationand has adopted the disclosure requirements of Statement.

 

(iv) Financial Interpretation No. 45

 

In November of 2002, the FASB issued FASBInterpretation No. 45, “Guarantors Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others.”  Interpretation No. 45 discusses thenecessary disclosures to be made by a guarantor in its financial statementsabout its obligations under certain guarantees that it has issued.  It also discusses that the guarantor mustrecognize a liability, at fair value, at the inception of the guarantee theobligation incurred in issuing the guarantee. The disclosure requirements are effective for 2002.  The reporting requirements are effective ona prospective basis for guarantees issued after December 31, 2002.

 

The Company has certain guaranteesdisclosable under FIN 45 as follows:

 

•                  The Company has guaranteed the payment of subleaserentals to our Landlord on several properties the Company sublet.  The maximum guarantee on these properties is$ 2.7 million.

•                  In the Company’s Mobile Government Segment, the Company may have to pay liquidateddamages in some cases if the Company’s sub-contractors do not perform on time. In addition, the Companysometimes indemnifies certain of its customers against damages, if any, theymight incur as a result of a claim brought against them related to third partysoftware imbedded in the Company’s products. The Company is unable to estimate the maximum exposure of such indemnificationsdue to the inherent uncertainty and the varying nature of the contractualterms.

 

The following table provides thechanges in the Company’s product warranties:

 
|                                                                          |   |   | **2002** |   |
|-------------------------------------------------------------------------------|--------|--------|----------|--------|
| Warranty  liability balance at January 1, 2002                                |   | $      | 1,943    |   |
| Liabilities  accrued for warranties issued during the period                  |   | 493    |     |
| Warranty  claims paid during the period                                       |   | (490   | )        |
| Changes  in liability for warranties during the period, including expirations |   | (1,158 | )        |
| Warranty  liability balance at December 31, 2002                              |   | $      | 788      |   |

 

(v) EITF 00-21

 

In November, 2002 the Emerging Issues Task Forceissued its final consensus on Revenue Arrangements with MultipleDeliverables.  This guidance iseffective for revenue arrangements entered into in fiscal periods beginningafter June 15, 2003 or alternatively, entities may elect to report the changein accounting as a cumulative-effect adjustment.  EITF 00-21 discusses criteria necessary to determine when anarrangement may be viewed to have separate units of accounting (and thusrevenue) and when an arrangement should be viewed as a single unit ofaccounting.  The Company is currentlyperforming an analysis of how this might affect revenue recognition forarrangements the Company routinely enters into that have multiple deliverables.

 

(vi) Financial Interpretation No.46

 

In January 2003, the FASB issued Interpretation No.46, "Consolidation of Variable Interest Entities, an interpretation of ARBNo. 51. "This interpretation addresses the consolidation by businessenterprises of variable interest entities as defined in theInterpretation.  The interpretationapplies immediately to variable interests in variable interest entities createdafter January 31, 2003, and to variable interests in variable interest entitiesobtained after January 31, 2003.  TheInterpretation is applied to the enterprise no later than the end of the firstannual reporting period beginning after June 15, 2003.  The application of this Interpretation isnot expected to have a material effect on the Company's financial statements.  The Interpretation requires certaindisclosures in financial statements issued after January 31, 2003 if it is reasonably possible that theCompany will consolidate or disclose information about variable interestentities when the Interpretation becomes effective.

 

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# **NOTE (5)  ACQUISITIONS**

 

(a)          ALLOCATIONOF PURCHASE PRICE

 

On March 15, 2002,the Company acquired certain assets and licenses from @Track. @Track is aleading provider of wireless-based vehicle fleet management and intelligentmobile-asset-tracking solutions.  Thepurchase consideration (excluding approximately $800,000 of purchase relatedexpenses) was $15.0 million consisting of $3.0 million in cash and a $12.0million note payable.  The note wasinterest bearing at 5.75% and was paid in equal monthly cash installments fromMay 2002 through July 2002.  Thisacquisition has been accounted for under the purchase method of accounting and,accordingly, the assets acquired and liabilities assumed have been recorded attheir estimated fair value as of the acquisition date.  The allocation of the purchase price forthis acquisition, which was determined based on a third party appraisal, issummarized as follows:

 
|                     |   | **2002**                   |   |
|--------------------------|--------|----------------------------|--------|
|                     |   | **(AMOUNTS IN THOUSANDS)** |   |
| Current assets           |   | $                          | 1,153  |   |
| Property and equipment   |   | 636                        |   |
| Identifiable intangibles |   | 2,815                      |   |
| Goodwill                 |   | 11,196                     |   |
| Total consideration      |   | $                          | 15,800 |   |

 

(b) PRO-FORMA RESULTS

 

The following summary,prepared on a pro forma basis, presents the results of the Company’s operations(unaudited) as if the @Track asset purchase had been completed as of January 1,2001:

 
|                                        |   | **Years Ended December 31,** |     |
|---------------------------------------------|--------|------------------------------|----------|
| **(IN THOUSANDS, EXCEPT PER SHARE DATA)**   |   | **2002**                     |     | **2001** |   |
|                                        |   | **(UNAUDITED)**              |     | **(UNAUDITED)** |   |
| Revenue                                     |   | $                            | 122,830  |   | $ | 143,872 |   |
| Net loss                                    |   | $                            | (324,540 | ) | $ | (1,652,720 | ) |
|                                        |   |                         |     |   |   |
| Net loss per share — basic and diluted |   | $                            | (7.71    | ) | $ | (40.58 | ) |

 

The unaudited pro forma results of operations are notnecessarily indicative of what actually would have occurred if the @Track assetpurchase had taken place as of January 1, 2001, nor are they a projection ofthe Company’s results of operations for any future period.

 

(c) 2000 AND PRIOR ACQUISITIONS

 

Through December 31, 2001, the Company recordedapproximately $1.718 billion in goodwill and other intangibles related to itsacquisitions.  During 2000 and 2001 theCompany performed on-going analysis of the recoverability of its goodwill andother intangibles and the value of its investments in accordance with SFAS No.121, “Accounting for the Impairment of Long-Lived Assets and For Long-LivedAssets to be Disposed Of.”  Based onquantitative and qualitative measures, the Company assessed the need to recordimpairment losses on long-lived assets used in operations when impairmentindicators were present.

 

Based on a variety of indicators, the Companydetermined during 2001 that the goodwill and other intangibles from itsacquisitions may have had become impaired. In accordance with SFAS No. 121, theCompany performed undiscounted cash flow analyses of its acquisitions todetermine whether any impairments existed. When the undiscounted cash flowswere less than the carrying value of the related assets, the Company determineda range of fair values using a combination of valuation methodologies includingi.) discounted cash flow analysis, which is based upon converting expectedfuture cash flows to present value, ii.) changes in market value since the dateof acquisition relative to other companies and indexes.

 

As a result of this review, the Company determinedthat the carrying value of goodwill and certain other intangible assets relatedto its acquisitions were not fully recoverable.  Accordingly, during 2001, the Company recorded impairment chargesof approximately $1.121 billion, which represents the difference between thecarrying value and fair value of the goodwill and other intangible assets.  Of the $1.121 billion, $775 million relatedto the acquisition of Riverbed Technologies, Inc. in March 2000.

 

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See Note 4 above for a discussion of more recentimpairments under SFAS No. 142 and SFAS No. 144.

 

(d) ACQUIRED INTANGIBLES

 

All of the Company’s identifiable intangibles arebeing amortized between two and seven years and goodwill was being amortized betweenthree and seven years. On January 1, 2002 the Company discontinued theamortization of goodwill due to its implementation of SFAS No. 142.

 

Intangible assets consists of the following (amountsin thousands):

 
|                                              |   | **ESTIMATED  USEFUL LIVES** |   | **DECEMBER 31,  2001** |    | **DECEMBER 31,  2002** |   |
|---------------------------------------------------|--------|-----------------------------|--------|------------------------|---------|------------------------|--------|
| Goodwill                                          |   | 3 – 7 Years            |   | $                      | 490,851 |                   | $      | 25,369 |   |
| Completed technology                              |   | 3 – 7 Years            |   | 68,577                 |    | 15,034                 |   |
| Trademarks                                        |   | 5 – 7 Years            |   | 4,302                  |    | 2,342                  |   |
| Acquired subscribers                              |   | 3 – 7 Years            |   | 6,400                  |    | 2,803                  |   |
| Other non-acquisition intangibles                 |   | 3 – 5 Years            |   | 12,779                 |    | 509                    |   |
| Total intangible assets                           |   |                        |   | 582,909                |    | 46,057                 |   |
| Less accumulated amortization                     |   |                        |   | (356,135               | )       | (5,661                 | )      |
|                                              |   |                        |   |                   |    |                   |   |
| Intangible assets net of accumulated amortization |   |                        |   | $                      | 226,774 |                   | $      | 40,396 |   |

 

**NOTE (6)INVESTMENTS**

 

Through December 31, 2001, the Company madeinvestments in other businesses totaling approximately $196.8 million.  The Company adjusts the carrying value ofits available-for-sale investments and equity method investments in publiccompanies to market and record the change in market value to othercomprehensive income.  In accordancewith SAB 59, “Accounting for Noncurrent Marketable Equity Securities”, theCompany assesses the decline in market value in certain of its public companyinvestments as other than temporary after reviewing the following factors:length of time and extent to which the market value of the investment has beenbelow cost, the financial position and the near-term prospects of the issuer,and the Company’s intent and ability to retain its investment in the investeefor a period of time sufficient to allow for any anticipated recovery in marketvalue.

 

With respect to investments in private companiesincluding those the Company accounts for using the equity method, the Companyperforms on-going reviews based on quantitative and qualitative measures.  In evaluating the Company’s private companyinvestments, the Company determined a range of fair values based on acombination of valuation methods where applicable.  The Company determines fair value from the range of possiblevalues, after considering the strength of the investee’s financial position,future prospects and risk profile of the invested company.

 

During 2001, the Company recorded a net charge of$143.4 million which included $136.7 million in impairment charges related toits investments.  The remainder of thenet charge related to net gains (losses) from the sales of investments, andchanges in the fair value of warrants. During 2002, the Company recorded a net charge of $14.4 million whichincluded $14.1 million in impairment charges related to our investments.  The remainder of the charge related to netgains (losses) from the sales of investments, and changes in the fair value ofwarrants.

 

**NOTE (7)RESTRUCTURING CHARGES**

 

During each of the lastthree quarters in 2001, the Company had restructuring charges totaling $45.0million.  The Company implemented anexpense reduction plan as part of the Company’s integration strategy focused onimproving operational efficiencies and the implementation of other measuresintended to reduce planned expenses. These efforts have resulted in the consolidation of excess facilitiesand a reduction in the Company’s work force. The charges related mainly to a workforce reduction of over 480positions and the closing or consolidation of twelve facilities. Employeeseparation benefits under the restructuring plan include severance, medical,and other benefits.  Facility closurecosts included expected losses on subleases, brokerage commissions, assetimpairment charges, contract termination costs and other costs.

 

During 2002, the Companycontinued its expense reduction plan focused on improving operationalefficiencies and the implementation of other measures in order to reduceplanned expenses.  These efforts haveresulted in the further consolidation of excess facilities and elimination ofpositions.  As a result of thisrestructuring plan, the Company recorded charges to earnings during 2002 of$37.7 million.  The charge related

 

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mainly to a workforcereduction of over 353 positions and the closing or consolidation of fourfacilities.  Employee separationbenefits of $5.6 million under the restructuring plan include severance,medical, and other benefits.  Facilityclosure and other costs of $32.1 million include expected losses on subleases,brokerage commissions, asset impairment charges, and other costs.  As of December 31, 2002, the accruedliability balance related to the restructuring was $32.5 million.

 

Calculation of therestructuring accrual related to expected losses on subleases requires theCompany to make estimates concerning: (1) the expected length of time tosublease the facility; (2) the expected rental rates on subleases; and, (3)estimated brokerage expenses associated with executing the sublease.  The Company used the assistance ofindependent real estate brokerage firms in developing these estimates and theCompany’s estimates may be impacted by future economic trends.  The expected losses on subleases have notbeen discounted. In addition, the Company has entered into negotiations withcertain of its landlords to terminate the leases for a one-time payment whichmay impact the amount and timing of the restructuring charge.  If the actual results differ from theCompany’s estimates, or as management’s best estimates change from quarter toquarter, based on the latest information, the Company is required to adjust itsrestructuring accrual related to facilities, including recording additionallosses.  These changes in assumptionsare reflected in the table below as adjustments.

 

A rollforward of therestructuring accrual is as follows:

 
|                                                            |   | **Employee  Separation  Benefits** |   | **Facility  Closure  Costs and Other** |   | **Total** |   |
|-----------------------------------------------------------------|--------|------------------------------------|--------|----------------------------------------|--------|-----------|--------|
| **2001 Restructuring:**                                         |   |                               |   |                                   |   |      |   |
| Second  quarter                                                 |   | $                                  | 4,870  |                                   | $      | 10,989    |   | $ | 15,859 |   |
| Third  quarter                                                  |   | 4,070                              |   | 14,528                                 |   | 18,598    |   |
| Adjustments  made during the third quarter                      |   | (147                               | )      | (220                                   | )      | (367      | )      |
| Fourth  quarter                                                 |   | 1,435                              |   | 6,386                                  |   | 7,821     |   |
| Adjustments  made during the fourth quarter                     |   | —                             |   | 3,095                                  |   | 3,095     |   |
| Total  restructuring charge for period ending December 31, 2001 |   | $                                  | 10,228 |                                   | $      | 34,778    |   | $ | 45,006 |   |
| Second  quarter reclassification from acquisition accounts      |   | —                             |   | 1,643                                  |   | 1,643     |   |
| Cash  payments                                                  |   | (8,626                             | )      | (10,206                                | )      | (18,832   | )      |
| Restructuring  liability as of December 31, 2001                |   | $                                  | 1,602  |                                   | $      | 26,215    |   | $ | 27,817 |   |
|                                                            |   |                               |   |                                   |   |      |   |
| **2002 Restructuring:**                                         |   |                               |   |                                   |   |      |   |
| First  quarter                                                  |   | $                                  | 2,690  |                                   | $      | 6,491     |   | $ | 9,181 |   |
| Adjustments  made during the first quarter                      |   | 941                                |   | 2,434                                  |   | 3,375     |   |
| Second  quarter                                                 |   | 110                                |   | 2,348                                  |   | 2,458     |   |
| Adjustments  made during the second quarter                     |   | (27                                | )      | 594                                    |   | 567       |   |
| Third  quarter                                                  |   | 587                                |   | 6,522                                  |   | 7,109     |   |
| Adjustments  made during the third quarter                      |   | —                             |   | 1,335                                  |   | 1,335     |   |
| Fourth  quarter                                                 |   | 1,280                              |   | 8,651                                  |   | 9,931     |   |
| Adjustments  made during the fourth quarter                     |   | 21                                 |   | 3,767                                  |   | 3,788     |   |
| Total  restructuring charge for period ending December 31, 2002 |   | $                                  | 5,602  |                                   | $      | 32,142    |   | $ | 37,744 |   |
| Second  quarter reclassification from other accruals            |   | —                             |   | 774                                    |   | 774       |   |
| Third  quarter non-cash charges                                 |   | —                             |   | (6,522                                 | )      | (6,522    | )      |
| Fourth  quarter non-cash charges                                |   | —                             |   | 1,903                                  |   | 1,903     |   |
| Cash  payments                                                  |   | (6,781                             | )      | (22,483                                | )      | (29,264   | )      |
| Total  restructuring liability as of December 31, 2002          |   | $                                  | 423    |                                   | $      | 32,029    |   | $ | 32,452 |   |

 

**NOTE(8)  RELATED PARTY TRANSACTIONS**

 

(a) AOL

 

The Company entered into a series of agreements (the “Agreements”) withAmerica Online, Inc. (“AOL”) in November 2001.  The agreements included a product development and licensingagreement, a media agreement, and a common stock purchase agreement.  On November 4, 2002, the Company, AOLand AOL Time Warner Inc. (“AOLTW” and, collectively with AOL, the “AOLParties”) entered into a Settlement Agreement and Mutual Release (the“Settlement Agreement”) pursuant to which the Company and the AOL Partiesagreed to terminate all of the Agreements with the exception of a StockPurchase Agreement.  The Stock PurchaseAgreement will remain in effect to govern the 737,790 shares of the Company’sstock purchased by AOL on December 3, 2001 but was modified by theSettlement Agreement so as not to require future investment in the Company byAOL. In connection with the termination of the other Agreements, the SettlementAgreement also provides for the release to the Company of approximately$5.3 million that the Company had previously deposited in an escrowaccount under the terms of the Agreements. The parties have agreed that no other amounts are due or owing to anyparty.  Pursuant to this settlement theCompany took a charge of approximately $6.5 million to write off certain AOLrelated intangible assets.  Such amounthas been recorded in the restructuring charge for the year ended December 31,2002.

 

57

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(b) ADDITIONAL RELATEDPARTY INFORMATION

 

In the ordinary course ofbusiness, the Company has entered into sales arrangements with entities inwhich the Company has equity interests or entities that have an equity interestin the Company.  For the years endedDecember 31, 2000, 2001 and 2002, the Company recorded revenue from theserelated parties aggregating approximately $10.5 million, $11.4 million and $1.6million, respectively.  As of December31, 2001 and 2002, the Company had gross accounts receivable from these relatedentities aggregating approximately $1.8 million and $200,000, respectively.

 

During the years 2000, 2001, and 2002, the Company received services fromstockholders and other related entities including Reuters (financial dataservices), Huber Oros (benefit coordination services) and AOL Time Warner(advertising services).  These companiesare considered related parties due to the fact that they are significantstockholders or entities with familial relationships with members of the seniormanagement of the Company or with significant shareholders of the Company. Forthe year ended December 31, 2002, related party expense was $5.3 million, themajority of which related to advertising services purchased.  For the years ended December 31, 2000 and2001, related party expenses were $5.7 million and $2.2 million respectively.

 

**NOTE(9)  SEGMENT INFORMATION**

 

(a) SEGMENTS

 

The Company’s operating segments include EnterpriseMobility Solutions, Transportation, and Mobile Government.

 

The Enterprise Mobility Solutions (EMS) Segment is focused onproviding integrated wireless data solutions to enterprises with product developmentemphasis on field service, sales force automation, distribution and deliverymanagement, and mail and messaging access.

 

In the Company’sTransportation Segment, its main products are MobileMaxTM, a vehicle locationand messaging solution for long-haul trucks, and a number of asset monitoringproducts, including GeoLogicTM, TrailerMaxTM and 20/20vTM.  The MobileMAXTM product allows transportationcompanies to have access to least-cost-routing capability of multi-modetechnology (terrestrial and satellite connectivity) to deliver two-way data anddispatch messaging and automatic, instantly communicated information on eachvehicle - most typically trucks.

 

Inthe Mobile Government Segment, the Company is a service provider in the area ofwireless  data solutions for publicsafety. The Company has products for both law enforcement and asset tracking.The Company’s public safety solutions are integrated into 47 different statedatabases as well as local and federal databases to deliver real-timeinformation in seconds without having to involve dispatch or otherresources.  The Company’s products inthis area are the PacketCluster family of products, the handheld version ofPacketCluster Patrol called PocketBlue, the FireRMS family of products for fireand rescue companies, and the handheld application for this community,PocketRescue.

 

Corporate and Other consists mainly of corporateassets.  The Company does not allocatecorporate assets to the Segments for internal reporting purposes.

 

The Company began to report its financial results bySegment as of the first quarter of 2000. During 2000, 2001 and 2002, theCompany’s reportable Segments have changed — and the Company expects them tocontinue to change — as its operating structure, business and the market in whichit operates evolves.  As the Company didnot report based on these segments last year, it is impracticable for theCompany to compare this year’s results to the results of last year’s.

 

Segment detail is summarized as follows:

 

| **YEAR ENDED  DECEMBER 31, 2002** |   | **Enterprise****Mobilility  Solutions** |   | **Transportation** |   | **Mobile  Government** |   | **Corporate  & Other** |   | **Total** |   |
|-----------------------------------|--------|-----------------------------------------|--------|--------------------|--------|------------------------|--------|----------------------------|--------|-----------|--------|
| Revenue                           |   | $                                       | 54,894 |               | $      | 41,147                 |   | $                          | 20,490 |      | $      | 0 |   | $ | 116,531 |   |
| Gross Profit (loss)               |   | $                                       | 18,300 |               | $      | 17,478                 |   | $                          | 13,533 |      | $      | 0 |   | $ | 49,311 |   |
| Total Assets                      |   | $                                       | 0      |               | $      | 0                      |   | $                          | 0      |      | $      | 473,409 |   | $ | 473,409 |   |
|                                   |        |                                         |        |                    |        |                        |        |                            |        |           |        |  |  |  |  |  |  |  |  |

 

(b) GEOGRAPHICAL REGIONS

 

The Company derives revenue primarily from the UnitedStates and Europe.  Informationregarding the Company’s revenues and long-lived assets in different geographicregions is as follows:

 

58

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|              |   | **TWELVE MONTHS ENDED  DECEMBER 31,** |    |
|-------------------|--------|---------------------------------------|---------|
|              |   | **2001**                              |    | **2002** |   |
| Revenue:          |   |                                  |    |   |   |
| U.S               |   | $                                     | 95,697  |   | $ | 107,103 |   |
| Aggregate Foreign |   | 17,183                                |    | 9,428 |   |
|              |   | $                                     | 112,880 |   | $ | 116,536 |   |
| Long-Lived Assets |   |                                  |    |   |   |
| U.S               |   | $                                     | 341,441 |   | $ | 82,898 |   |
| Aggregate Foreign |   | 11,811                                |    | 733 |   |
|              |   | $                                     | 353,525 |   | $ | 83,631 |   |

 

**NOTE (10) PROPERTY AND EQUIPMENT**

 

Property and equipment consists of the following (inthousands):

 
|                                        |   |                        |   | **DECEMBER  31,** |   |
|---------------------------------------------|--------|-----------------------------|--------|-------------------|--------|
|                                        |   | **ESTIMATED  USEFUL LIVES** |   | **2001**          |   | **2002** |   |
| Furniture and fixtures                      |   | 7 Years                     |   | $                 | 2,886  |   | $ | 2,786 |   |
| Computer and equipment                      |   | 3 – 10 Years           |   | 22,208            |   | 20,319 |   |
| Software                                    |   | 3 Years                     |   | 20,964            |   | 22,654 |   |
| Leasehold improvements                      |   | Term of Lease               |   | 8,687             |   | 6,913 |   |
| Airplane                                    |   | 10 Years                    |   | 11,765            |   | — | (1) |
| Network operations centers                  |   | 3 Years                     |   | 24,580            |   | 24,292 |   |
| Construction in progress                    |   | —                      |   | 2,822             |   | — |   |
| Total property and equipment                |   |                        |   | $                 | 93,912 |   | $ | 76,964 |   |
| Less depreciation                           |   |                        |   | (32,608           | )      | (57,663 | ) |
| Property and equipment net of  depreciation |   |                        |   | $                 | 61,304 |   | $ | 19,301 |   |

 

----

(1) In 2002, this asset was reclassified as assetsheld for sale in accordance with SFAS No. 144.

 

**NOTE (11) DEBT**

 

Notespayable at December 31, 2001 and 2002 consists of $290.5 million, and $154.9million of 6% convertible subordinated notes (the Notes) due in 2005.  During 2002, the Company bought back $135.6million of outstanding Notes and recognized an extraordinary gain of $42.8million on the early extinguishment of debt. During 2001, the Company bought back $20.0 million of the outstandingNotes and recognized an extraordinary gain of $7.7 million on the earlyextinguishment of debt.

 

Also included in notes payable at December 31, 2001 is$10.3 million of notes payable to certain former shareholders of SynamicLimited. Synamic Limited was acquired by Sila, a majority owned subsidiary ofthe Company, in August 2000.  The Notewas payable between August 15, 2002 and August 15, 2003 at the formershareholders’ discretion and bore interest at a rate of 6.15% through April 15,2001, at which time the rate was adjusted to 5.9%.  On August 15, 2002, the Company paid this obligation in full.

 

The aggregate maturities of debt for each of the fiveyears subsequent to December 31, 2002 are as follows (amounts in thousands):

 

59

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| 2003       |   | $       | 4       |   |
|------------|--------|---------|---------|--------|
| 2004       |   | 17      |    |
| 2005       |   | 154,925 |    |
| 2006       |   | —  |    |
| Thereafter |   | —  |    |
|       |   | $       | 154,946 |   |

 

##### **NOTE (12) INCOME TAXES**

 

The Company has provided no current income taxes dueto the losses incurred in all periods. The income tax benefit for 2000 and 2001 consists primarily of a foreigndeferred tax benefit associated with the amortization of identifiableintangible assets acquired by Sila.  Theincome tax benefit for 2002 primarily relates to refunds received from thecarryback of federal net operating losses to prior tax years.

 

A reconciliation of the statutory Federal income taxrate and the effective income tax rate for the year ended December 31, 2000,2001 and 2002 follows:

 
|                                             |   | **2000** |   | **2001**   |   | **2002** |   |
|--------------------------------------------------|--------|----------|--------|------------|--------|----------|--------|
| Statutory Federal income tax rate                |   | (35.0    | )%     | (35.0      | )%     | (35.0    | )%     |
| Effect of:                                       |   |     |   |       |   |     |   |
| Nondeductible goodwill   amortization/impairment |   | 18.9     |   | 21.2       |   | 13.9     |   |
| Foreign                                          |   | 1.1      |   | 1.9        |   | 0.4      |   |
| Other                                            |   | (1.0     | )      | 0.2        |   | (0.4     | )      |
| Valuation allowance                              |   | 15.6     |   | 11.1       |   | 20.9     |   |
| Effective income tax rate                        |   | (0.4     | )%     | (0.6  | )%     | (0.2     | )%     |

 

The tax effects of temporary differences that giverise to significant portions of the deferred tax assets and liabilities atDecember 31, 2001 and 2002, are presented below (amounts in thousands):

 
|                                         |   | **DECEMBER  31, 2001** |    | **DECEMBER  31, 2002** |   |
|----------------------------------------------|--------|------------------------|---------|------------------------|--------|
| Deferred tax assets:                         |   |                   |    |                   |   |
| Net operating loss carryforwards             |   | $                      | 232,755 |                   | $      | 268,011 |   |
| Investments                                  |   | 53,359                 |    | 39,965                 |   |
| Capital loss carryforwards                   |   | 14,213                 |    | 31,612                 |   |
| Stock related compensation                   |   | 4,998                  |    | 6,535                  |   |
| Allowance for doubtful accounts              |   | 4,321                  |    | 3,180                  |   |
| Accrued compensation                         |   | 4,036                  |    | 2,037                  |   |
| Reserves and other                           |   | 16,259                 |    | 22,935                 |   |
| Depreciation and amortization                |   | —                 |    | 6,574                  |   |
| Intangibles                                  |   | —                 |    | 23,781                 |   |
| Tax credit carryforwards                     |   | 3,337                  |    | 5,946                  |   |
| Gross deferred tax assets                    |   | $                      | 333,278 |                   | $      | 410,576 |   |
| Valuation allowance for deferred tax  assets |   | (331,729               | )       | (410,576               | )      |
| Net deferred tax assets                      |   | $                      | 1,549   |                   | $      | — |   |
|                                         |   |                   |    |                   |   |
| Deferred tax liabilities:                    |   |                   |    |                   |   |
| Depreciation and amortization                |   | $                      | 506     |                   | $      | — |   |
| Intangibles                                  |   | 1,043                  |    | —                 |   |
| Net deferred tax liabilities                 |   | $                      | 1,549   |                   | $      | — |   |
| Deferred income tax liability, net           |   | $                      | —  |                   | $      | — |   |

 

60

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The net change in the valuation allowance for deferredtax assets was an increase of $226.1 million in 2001 and $78.9 million in2002.  The increase in 2002 consists ofan increase of $78.9 million related to continuing operations.  The increase in 2001 consists of an increaseof $219.6 million related to continuing operations and an increase of $6.5million related to amounts booked directly to stockholders’ equity.

 

In addressing the realizability of deferred taxassets, management considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized.  The ultimate realization of deferred taxassets is dependent on the generation of future taxable income during theperiods in which those temporary differences become deductible.  Management considers the scheduled reversalof deferred tax liabilities, projected future taxable income and tax planning strategiesin making this assessment.  Based uponthe level of historical taxable income and projected future taxable income overthe periods in which the deferred tax assets are deductible, management hasdetermined that a valuation allowance of $331.7 million and $410.6 million isrequired as of December 31, 2001 and 2002, respectively.

 

As of December 31, 2002, the Company had Federal andState net operating loss carryforwards of approximately $638.8 million thatexpire between 2012 and 2022.  Inaddition, the Company has capital loss carryforwards of approximately $90.3million that expire between 2006 and 2007. As a result of changes in common stock ownership, the future realizationof net operating loss carryforwards, capital loss carryforwards and certainother tax credits may be limited.

 

**NOTE (13) PENSION PLANS**

 

The Company has two defined contribution plans underSection 401(k) of the Internal Revenue Code that provide for voluntary employeecontributions of 1 to 15 percent of compensation for substantially allemployees.  The Company contributed$636,000, $2.2 million and $1.4 million to the plans for the years endedDecember 31, 2000, 2001 and 2002, respectively.

 

**NOTE (14) STOCK OPTIONS AND WARRANTS**

 

In 1996, the Company adopted a Unit Option Plan. InSeptember 1999, the Company adopted the 1999 Equity Incentive Plan (the Plan)to replace the Unit Option Plan.  Underthe Plan, the Company has the ability to grant options to acquire up to 20% ofthe outstanding shares of common stock to its employees, directors, and serviceproviders.  Options under the Plangenerally expire after ten years and normally vest over a period of up to fouryears.  Options are generally granted atan exercise price equal to the fair value on the grant date. Effective December15, 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 togrant options to acquire up to an additional 5% of the outstanding shares ofcommon 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 aregenerally granted at an exercise price equal to the fair value of the commonstock on the grant date.

 

In January 2001, the Company’s employees were offeredthe right to exchange existing options for shares of restricted stock.  In total, 567 employees agreed to have theiroptions canceled in exchange for approximately 756,000 shares of restrictedstock.  The Company recorded expense of **$**5.9 million and $2.7 million related tothis stock during 2001 and 2002 respectively, and expects to record up to $2.8million of expense over the next 2****yearsassociated with the issuance of the restricted stock.

 

The per share weighted-average value of optionsgranted by the Company during 2000, 2001 and 2002 was $113.35, $7.11 and $2.22,respectively, on the date of grant using the Black-Scholes option-pricingmodel.  The 2000 and 2001 calculationsused an expected option life of four years and volatility of 70 percent.  The amounts calculated for 2002 were basedon an expected option life of five years and volatility of 70 percent.  In addition, the calculations assumed arisk-free interest rate of 5.08 percent to 6.38 percent in 2000, 3.70 percentto 4.71 percent in 2001 and 4.95 percent to 5.09 percent in 2002.  A summary of the stock option activity is asfollows:

 

61

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|                                            |   | **2000**                                            |   | **2001**               |   | **2002**                                           |   |
|-------------------------------------------------|--------|-----------------------------------------------------|--------|------------------------|--------|----------------------------------------------------|--------|
|                                            |   | **WEIGHTED-  AVERAGE  EXERCISE  NUMBER  OF SHARES** |   | **PRICE  (PER SHARE)** |   | **WEIGHTED  AVERAGE  EXERCISE  NUMBER  OF SHARES** |   | **PRICE  (PER SHARE)** |   | **WEIGHTED  AVERAGE  EXERCISE  NUMBER  OF SHARES** |   | **PRICE  (PER SHARE)** |   |
|                                            |   | **(IN  THOUSANDS)**                                 |   |                   |   | **(IN  THOUSANDS)**                                |   |   |   | **(IN  THOUSANDS)** |   |   |   |
|                                            |   |                                                |   |                   |   |                                               |   |   |   |   |   |   |   |
| Stock options outstanding at beginning of  year |   | 3,933                                               |   | $                      | 4.48   |                                               | 6,957  |   | $ | 64.61 |   | 6,251 |   | $ | 19.22 |   |
|                                            |   |                                                |   |                   |   |                                               |   |   |   |   |   |   |   |
| Granted                                         |   | 4,982                                               |   | $                      | 91.69  |                                               | 3,825  |   | $ | 12.72 |   | 3,848 |   | $ | 3.01 |   |
|                                            |   |                                                |   |                   |   |                                               |   |   |   |   |   |   |   |
| Exercised                                       |   | (1,612                                              | )      | $                      | 3.01   |                                               | (529   | ) | $ | 2.47 |   | (481 | ) | $ | 1.31 |   |
|                                            |   |                                                |   |                   |   |                                               |   |   |   |   |   |   |   |
| Canceled                                        |   | (346                                                | )      | $                      | 56.40  |                                               | (4,002 | ) | $ | 92.83 |   | (2,539 | ) | $ | 19.57 |   |
| Outstanding at end of year                      |   | 6,957                                               |   | $                      | 64.61  |                                               | 6,251  |   | $ | 19.22 |   | 7,079 |   | $ | 9.91 |   |
|                                            |   |                                                |   |                   |   |                                               |   |   |   |   |   |   |   |
| Stock options exercisable at year-end           |   | 1,435                                               |   | $                      | 4.38   |                                               | 2,336  |   | $ | 9.31 |   | 2,282 |   | $ | 11.44 |   |

 

The following table summarizes information about stockoptions at December 31, 2002:

 
|                            |   | **OPTIONS  OUTSTANDING**           |   | **OPTIONS  EXERCISABLE**                          |   |
|---------------------------------|--------|------------------------------------|--------|---------------------------------------------------|--------|
| **RANGE OF  EXERCISE PRICES**   |   | **NUMBER  AT  DECEMBER 31,  2002** |   | **WEIGHTED-AVERAGE  REMAINING  CONTRACTUAL LIFE** |   | **WEIGHTED-AVERAGE  EXERCISE PRICE  (PER SHARE)** |   | **NUMBER  AT  DECEMBER 31,  2002** |   | **WEIGHTED-AVERAGE  EXERCISE PRICE  (PER SHARE)** |   |
|                            |   | **(IN  THOUSANDS)**                |   | **(IN  YEARS)**                                   |   |   |   | **(IN  THOUSANDS)** |   |   |   |
| Restricted Stock                |   | 684,255                            |   | 8.4                                               |   | $ | 0.00 |   | 0 |   | $ | 0.00 |   |
| $    0.24—$1.60  |   | 1,110,925                          |   | 5.7                                               |   | $ | 1.48 |   | 1,109,520 |   | $ | 1.48 |   |
| $    1.61—$4.80  |   | 3,065,856                          |   | 8.7                                               |   | $ | 3.39 |   | 367,409 |   | $ | 3.20 |   |
| $    4.81—$8.53  |   | 231,213                            |   | 7.3                                               |   | $ | 7.33 |   | 90,738 |   | $ | 7.92 |   |
| $    8.54—$34.75 |   | 1,509,683                          |   | 7.7                                               |   | $ | 12.84 |   | 489,219 |   | $ | 12.07 |   |
| $ 34.76—$75.38             |   | 347,033                            |   | 7.4                                               |   | $ | 66.20 |   | 169,690 |   | $ | 62.62 |   |
| $ 75.39—$92.00             |   | 63,600                             |   | 6.3                                               |   | $ | 83.25 |   | 25,464 |   | $ | 83.14 |   |
| $  92.01—$235.00           | 67,091 |                               | 5.0    |                                              | $      | 130.52 |   | 29,723 |   | $ | 131.86 |   |
|                            |   | 7,079,656                          |   | 7.8                                               |   | $ | 9.91 |   | 2,281,763 |   | $ | 11.44 |   |

 

**NOTE (15) COMMITMENTS ANDCONTINGENCIES**

 

(a) LEGAL PROCEEDINGS

 

Aetheris among the hundreds of defendants named in nine class action lawsuits seekingdamages on account of alleged violations of securities law.  The case is being heard in the United StatesDistrict Court for the Southern District of New York.  The court has consolidated the actions by all of the nameddefendants that actually issued the securities in question.  Now there are approximately 310 consolidatedcases before Judge Scheindlin, including the Aether Systems action, under thecaption In Re Initial Public Offerings Litigation, Master File 21 MC 92(SAS).

 

Theseactions were filed on behalf of persons and entities that acquired our commonstock after our initial public offering in October 20, 1999.  Among other things, the complaints claimthat prospectuses, dated October 20, 1999 and September 27, 2000 and issued byAether in connection with the public offerings of common stock, allegedlycontained untrue statements of material fact or omissions of material fact inviolation of securities laws because the prospectuses allegedly failed todisclose that the offerings’ underwriters had solicited and received additionaland excessive fees, commissions and benefits beyond those listed in thearrangements with certain of their customers which were designed to maintain,distort and/or inflate the market price of the Company’s common stock in theaftermarket.  The actions seek unspecifiedmonetary damages and rescission.  Aetherbelieves the claims are without merit and is vigorously contesting theseactions.

 

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 courtissued an Opinion and Order on defendants’ motions to dismiss, which grantedthe motions in part and denied the motions in part.  As to Aether Systems,the motion to dismiss the claims against it was denied in its entirety. Discovery is now commencing.  Because

 

62

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the litigation is at a very early stage, the Company is unable toassess the likelihood of an unfavorable outcome and can make no determinationas to the amount or range of potential loss, if any.

 

Aether is also a party to other legal proceedings in the normal course ofbusiness.  Based on evaluation of thesematters and discussions with counsel, the Company believes that liabilitiesarising from these matters will not have a material adverse effect on theconsolidated results of its operations or financial position.

 

(b) CONTRACTUAL COMMITMENTS

 

For fiscal year 2003, the Company has contractualcommitments of approximately $43.7 million primarily relating to RIM inventorypurchase commitments, EDS purchase commitments and Motient airtime purchasecommitments.  Although there can be noassurance, the Company believes that actual expenditures related to these itemsin 2003 will be less than $43.7 million due to reductions the Company iscurrently in the process of negotiating.

 

(c) LEASES

 

The Company is obligated under noncancelable operatingleases for office space that expire at various dates through 2010.  Future minimum lease payments undernoncancelable operating leases are approximately as follows: (in thousands)

 

|                         |   | **YEAR ENDING DECEMBER 31,** |   |
|------------------------------|--------|------------------------------|--------|
|                         |   | **Gross  Commitments**       |   | **Amounts  Receivable  Under Subleases** |   |
|                         |   |                         |   |   |   |
| 2003                         |   | $                            | 12,021 |   | $ | 56 |   |
| 2004                         |   | 10,894                       |   | 56 |   |
| 2005                         |   | 8,735                        |   | 5 |   |
| 2006                         |   | 8,109                        |   | — |   |
| 2007                         |   | 7,999                        |   | — |   |
| Thereafter                   |   | 23,635                       |   | — |   |
| Total minimum lease payments |   | $                            | 71,393 |   | $ | 117 |   |

 

Rent expense under operating leases was approximately$4.5 million, $13.7 million, and $ 6.6 million for the years ended December 31,2000, 2001 and 2002, respectively. Facilities representing approximately $61.3 million of the Company’sminimum lease payments have been subleased or are available for sublease.  There can be no assurance that the Companywill successfully sublease these facilities.

 

(d) LETTERS OF CREDIT

 

During the normal course ofoperations, the Company has also entered into various letter of creditagreements.  As of December 31, 2002 theCompany had outstanding $ 7.8 million in letters of credit which expire atvarious times over the next eight years.

 

 

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**NOTE (16) QUARTERLY FINANCIALINFORMATION (UNAUDITED)**

 
|                                                |   | **QUARTER  ENDED  MARCH 31,  2002** |   | **QUARTER  ENDED  JUNE 30,  2002** |   | **QUARTER  ENDED  SEPTEMBER 30,  2002** |   | **QUARTER  ENDED  DECEMBER 31,  2002** |   | **YEAR  ENDED  DECEMBER 31,  2002** |   |
|-----------------------------------------------------|--------|-------------------------------------|--------|------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|-------------------------------------|--------|
| Revenue                                             |   | $                                   | 23,672 |                               | $      | 31,618                                  |   | $                                      | 31,711 |                                | $      | 29,530 |   | $ | 116,531 |   |
| Gross profit                                        |   | 9,908                               |   | 13,314                             |   | 13,428                                  |   | 12,661                                 |   | 49,311                              |   |
| Net loss                                            |   | (55,634                             | )      | (19,455                            | )      | (226,212                                | )      | (24,121                                | )      | (325,422                            | )      |
| Net loss per common share — basic and  diluted |   | (1.32                               | )      | (0.46                              | )      | (5.37                                   | )      | (0.57                                  | )      | (7.73                               | )      |
|                                                     |        |                                     |        |                                    |        |                                         |        |                                        |        |                                     |        |  |  |  |  |  |

 
|                                                |   | **QUARTER  ENDED  MARCH 31,  2001** |   | **QUARTER  ENDED  JUNE 30,  2001** |   | **QUARTER  ENDED  SEPTEMBER 30,  2001** |   | **QUARTER  ENDED  DECEMBER 31,  2001** |   | **YEAR  ENDED  DECEMBER 31,  2001** |   |
|-----------------------------------------------------|--------|-------------------------------------|--------|------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|-------------------------------------|--------|
| Revenue                                             |   | $                                   | 30,659 |                               | $      | 32,084                                  |   | $                                      | 24,948 |                                | $      | 25,189 |   | $ | 112,880 |   |
| Gross profit (loss)                                 |   | 10,826                              |   | 13,484                             |   | (2,623                                  | )      | 10,439                                 |   | 32,126                              |   |
| Net loss                                            |   | (1,200,300                          | )      | (103,640                           | )      | (243,379                                | )      | (106,776                               | )      | (1,654,095                          | )      |
| Net loss per common share — basic and  diluted |   | (29.67                              | )      | (2.55                              | )      | (5.98                                   | )      | (2.59                                  | )      | (40.61                              | )      |
|                                                     |        |                                     |        |                                    |        |                                         |        |                                        |        |                                     |        |  |  |  |  |  |

 

**NOTE (17) SUBSEQUENT EVENTS**

 

On January 16, 2003, the Company signed severalagreements with Electronic Data Systems Corporation (EDS).  Under an alliance agreement, the companieswill jointly develop and market new solutions using the Company’s technology.  EDS plans to install a network to deliverwireless solutions connecting the Company with suppliers and clients using anEDS facility as the management hub. Additionally, under a separate managed services agreement, EDS willmanage the Company’s internal IT operations and customer care services for feesand specified costs.  As a result of themanaged services agreement, the Company will be transitioning itsresponsibility for monitoring its network operations to EDS.  Further, certain of the Company’s employeeswill become employees of EDS.

 

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**INDEPENDENTAUDITORS’ REPORT**

 

The Board of Directors

Aether Systems, Inc.:

 

Under date of February 4, 2003, we reported on theconsolidated balance sheets of Aether Systems, Inc. and subsidiaries as ofDecember 31, 2001 and 2002, and the related consolidated statements ofoperations and other comprehensive loss, stockholders’ equity, and cash flowsfor each of the years in the three-year period ended December 31, 2002, whichare included in this Annual Report on Form 10-K. We did not audit theconsolidated financial statements of Sila Communications Limited, amajority-owned subsidiary, as of December 31, 2001 and for the years endedDecember 31, 2000 and 2001, which statements reflect total assets constituting2.2% of the related consolidated total in 2001and total revenues constituting21.7% and 11.5% of the related consolidated totals in 2000 and 2001,respectively.  Those statements wereaudited by other auditors, whose report has been furnished to us, and ouropinion insofar as it relates to the amounts included for Sila CommunicationsLimited is based solely on the report of the other auditors.  In connection with our audits of theaforementioned consolidated financial statements, we also audited the relatedconsolidated financial statement schedule. This consolidated financial statement schedule is the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thisconsolidated financial statement schedule based on our audits.

 

In our opinion, based on our audits and the report ofthe other auditors, such consolidated financial statement schedule, whenconsidered in relation to the basic consolidated financial statements taken asa whole, presents fairly, in all material respects, the information set forththerein.

 
|   | */s/  KPMG LLP*     |   |
|--------|---------------------|--------|
|   |                |
|   | *McLean, Virginia*  |   |
|   | *February  4, 2003* |   |

 

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**SCHEDULE II**

**VALUATIONAND QUALIFYING ACCOUNTS**

**YEARSENDED DECEMBER 31, 2000, 2001 AND 2002**

(AMOUNTS IN THOUSANDS)

 
| **DESCRIPTION**                 |   | **BALANCE AT  BEGINNING OF YEAR** |   | **ACQUIRED  BALANCES** |   | **CHARGED TO COSTS  AND EXPENSES** |   | **CHARGED TO  OTHER ACCOUNTS** |   | **DEDUCTIONS** |   | **BALANCE AT  END OF YEAR** |   |
|---------------------------------|--------|-----------------------------------|--------|------------------------|--------|------------------------------------|--------|--------------------------------|--------|----------------|--------|-----------------------------|--------|
| 2000                            |   |                              |   |                   |   |                               |   |                           |   |           |   |                        |   |
| Allowance for doubtful accounts |   | $                                 | 56     |                   | $      | 4,478                              |   | $                              | 1,391  |           | $      | —                      |   | $ | 230 |   | $ | 5,695 |   |
| 2001                            |   |                              |   |                   |   |                               |   |                           |   |           |   |                        |   |
| Allowance for doubtful accounts |   | 5,695                             |   | —                 |   | 9,801                              |   | 4,363                          |   | 9,298          |   | 10,561                      |   |
| 2002                            |   |                              |   |                   |   |                               |   |                           |   |           |   |                        |   |
| Allowance for doubtful accounts |   | 10,561                            |   | —                 |   | 3,578                              |   | 517                            |   | 6,967          |   | 7,689                       |   |
|                                 |        |                                   |        |                        |        |                                    |        |                                |        |                |        |                             |        |  |  |  |  |  |  |

 

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