| AETHER HOLDINGS INC ITEM 1A RISK FACTORS Our business activities are subject to various important risks and uncertainties, including the following: Risks of our Current Business 1 |
| Increases in prepayment rate adversely affect us |
| The MBS we acquire are backed by pools of underlying mortgage loans |
| The payments we receive from our MBS are generally, payments by the mortgagors on the underlying mortgage loans |
| When borrowers prepay their mortgage loans at rates that are faster than expected, the result is that our MBS are prepaid faster than expected |
| These accelerated prepayments may adversely affect the performance of our business |
| Prepayment rates generally increase when interest rates fall and decrease when interest rates rise, but changes in prepayment rates are difficult to predict |
| Prepayment rates also may be affected by conditions in the housing and financial markets, general economic conditions and the relative interest rates on fixed-rate and adjustable-rate mortgage loans |
| When they were purchased, our MBS had a higher interest rate than the market interest rate at the time |
| In exchange for this higher interest rate, we paid a premium over the market value to acquire the security |
| In accordance with accounting rules, we amortize this premium on a level yield over the term of the MBS If the MBS is prepaid in whole or in part prior to its maturity date, however, we would be required to amortize all (or a corresponding portion, in the case of a partial prepayment) of the remaining unamortized premium |
| This accelerated amortization negatively impacts the yield on our MBS We could, however, reduce the potential negative impact of increased prepayments by acquiring MBS at a discount |
| In accordance with GAAP, we would recognize this discount on a level yield over the term of the MBS If a discounted security is prepaid in whole or in part prior to its maturity date, we will recognize income equal to the amount of the discount not previously recognized (or a portion of such remaining discount, in the case of a partial prepayment) |
| Consequently, the reported performance of our business would be enhanced if discounted securities are prepaid faster than expected |
| While we seek to minimize prepayment risk to the extent practical, in selecting investments we manage the prepayment risk against other risks and the potential returns of each investment |
| No strategy, however, can completely insulate us from prepayment risk |
| An increase in interest rates adversely affects the book value of our MBS Increases in the general level of interest rates may cause the fair market value of our assets to decline |
| Generally, hybrid adjustable-rate MBS (during the fixed-rate component of the mortgages underlying such securities), which comprised 100prca of our MBS at December 31, 2005, will be more negatively affected by such increases than traditional one-year adjustable-rate mortgage securities |
| In accordance with GAAP, we are required to reduce the carrying value of our MBS by the amount of any decrease in the fair value of our MBS compared to their respective amortized costs |
| If decreases in fair value occur, we are required by GAAP to either reduce current earnings or reduce stockholders’ equity without immediately affecting current earnings, depending on the accounting classification of the MBS and whether or not we believe the losses are temporary |
| In either case, our net book value decreases to the extent of any decreases in fair value |
| If we are unable to renew or obtain additional sufficient funding on favorable terms or at all, we could incur losses |
| We depend on borrowings, which to date have been short-term borrowings under repurchase agreements, to fund purchases of MBS in excess of our available cash |
| Our ability to satisfy commitments to purchase additional MBS depends on our ability to enter into repurchase agreements in sufficient amounts and on favorable terms |
| In addition, because repurchase agreements are short-term arrangements and MBS are long-term securities, we must be able to continually renew or replace outstanding repurchase agreements as they mature |
| We currently have repurchase arrangements with five lenders to provide financing for our purchases of MBS These arrangements are not commitments to lend money to us |
| If we are unable to obtain funds to satisfy our MBS purchase commitments, or if we are unable to renew or replace maturing borrowings on favorable terms or at all, our financial condition and results could be materially and adversely affected |
| We could be required to sell our MBS (or to sell forward purchase commitments prior to their settlement, or sell the underlying MBS at the time of settlement) under adverse market conditions, or for prices and on terms that are less favorable than those we might otherwise be able to secure |
| In such situations, we would be forced to sell investments at a loss |
| Our cash balances and cash flows may become limited relative to our cash needs and our borrowings could force us to sell assets under adverse market conditions |
| Our primary liquidity risk arises from financing long-maturity MBS with short-term borrowings |
| Because we have purchased certain of our MBS with borrowed funds, a decline in the market value of our investment securities, caused by rising interest rates or 11 ______________________________________________________________________ prepayments, may result in our lenders initiating margin calls |
| A margin call means that the lender requires us to pledge additional collateral to re-establish the ratio of the market value of the collateral to the amount of the borrowing |
| If we are unable to satisfy margin calls, our lenders may foreclose on our collateral |
| This could force sales of our MBS under adverse market conditions where the value of the collateral securing our borrowing is less than the amount owed to our lenders |
| In this case, we would be responsible for any deficiency between the value of the collateral and the amounts we borrowed |
| This would increase our liquidity needs |
| Additionally, repurchase agreements may qualify for special treatment under the Bankruptcy Code |
| This special treatment would allow the lenders under these agreements to avoid the automatic stay provisions of the Bankruptcy Code and to liquidate the collateral under these agreements without delay |
| Limitations on our ability to raise additional capital through sales of shares of our capital stock may restrict our ability to address liquidity needs through stock issuances and may limit our ability to expand our MBS portfolio by raising additional capital through such stock offerings |
| Because of limitations imposed by sections 382 and 383 of the Internal Revenue Code, which regulate our ability to use our accumulated net operating loss carryforwards and capital loss carryforwards in the future (as discussed below), there are limits on the number of additional shares of stock we can sell to raise additional capital |
| Accordingly, assuming market conditions would otherwise permit us to sell additional shares of our stock, this legal limit may prevent us from raising as much additional capital through sales of our stock as we might want or need at any particular time |
| We also may not be able to increase the size of our MBS portfolio as much or as rapidly as we would otherwise like, because of limits on our ability to raise additional cash through stock offerings |
| We may change our investment policies and guidelines without stockholder approval |
| Our Board of Directors, with the advice of our management and FinPro, determine all of our investment policies and guidelines |
| The Board of Directors may amend or revise these investment policies and guidelines at any time without notice to stockholders |
| Changes to the leverage ratio, types of securities included in our portfolio and changes to our risk management policies could adversely affect our financial condition, results of operations, or the market price of our common stock |
| Competition may increase and negatively impact our business |
| The success of our business depends, in large part, on our ability to acquire MBS at favorable spreads over borrowing costs, as well as our ability to sell MBS at favorable prices when necessary in response to changing market conditions |
| In acquiring and selling MBS, we compete against REITs, financial institutions, such as banks, savings and loans, life insurance companies and institutional investors such as mutual funds and pension funds |
| Many of these entities have greater financial resources than us and as a result, we may not be able to acquire sufficient MBS at favorable spreads over our borrowing costs |
| In addition, we may face competition for a limited number of buyers at a time when we are seeking to sell MBS, which could result in us receiving less favorable prices for MBS that we sell |
| Our investment advisor (FBR) may be one of these competitors, to the extent it seeks to sell MBS for its affiliate, which has a very large MBS portfolio and has committed to repositioning a portion of that portfolio |
| ” Existing competitors may grow, and new competition may enter the market over time, all of which can increase competition and could result in less favorable pricing and lower yields on assets |
| Defaults on the mortgage loans underlying our MBS may reduce the value of our investment portfolio and harm our results of operations |
| We bear the risk of any losses resulting from any defaults on the mortgage loans underlying the MBS in our investment portfolio |
| The MBS that we purchased are subject to guarantees of the payment of principal and interest on mortgage loans underlying such MBS, either by federal government agencies, including Ginnie Mae, or by federally-chartered corporations, including Fannie Mae and Freddie Mac |
| While Ginnie Mae’s obligations are backed by the full faith and credit of the United States, the obligations of Fannie Mae and Freddie Mac are solely their own |
| As a result, a substantial deterioration in the financial strength of Fannie Mae, Freddie Mac could increase our exposure to future delinquencies, defaults or credit losses on our holdings of Fannie Mae or Freddie Mac-backed MBS, and could harm our results of operations |
| In addition, while Freddie Mac guarantees the eventual payment of principal, it does not guarantee the timely payment thereof, and our results of operations may be harmed if borrowers are late or delinquent in their payments on mortgages underlying Freddie Mac-backed MBS Moreover, Fannie Mae, Freddie Mac, Ginnie Mae guarantees relate only to payments on the mortgages underlying such agency-backed or corporate-backed securities, and do not guarantee the market value of such MBS or the yields on such MBS As a result, we remain subject to interest rate risks; prepayment risks, extension risks and other risks associated with our investment in such MBS and may experience losses in our investment portfolio |
| A prolonged economic slow-down, a lengthy or severe recession or declining real estate values could harm our operations |
| The residential mortgage market has experienced considerable growth during the past ten years, with total outstanding US mortgage debt growing from approximately dlra4dtta4 trillion at the end of 1993 to approximately dlra8dtta2 trillion as of December 2005, according to the Bond Market Association and the Federal Reserve |
| If this growth cannot be sustained or we suffer an economic recession, the market for MBS may be adversely affected |
| Differences in timing of interest rate adjustments on our acquired securities and on our borrowings adversely affect our MBS business and the returns on the portion of our cash we invest in MBS We have relied primarily on short-term borrowings under repurchase agreements to acquire MBS with longer-term maturities |
| The interest rates on our short-term borrowings fluctuate monthly and carry interest rates that are based on prevailing short-term interest rates |
| Conversely, all of the MBS we have acquired are hybrid, adjustable-rate securities |
| This means that the interest rates on our MBS are initially fixed for a period of time, generally three years, subsequent to which they vary over time based upon changes in an objective index such as one year LIBOR or the one year Constant Maturity Treasury Rate, which generally reflect longer term interest rates |
| Accordingly, as short-term interest rates increase, it adversely affects our investment strategy and the returns on our capital |
| As interest rates increased during 2005, we experienced a negative interest spread which adversely affected our net interest income because the interest rates on our borrowings adjusted upward faster than the interest rates on our adjustable-rate securities |
| Interest rate caps could reduce the returns from our business |
| Adjustable-rate and hybrid adjustable-rate MBS are typically subject to periodic and lifetime interest rate caps |
| Periodic interest rate caps limit the amount an interest rate can increase during any given adjustment period |
| Lifetime interest rate caps limit the amount an interest rate can increase over the life of the security |
| Our borrowings are not subject to similar restrictions |
| Accordingly, in a period of rapidly increasing interest rates (such as over the last three quarters), we would experience a decrease in net income or experience a net loss from our MBS portfolio because increases in the interest rates on our borrowings will not be limited, while increases in the interest rates on our adjustable-rate securities would be capped |
| Hedging against interest rate exposure could adversely affect performance of our portfolio of MBS We may enter into derivative transactions and other hedging strategies, such as interest rate swaps and caps, options to purchase swaps and caps, financial futures contracts and options on futures that are intended to hedge our exposure to rising rates on funds borrowed to finance our investment securities |
| Interest rate hedging may fail to reduce exposure to interest rate and prepayment risks discussed in this “Risk Factors” section because, among other things: • interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates, and the cost of implementing the hedge may offset its potential benefit; • available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought; • the duration of the hedge may not match the duration of the related liability; and • the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs its ability to sell or assign its side of the hedging transaction |
| We are dependent on FBR to assist us in managing the portfolio of MBS Because we do not have experience in managing a leveraged portfolio of MBS, we are heavily dependent on the efforts and expertise of FBR If we were to lose FBR’s services, our ability to fulfill our objectives and continue our MBS business could be adversely affected |
| As of July 1, 2005, the initial one-year term of our agreement with FBR expired, and this agreement is now continuing on a month-to-month basis without a fixed term, subject to the right of either party to terminate the agreement with ninety days prior notice |
| During the term of the agreement, unanticipated changes in circumstances to us or FBR could result in FBR ceasing to provide services to us |
| Accordingly, we cannot assure you that FBR will continue to work with us |
| FBR has not indicated that it plans to terminate its contract with us or that the repositioning of FBR’s portfolio will have any impact on its ability to continue to manage our portfolio |
| If FBR were to terminate its agreement with us, however, it may be difficult for us, within a reasonable period of time, to replace FBR with another firm having comparable expertise and offering comparable financial terms |
| FBR manages a multi-billion dollar portfolio of MBS for an affiliate using a strategy very similar ours |
| On December 21, 2005, an affiliate of FBR announced that it will reposition its MBS portfolio and sell some portion of its existing portfolio beginning in the first 13 ______________________________________________________________________ quarter of 2006 |
| FBR may face potential conflicts of interest, including the allocation of opportunities to sell MBS at favorable prices |
| We may seek to sell MBS in response to unfavorable market conditions at a time when many other MBS investors (including FBR) are seeking to sell |
| FBR has no obligation to resolve in our favor conflicts of interest that may arise in connection with competing portfolios |
| Employees of FBR will only devote the time and attention to our MBS that they deem necessary in their discretion, and there may be conflicts in allocating time, services and functions between our portfolio and other portfolios that FBR manages |
| The failure of employees of FBR to devote adequate time and attention to our MBS strategy could adversely affect the performance of our business |
| FBR’s past performance or the performance of other companies that invest in MBS may not be indicative of how our MBS portfolio will perform |
| The operations and results of any business with which FBR or its related companies have been or are associated or of any other company that follows a strategy similar to the one we are involved in are not intended to be, and should not be considered as, any indication of the likely future performance of our leveraged portfolio of MBS The performance of our MBS portfolio may be affected by changes in market conditions, prepayment rates, availability of financing and interest rates, which are outside of our control or the control of FBR In addition, other companies employing a strategy similar to the one we are pursuing may have different investment policies or greater financial resources than we have |
| Therefore, the past performance of FBR or other companies that use a strategy similar to ours is no guarantee, and may not be indicative, of the future performance of our portfolio of MBS 16 |
| Changes in our business strategy may adversely affect out MBS portfolio and near term earnings |
| We have used borrowed funds to purchase a portion of the securities in our MBS portfolio |
| If we change our overall business strategy at a time when we have outstanding borrowings, our current lenders may cease to renew such borrowings at maturity |
| This could force us to sell our MBS under adverse market conditions, which could result in additional losses |
| A new business strategy would be subject to new and additional risks |
| We also may experience transition expenses and the increase in operating costs as we implement a new strategy |
| Loss of Investment Company Act exemption would adversely affect us |
| In managing a leveraged portfolio of MBS, we rely on an exemption from the Investment Company Act of 1940 for companies that are engaged primarily in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate |
| Under the SEC staff’s current interpretation of that exemption, in order to meet the criteria for such exemption, we have to maintain at least 55prca of our assets in qualifying real estate interests, such as whole pool mortgage interests issued by FHLMC, FNMA or GNMA, and at least 25prca of our assets in other real estate related assets, such as non-whole pool MBS This 25prca minimum is reduced to the extent we invest more than 55prca of our assets in qualifying real estate interests |
| These requirements could limit our ability to purchase certain types of MBS that might otherwise be attractive, and these restrictions could result in a lower level of income from our portfolio |
| Changes in the Investment Company Act of 1940 or the rules there under, or in the SEC staff’s interpretation of the statute and rules, could force us to sell a substantial portion of our portfolio under potentially adverse market conditions |
| In addition, the use of leverage is a fundamental part of our MBS business |
| In the event we were required to register as an investment company under the Investment Company Act of 1940, our ability to use leverage and the returns on our equity capital would be substantially reduced, we would suffer additional regulatory costs and expenses and we would not be able to pursue our MBS business as described in this Report |
| We may not be able to realize value from our tax loss carryforwards |
| As of December 31, 2005, we had federal net operating loss carryforwards of approximately dlra777dtta8 million that expire between 2016 and 2025 |
| In addition, we had capital loss carryforwards of approximately dlra272dtta2 million that expire between 2006 and 2010 |
| In the event were to undergo an ownership change as defined in section 382 of the Internal Revenue Code, our net operating loss carryforwards and capital loss carryforwards generated prior to the ownership change would be subject to annual limitations, which could reduce, eliminate, or defer the utilization of these losses |
| Based upon a review of past changes in our ownership, as of December 31, 2005, we do not believe that we have experienced an ownership change (as defined under section 382) that would result in any limitation on our future ability to use these net operating loss and capital loss carryforwards |
| However, we can not assure you that the IRS or some other taxing authority may not disagree with our position and contend that we have already experienced such an ownership change, which would severely limit our ability to use our net operating loss carryforwards and capital loss carryforwards to 14 ______________________________________________________________________ offset future taxable income |
| Generally, an ownership change occurs if one or more stockholders, each of whom owns 5prca or more in value of a corporation’s stock, increase their aggregate percentage ownership by more than 50prca over the lowest percentage of stock owned by such stockholders at any time during the preceding three-year period |
| For example, if a single stockholder owning 10prca of our stock acquired an additional 50dtta1prca of our stock in a three-year period, a change of ownership would occur |
| Similarly, if ten persons, none of whom owned our stock, each acquired slightly over 5prca of our stock within a three-year period (so that such persons own, in the aggregate more than 50prca) an ownership change would occur |
| Ownership of stock is determined by certain constructive ownership rules which can attribute ownership of stock owned by entities (such as estates, trusts, corporations, and partnerships) to the ultimate indirect owner |
| For purposes of this rule, all holders who each own less than 5prca of a corporation’s stock are generally treated together as one (or, in certain cases, more than one) 5prca stockholder |
| Transactions in the public markets among stockholders owning less than 5prca of the equity securities generally are not included in the calculation |
| Special rules can result in the treatment of options (including warrants) or other similar interests as having been exercised if such treatment would result in an ownership change |
| Due to the importance of avoiding a future ownership change under the tax laws, we will be limited in our ability to issue additional stock in the future to provide capital for our business |
| We would only be able to issue such additional stock in a manner that would not cause an ownership change, for purposes of these rules, and thus, as discussed above, our ability to access the equity markets could be restricted, to some extent |
| We may not be able to use our tax loss carryforwards because we may not generate taxable income |
| The use of our net operating loss carryforwards is subject to uncertainty because it is dependent upon the amount of taxable income we generate |
| Similarly, the extent of our actual use of our capital loss carryforwards is also subject to uncertainty because their use depends on the amount of capital gains we generate |
| There can be no assurance that we will have sufficient taxable income (or capital gains) in future years to use the net operating loss carryforwards or capital loss carryfowards before they expire |
| This is especially true for our capital loss carryfowards, because they expire over a shorter period of time than our net operating loss carryforwards |
| The IRS could challenge the amount of our tax loss carryforwards |
| The amount of our net operating loss carryforwards and capital loss carryforwards has not been audited or otherwise validated by the IRS The IRS could challenge the amount of our net operating loss carryforwards and capital loss carryforwards, which could result in an increase in our liability for income taxes |
| In addition, calculating whether an ownership change has occurred is subject to uncertainty, both because of the complexity and ambiguity of section 382 and because of limitations on a publicly traded company’s knowledge as to the ownership of, and transactions in, its securities |
| Therefore, we cannot assure you that the calculation of the amount of our net loss carryforwards may not be changed as a result of a challenge by a governmental authority or our learning of new information about the ownership of, and transactions in, our securities |
| We expect to be subject to the alternative minimum tax and our net loss carryforwards would not offset that tax in its entirety |
| We do not plan to seek to qualify as a REIT under the Internal Revenue Code and we will therefore continue to be subject to state and federal income tax |
| However, as a result of our capital loss carryforwards and net operating loss carryforwards, we anticipate our federal income tax liability for the current fiscal year as well as for several years into the future to be substantially reduced |
| We do expect to be subject to the alternative minimum tax provisions of the Internal Revenue Code which limits the use of net operating loss carryforwards |
| These provisions would result, in effect, in 10prca of our alternative minimum taxable income being subject to the 20prca alternative minimum tax assessed on corporations |
| This amounts to a 2prca effective tax rate on our alternative minimum taxable income |
| The IRS may seek to impose the accumulated earnings tax on some or all of the taxable income we retain |
| As a component of our MBS investment strategy, we expect to retain all or a substantial portion of future earnings over the next several years to finance the development and growth of our business |
| As a result, we may not declare or pay any significant dividends on shares of our common stock for an extended period |
| If the IRS were to believe we were accumulating earnings beyond our reasonable business needs, the IRS could seek to impose an accumulated earnings tax, or AET, of 15prca on our accumulated taxable income |
| We do not believe that we will be subject to the AET due to various reasons, including the existence of our large deficit in accumulated earnings and profits |
| However, the IRS may disagree with us on this point, and the IRS may attempt to impose the AET on all or a portion of our taxable income |
| In such event, we would expect to challenge any attempt by the IRS to impose the AET on our business, but the outcome of such a challenge is uncertain |
| 15 ______________________________________________________________________ If we were to distribute our accumulated taxable income for each year to our stockholders as dividends, we would not be subject to the AET for the amounts so distributed, but would only be subject to the AET for the amount of earnings retained |
| If we were to pay dividends to stockholders out of current earnings, these dividends would, generally speaking, be eligible to be treated as “qualified dividends” for federal income tax purposes, taxed at the current maximum federal rate of 15prca, assuming that the recipient stockholder meets the various requirements under the Internal Revenue Code for such treatment |
| The maximum rate for qualified dividends is currently projected to increase to the maximum federal income tax rate applicable to ordinary income (currently 35prca) for tax years beginning after December 31, 2008 in accordance with the Jobs and Growth Tax Relief Reconciliation Act of 2003 |
| Possible changes in legislation could negatively affect our investments |
| Prospective investors should recognize that the present US federal income tax treatment of an investment in our stock may be modified by legislative, judicial or administrative action at any time, and that any such action may affect investments and commitments previously made |
| The rules dealing with US federal income taxation are constantly under review by persons involved in the legislative process and by the Internal Revenue Service and the US Treasury Department, resulting in revisions of regulations and revised interpretations of established concepts as well as statutory changes |
| Revisions in US federal tax laws and interpretations thereof could adversely affect the tax consequences of an investment in our stock and could impair our ability to use the tax benefits associated with our tax loss carryforwards |
| However, we are not aware of any proposed changes in the tax laws or regulations that would materially impact our ability to use our tax loss carryforwards |
| Limits on ownership of our common stock could have an adverse consequence to you and could limit your opportunity to receive a premium on our stock |
| As noted above, it is important that we avoid an ownership change under section 382 of the Internal Revenue Code, in order to retain the ability to use our net operating loss carryforwards and capital loss carryforwards to offset future income |
| This means that a potential buyer of our stock might be deterred from acquiring our common stock while we still have significant tax losses being carried forward, because such an acquisition might trigger an ownership change and severely impair our ability to use our tax losses against future income |
| Thus, this potential tax situation could have the effect of delaying, deferring or preventing a change in control and, therefore, could adversely affect our shareholders’ ability to realize a premium over the then prevailing market price for our common stock in connection with a change in control |
| On July 12, 2005, the stockholders of Aether Systems approved a holding company reorganization of Aether Systems in which each share of Aether Systems common stock was exchanged for one share of common stock of the Company and Aether Systems became a wholly-owned subsidiary of the Company |
| Shares of the Company contain certain transfer restrictions on the ownership of our common stock |
| Although these transfer restrictions are designed as a protective measure to avoid an ownership change, they may have the effect of impeding or discouraging a merger, tender offer or proxy contest, even if such a transaction may be favorable to the interests of some or all of our shareholders |
| This effect might prevent stockholders from realizing an opportunity to sell all or a portion of their common stock of the Company at a premium to the prevailing market price |
| We may be required to indemnify the purchasers of our EMS, Transportation and Mobile Government businesses |
| We may be required to indemnify Telecommunication System, Inc |
| (f/k/a Slingshot Acquisition Corporation) (“Geologic”) and/or BIO-key International Inc |
| (“BIO-key”) for certain breaches of representations and warranties and other covenants that we gave to TCS, Geologic and BIO-key with respect to the sales of the EMS, Transportation and Mobile Government businesses, respectively |
| Our indemnification liability to Geologic under the asset purchase agreement is limited to dlra10dtta0 million, other than in the case of fraud and with respect to a small number of specific representations, such as those relating to taxes owed for periods prior to the closing of the sale of the Transportation segment |
| In addition, we remain fully liable for any claims that may arise relating to our operation of the Transportation business prior to the date on which Geologic acquired that business from us |
| As previously disclosed, in the third quarter of 2005, Geologic notified us of, and we responded to, various indemnification claims for alleged breaches of representations and warranties under the asset purchase agreement pursuant to which we sold our Transportation business to Geologic |
| The parties have been unable to resolve their disagreement over Geologic’s claim for indemnification and on March 13, 2006, Geologic filed a lawsuit against the Company in the Supreme Court of the State of New York |
| Geologic’s claims primarily involve allegations that we did not fully disclose certain aspects of our Transportation business’ relationships with one of its major customers and two of its major suppliers that allegedly resulted in the devaluation of inventory and other adverse effects to the Transportation business after the sale |
| Geologic contends that it has suffered damages in excess of dlra30 million as a result of these alleged breaches |
| We believe that Geologic’s claims are without merit and intend to vigorously defend against them |
| However, we cannot predict the outcome of this litigation, and an adverse resolution of such claims could require us to make a significant cash payment to Geologic |
| In such event, we would record a charge against earnings, further increasing the loss on the sale of the Transportation segment |
| Most of the indemnification provisions relating to the sale of our EMS segment have now expired |
| Most of the indemnification provisions relating to the other two businesses will continue through the first quarter of 2006 |
| 16 ______________________________________________________________________ Our indemnification liability to BIO-key under the asset purchase agreement is limited to dlra2dtta0 million, other than in the case of fraud and with respect to a small number of specific representations, such as those relating to taxes owed for periods prior to the closing of the sale of the Mobile Government segment |
| We also remain fully liable for any claims that may arise relating to our operation of the Mobile Government business prior to the date on which BIO-key acquired that business from us |
| We have agreed to maintain certain credit support and performance assurance arrangements on behalf of BIO-key |
| Under a sales agreement with Hamilton County, Ohio, our potential liability is secured by a dlra7dtta9 million letter of credit to assure performance under the terms of that sales agreement |
| We also have been required to sublease (rather than assign) to BIO-key the Mobile Government leased facility in Marlborough, Massachusetts, and to keep in place a dlra749cmam000 letter of credit in favor of the landlord under the lease |
| On January 23, 2006, we entered into two agreements that amend the collateral security and credit arrangements originally entered into with BIO-key |
| In the agreements, if certain conditions are met, we agreed to release to BIO-key up to dlra1 million of cash collateral currently held by us and will have expanded rights relating to BIO-key’s dlra749cmam000 security deposit for the sublease by BIO-key of Massachusetts office space |
| For a further discussion of these matters involving Geologic and BIO-key, see Notes 14 and 17 of the notes to the Consolidated Financial Statements included in Item 8 of this Report |
| We may also be required to indemnify TCS under the asset purchase agreement for certain breaches of representations and warranties and other covenants that we gave to TCS with respect to the sale of our EMS segment |
| This liability is limited to dlra7dtta6 million, other than in the case of fraud and with respect to a small number of specific representations, such as those relating to taxes owed for periods prior to the closing of the sale of the EMS segment |
| In addition, we remain fully liable for any claims that may arise relating to our operation of the EMS business prior to the date on which TCS acquired that business from us, including any liability arising from our past sales of the blackberry devices manufactured by Research In Motion (“RIM”) |
| Recently, the US Court of Appeals ruled that RIM violated 16 patents owned by intellectual property holding company NTP, Inc |
| The case was remanded on February 24, 2006 to the District Court to determine whether or not RIM should be enjoined selling the violating products |
| It has been reported that the parties have since reached a settlement agreement |
| Other than our dispute with Geologic, we are not currently aware of any potential claims that we would expect to be significant |
| However, claims may arise in the future that could impose substantial liabilities on us |
| Other Risks of Our Business 1 |
| Our success in identifying and implementing strategic alternatives may impact our business |
| We may incur additional costs and expenses in evaluating and pursuing potential new business opportunities |
| There can be no assurance that we will locate a suitable business opportunity or that any transition of our business will be successful or enable us to utilize our loss carryforwards |
| Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses |
| Because we have a relatively small corporate staff, we rely heavily on outside professional advisers to assist us with the various governance and compliance obligations we have as a public company |
| As a result, our operating expenses in 2003, 2004, and 2005 include significant outside professional fees, and we expect to continue to incur such expenses in the future |
| These costs have included increased accounting related fees associated with preparing the attestation report on our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002 |
| These costs have offset a portion of the savings we realized through our expense reduction program |
| In addition, more recent, regulations and standards are subject to varying interpretations, as well as modifications by the SEC and the Nasdaq |
| The way in which these laws, regulations and standards are applied and implemented may change over time, which could result in even higher costs to address and implement revisions to compliance (including disclosure) and governance practices |
| We are committed to maintaining high standards of corporate governance and public disclosure |
| As a result, we intend to invest resources to comply with evolving laws, regulations and standards, and in addition to increased general and administrative expenses, this investment will require management to devote time and attention that will not be available for other matters |
| If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed and we could be exposed to potential liabilities |